From MiFID I to MiFID II
What are the effects of change?
The second Markets in Financial Instruments Directive (“MiFID II”, the “Directive”) is fast approaching as the implementation deadline of January 2018 is less than 6 months away. Alongside the Directive, the Markets in Financial Instruments Regulation (“MiFIR”) has also been issued. Despite the imminent deadline, the impact to firms, both those licensed under MIFID I, but also on distributors, is still unclear in certain respects. Certain issues are still being clarified, although significant progress is being made, particularly with ESMA issuing regular clarifications.
The revision of the legislation sets out a number of clear objectives, focusing mainly on increased investor protection, governance requirements, amendments to remuneration, and strengthened supervision, while simultaneously increasing the scope of products and services that fall within the amended regulation. Each of these will impact licensed firms in different of ways.
Investor Protection, continuously at the top of law-makers agendas, is targeted directly and indirectly through a number of the amendments within MiFID II. Various provisions are included to ensure that licensed firms have proper procedures in place to ensure that all relevant information is disclosed to investors. The relevant details required to be communicated have increased, and include the full costs to customers for the provision of the service, broken down into significant detail. It also requires more in-depth suitability assessments, while increasing the range of investment products considered, together with additional pre- and post- trade information. Where investment advice is provided, disclosure must be made as to whether such was provided on an independent basis, with MiFID II setting out the criteria that constitutes independence, which have been enhanced from the previous regulation.
The legislation also introduces stricter requirements in terms of the conduct of business of MiFID firms specifically for communication, disclosure and transparency in favour of investors.
The stringent requirements over governance arrangements is also an enhancement to the protection of investors as attention has been placed on the suitability of the management body of investment firms, both in terms of their competence and experience for their respective roles, as well as their ability to commit to these while taking into account any other appointments. Specific members of management bodies and those undertaking the licensable activities of the investment firms will also face stricter controls in relation to remuneration, both of a variable and fixed nature. Such controls are being introduced as a measure to attempt to combat and manage conflicts of interests, while also looking to align the risk profile of the investors with that of key employees during the discharge of their day-to-day duties.
Governance matters are being viewed as fundamental to the proper protection of investors, and increasing accountability is also catered for within the regulation.
From an operational perspective, investment firms, as well as previously non-MIFID service providers, such as certain distributors, will need to assess whether the inclusion of the additional financial instruments being brought into the scope by MiFID II will impact their service offering. The extended provisions now cover all emission allowances, credit institutions’ structured deposits, specific packaged retail investment products (“PRIPs”) and the sale of financial instruments issued by the investment firm itself. These amendments have been introduced specifically to cater for those products which were seen to be falling under the radar under the previous directive. The definition of non-complex instruments has also been amended and now excludes, for example, structured undertakings for the collective investment of transferable securities (“UCITS”), thus making the appropriateness assessment mandatory for investment firms prior to the sale selling any structured UCITS.
Transaction reporting continues to be associated with regulatory risk and has been given its due significance within the updated legislation. Firstly, the legislative package introduces a new execution venue, i.e. the Organised Trading Facility (“OTF”). Non-equity instruments will be captured through OTFs thus encompassing operator and trading systems which previously fell outside of the scope of transaction reporting. The creation of this new venue will see reportable instruments being traded on Regulated Markets, OTFs and Multilateral Trading Facilities. On a separate note, the products which require reporting under MiFID II extends past the scope of the original directive, and includes almost all instruments which are traded on the aforementioned European venues, including non-EU derivatives which relate to an EU security. With 65 total data fields, compared with the 24 data fields previously included under the original directive, the content of the data to be reported now encompasses detailed data for both buyer and seller identification. This includes traders and decision makers, together with additional detailed information on the traded instruments, and a number of indicators that would place a trade in a specific context such as the use of waivers or short selling. MiFID firms will be required to have in place agreements with Approved Publication Arrangement (“APA”) firms for the publication of trade reports which will be submitted. APAs will require authorisation to be able to discharge these responsibilities.
Under MiFIR, the onus of the transaction reporting has shifted onto the counterparty who initiates the transaction, usually the buy-side investment firms, as investment firms are responsible for ensuring transaction reporting information for their firm is accurately undertaken and properly recorded. Therefore, reliance can no longer be placed on the executing party, as adequate oversight by each investment firm must be undertaken, and continuously monitored.
MIFID II is also seeking to increase transparency to investors, by ensuring the costs breakdown is provided to the end-user in its entirety. This will most likely result in MIFID firms limiting recourse to external research providers, since either investment services providers will have to absorb the costs incurred in obtaining such research themselves, or they will set-up research accounts on behalf of investors. This means that such fees will now be shown separately from trade execution costs.
However, the increased transparency that MIFID II brings about is not without its problems. The increase in information may serve to confuse investors who have previously not been subject to this level of detail, and may not have the expertise to decipher it. They may also incur further costs in order to understand the detail that will need to be provided to them. Additionally, under the PRIPS regulation, the parameters in relation to the disclosure of costs are significantly different in some respects, which may be a further cause for confusion that could also affect experienced users. Harmonisation of disclosure has not been achieved within the different directives, though future revisions will hopefully tackle this.
The cost of compliance with MIFID II will undoubtedly increase costs for investment services providers, in terms of the changes mentioned above. The improvements to governance, the increased transparency and disclosure requirements, together with the more onerous reporting obligations, will no doubt prove challenging, particularly for the small to medium players, common to our local market. The challenge going forward is definitely for these firms to make investors aware that the changes will benefit them most, and that by making the investment firms safer, they will be more attractive to investors, and increase investor safety and confidence.