MiFID II – what do you need to be compliant?

Compliance-01

The near-final rules on MiFID II were published by the FCA in March this year.

Here we examine exactly what the regulation is, and what you need to do to be compliant.

What is MiFID II?

The Markets in Financial Instruments Directive II is legislation that builds on MiFID – the Markets in Financial Instruments Directive.

MiFID came into force in the UK in November 2007 and is an EU regulation for firms that provide services to clients linked to ‘financial instruments’.

The legislation also regulates the venues where those instruments are traded.

The original regulation was introduced to increase competition and consumer protection in the financial services sector across the European Economic Area (EEA).

Why do we now have MiFID II?

The regulation has been updated following the financial crisis, to reflect lessons learned around transparency and best practice. It also aims to strengthen investor protection.

Its high level goals are:

  • Increased transparency of markets
  • More structured trading marketplaces
  • Lower-cost market data
  • Improved best execution
  • Orderly trading behaviour within markets
  • Costs of trading and investing made more explicit

In many areas of product governance, MiFID II will introduce far more prescriptive requirements around the creation and distribution of financial products.

The legislation was originally slated to come into effect in January 2017, but was delayed. Firms now have until 3 January 2018 to ensure their processes and products comply.

Who does it affect?

The Directive will impact:

  • Brokers
  • Dealers
  • Trading venues
  • Hedge fund managers
  • Asset managers
  • Global corporations in the financial services market

And although it is an EU regulation, because the financial markets are international in scope, it will impact transactions and businesses worldwide.

MiFID and MiFID II - some key differences

There are several changes between the two regulations. These relate to:

  • client reporting – all clients now need to be informed if the value of their portfolio drops by 10%
  • best execution (the duty of an investment services firm, such as a stock broker, executing orders on behalf of customers to ensure the best execution possible for their customers' orders)
  • product governance
  • aggregation of costs and charges
  • marketing material for professional clients – which will now be treated as a financial promotions

Understanding these requirements and their implications is the key first step in preparing for MiFID II implementation. You can read more in our Guide to MiFID II – All you need to know about the Markets in Financial Instruments Directive.

How will MiFID II impact Compliance teams?

Because the new rules have implications for many areas of the business, they will mean significant work for Compliance teams.

As the FCA say on its website, ‘MiFID II is a wide-ranging piece of legislation and, depending on your business model, could affect a wide range of your firm’s functions – from trading, transaction reporting and client services to IT and HR systems’.

The changes required affect your:

  • Business and operating models
  • Data processing and holding
  • Systems
  • People
  • Processes

What is changing under MiFID II?

  • Product governance

Requirements around product governance are far more prescriptive under the new legislation.

Products are defined as:

  • In terms of ‘manufacturing’ – financial instruments and structured deposits
  • In terms of ‘distribution’ – financial instruments, structured deposits and investment services 
  • Communications to clients now count as financial promotions

This is one of the biggest changes from the existing rules, and one that will have a big impact on compliance. All communications to clients (including institutional investors) will now fall under the umbrella of ‘financial promotions’ and be regulated as such.

The FCA says:

‘All information, including marketing communications, addressed by the investment firm to clients or potential clients shall be fair, clear and not misleading. Marketing communications shall be clearly identifiable as such.’

  • Requirement to inform clients when portfolio value falls by 10%

Every time a client’s portfolio drops in value by 10% or more, they must be informed.

This requires accurate monitoring. It also requires communications processes that kick in when the value falls by 10% or more.

Your team and the business need to work together to decide how you will manage communications around this. Can you automate some of the process to make it easier and reduce the potential for compliance breaches?

  • The need for best execution

Best execution is the requirement for firms to ‘take all sufficient steps to obtain…the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to execution’.

The term ‘all sufficient steps’ is a higher legal standard than MiFID.

Again, you will need to work with your business leaders and operations teams to identify how you will manage this, and exactly what you need to do to comply.

  • Transaction reporting requirements extended

MiFID II increases the scope of firms' reporting requirements significantly.

You will have to report on nearly all instruments traded on regulated markets, Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTF), as well as on financial instruments whose underlying components are traded on these markets.

For each of these, more detailed transaction information needs to be reported than has previously been the case. 

Again, you will need to work out how you will manage this reporting.

  • Stricter archive/audit trail requirements

One of the regulations’ core requirements is around record keeping. They say that:

‘Firms must capture records, in context, across multiple channels from all approved devices. Content, not channel, is determinative.

Firms must not only accurately capture all communications, but these records must be ‘readily available for search, analysis and retrieval upon request from the local regulator’.

Having a process for creating a compliant audit trail of all marketing and sales communications is therefore vital. Our blog on best practice record keeping has more tips on this.

Initially, MiFID II proposed requiring all firms to record telephone conversations. This was relaxed in a policy statement released in March 2017, which gave firms more leeway over how they choose to comply with the audit trail requirements.

However, it is thought unlikely that firms’ current record-keeping processes will adequately fulfil the requirements, so firms will need to make some changes.

  • Aggregation of costs and charges

All costs and associated charges related to investment or ancillary services and financial instruments will have to be disclosed to clients under the new rules. 

This encompasses a wider range of costs than the original MiFID requirements.

What steps should firms take now?

MiFID II is becoming a staple topic in the media, with firms waking up to changes it demands.

The FCA has made it clear that ‘Firms will need to start planning for the MiFID II changes ahead of the finalisation of the EU implementing legislation and the subsequent changes that we and the PRA make to our Handbooks, and changes that HM Treasury makes to financial services legislation’.

Getting on the front foot regarding the requirements and the amendments you will need to make to processes, products and communications, is vital.

If you want more detail on the Directive and its implications for FCA-regulated firms, you can read our free Guide to MiFID II. The Guide is available to download for free from our website.

Nothing in this document should be treated as an authoritative statement of the law. Action should not be taken as a result of this document alone. We make no warranty and accept no responsibility for consequences arising from relying on this document.

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