Financial industry professionals and politicians continue to debate whether the MiFID II financial regulations should be scrapped once Britain leaves the European Union.
Some have argued that MiFID II was shaped around European needs and will shortly no longer affect Britain. However, this view severely understates the central role that Britain played in shaping MiFID II, which focused on the urgent need for regulation as the financial sector expanded into the digital world.
From its very inception in 2008, the predecessor, MiFID I, sought to restore public financial confidence after the crash of 2007. As the UK has just entered its first recession in eleven years, financial regulation, trust, and compliance are more important than ever.
MiFID II and synchronized time
Synchronized timing is one area of MiFID II which has been accepted by market participants as an essential method of improving data quality within an audit chain. Article 50 requires every server that is an active market participant to have a maximum divergence of between 100 microseconds or 1 millisecond (depending on the speed of the server’s trading activity) from the benchmark of UTC (Universal Time). This means application timestamps will be consistently reliable for audit purposes or reconstruction of events.
Without synchronized time clocks on servers will drift. If different clocks in a shared process drift by even small amounts, audit trails become chaotic. The timestamps become unreliable, sequence and interval in the logs cannot be trusted, and it becomes extremely difficult to track the enormous amount of digital data which is transferred every single second of the day.
More examples of the consequences of unsynchronized time are consistently emerging. How can the Bank of England ensure that nobody is profiting by arbitraging the delay of the video feed of the bank’s policy announcements versus the faster audio feed delivery, as happened recently? Or how should online gambling applications react when people sitting courtside at Wimbledon are seeking to arbitrage the latency between when a bet reaches an application gateway versus the slower delivery of television signals reaching a TV set?
The answer: they need to improve their timing synchronization across their processes, so that they can reconcile when an event happened in the real world and when an application recorded it. As applications become faster and more distributed, it is inevitable that latency differences emerge between the older applications and the new. However, if all the clocks in the process share the same, accurate time, the latencies will no longer be hidden and more difficult to exploit.
In 2018, MiFID II took decisive steps to resolve these problems in financial services. Its enforcement of firm rules on timing infrastructure has resulted in progressive technology innovation, meaning that it has never been easier, and cheaper, to ensure accurate time.
Companies wanting to install synchronized time no longer need to install individual grandmaster clocks exclusively for their own use. Instead, they can download highly accurate software that connects to trusted timing sources using their existing connectivity and effectively rent access to grandmaster clocks in the cloud as a subscription. This ultimately enables companies to execute existing obligations for less.
Hashing out MiFID II
Traceable timestamping has become an essential element of the post-MiFID world. Its possible application within hash ledgers and blockchain is a strong example of this.
Blockchain is currently heralded for its ability to provide a secure audit trail, as its use of hash ledgers ensures that any transaction is immutable. But often the hash chain still relies on unsynchronized clocks to provide the timestamps in the applications.
The addition of an accurate timestamp would provide precise information about when the event occurred. This means that Blockchain would gain an extra layer of protection and that any transactions that occur would be more easily traceable to a physical reference as a form of verification.
The benefit of this is highlighted through the automatic verification of sequence and interval in a process to aid in the resolution of trading disputes. Take the case of smart contracts: digital contracts which are programmed to self-execute when the pre-established conditions have been met. The use of hash ledgers in smart contracts means that the terms of the contract cannot be changed without all parties knowing. However, by insisting all parties in the process have accurate time and verified timestamps, you have an additional independent verification of the validity of the blockchain sequence.
We need global trust in financial services
MiFID II demanded that any digital financial transaction that occurs across EMEA must be traceable with precision timing and inventive new software has made it happen. Britain will need these strong financial regulations as its global trading presence shifts to become more independent in the coming months and business emerges from the triage phase of the pandemic crisis.
Firstly, maintaining the European standard of MiFID II ensures continued access to the EU’s trading bloc. In 2018, the EU launched the ‘Equivalence’ system, which stipulates that the access of British financial services firms to the bloc is dependent on whether British regulation continues to be as stringent as the European Union’s.
Secondly, any changes to MiFID II would only further shake public and investor trust in the market, which is vital to investor confidence. This was exemplified in early February when the sterling dropped significantly against the US dollar following a Bloomberg discussion about a MiFID “shake up” by the ESMA).
MiFID II has made the financial world a more accountable and reliable place. It promotes international trust in the data standards of financial services through its support of critical infrastructure such as timing resilience. Discussion of terminating MiFID alongside Brexit adds doubt about future standards and creates unnecessary risk for the British economy. We may wish to unilaterally control the standards under which we operate, but if we want to trade with others, we need to cooperate on regulatory matters so our partners trust our standards and market confidence is protected.
Simon Kenny, CEO, Hoptroff