What lessons can be learned from the Merrill Lynch failure?

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What happened to MLI should lead to other regulated firms to question whether their reporting systems are sufficient. What will happen with the larger MiFIR and transaction reporting requirements and what lessons can be learned from the MLI failure?

What actually went wrong at MLI?

 

  • Representatives attended meetings of industry bodies which discuss preparations for compliance
  • Staff conducted gap analysis around the required fields
  • The project was not fully resourced until November 2013, seemingly waiting until it was confirmed implementation would not be delayed and leaving less than three months to conclude and test changes before requirements took effect and was not sufficient to fully address:
    • Late 2013 ESMA Q&A on ETD reporting requirements
    • Issues with the market leg of ETD transactions not being recorded separately led to a requirement for additional coding to generate a synthetic market side
    • There not being enough internal expertise requiring engagement of subject matter experts from outside the firm
    • Testing was done on a shorter timescale than normally required for this type of project and was done primarily by external project management and did not include front to back testing
  • In the 15 months following implementation no pro-active testing was undertaken and while some small sample testing was done in May and October 2015, no automated testing and no adequate accuracy and completeness testing was done until February 2016
  • Any testing done was performed by the persons responsible for the day to day operation of the reporting requirement and not dedicated testing personnel
    • Failures were under Article 9 of EMIR and Principle 3
    • Failing to make reports of details related to derivative contracts
    • Failing to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems

The FCA conducted the assessment of a penalty under the 5-step process:

 

  • Determined the appropriate basis of fine for the misreported or non-reported transactions was to attribute a value of £1.50 to each of the 68.5 million trades not reported
  • In considering the severity of the failures the FCA took into account that MLI did not profit or avoid any loss, that there was no loss to consumers, investors or other market users and no potentially significant effect on market confidence. While the breaches were multiple and serious, there was no evidence that they were committed intentionally. This resulted in a 30% reduction of the attributable value
  • However, in looking at the third step, the FCA considered the mitigating factors of bad data from the trade repository and MLI’s self-initiated remediation plan but found the aggravating factors of two previous final notices with respect to transaction reporting breaches of a similar nature and the fact that the FCA had communicated the importance of compliance in a number of ways. It concluded that a 60% increase was warranted principally because of MLI’s failure to achieve acceptable standards of transaction reporting despite previous Enforcement Action on this topic
  • The final fine was reduced by 30% to reflect the agreement MLI reached with the FCA at stage 1 in the process

What are the take away lessons and serious considerations for firms?

 

  • That the initial attribution of £1.50 per misreported or non-reported trades could be devastating to a small or medium sized firm
  • Whether they are complying with all of their transaction reporting obligations, both under EMIR and MiFID
  • Whether they have adequate oversight arrangements, which includes allocating the right amount or resources for changes impacting under MiFID II and MiFIR
  • Whether they have provided for timely, adequate and appropriate testing of their reporting systems
  • If they have faced enforcement action in relation to transaction reporting in the past, that the penalty for failing in the same area can lead to a substantial increase in the fine