In March this year, the FCA published near-final rules on MiFID II.
But what is MiFID II, and what do you need to do to comply?
Here we provide a quick guide to the Markets in Financial Instruments Directive II and pinpoint some of the key actions firms should take now.
What is MiFID II?
MiFID II builds on MiFID – the Markets in Financial Instruments Directive.
MiFID came into force in the UK in November 2007. It is EU legislation regulating firms that provide services to clients linked to ‘financial instruments’.
The legislation also regulates the venues where those instruments are traded.
Its aim was to increase competition and consumer protection in the financial services sector across the European Economic Area (EEA).
Why MiDID II?
Lessons learned from the financial crisis, along with a desire to strengthen investor protection, have led to the updating of the regulations.
MiFID II will introduce far more prescriptive requirements in many areas of product governance, covering the creation and distribution of financial products.
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
The legislation comes into effect on 3 January 2018 – a delay to the original implementation date of January 2017.
Who does it affect?
The Directive will impact:
- Trading venues
- Hedge fund managers
- Asset managers
- Global corporations in the financial services market
Geographically, although it is an EU regulation, the international scope of the financial markets means it will impact transactions worldwide.
Some of the big changes 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 MiFID II Guide.
How will the changes impact you?
The new rules will have significant implications for anyone working in the financial instruments market. They will affect your:
- Business and operating models
- Data processing and holding
The FCA, on its MiFID II web page says that ‘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’.
What are the headline changes?
MiFID II has far more prescriptive requirements around product governance.
Products are defined as:
- In terms of ‘manufacturing’ – financial instruments and structured deposits
- In terms of ‘distribution’ – financial instruments, structured deposits and investment services
One of the requirements is that:
‘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.’
This applies equally to retail and institutional investors. In other words, communications to professional investors will become ‘financial promotions’ and be regulated as such.
This is one of the most fundamental changes from the MiFID rules.
Informing 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, as well as decisions around the practicalities of managing the process. How will communications around this be managed? How much can you automate and what will need to be done manually?
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. Firms will need to work out how to ensure they are taking these steps, and exactly what they need to do to comply.
MiFID II significantly extends the scope of firms' reporting requirements.
Firms 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 component traded on these markets.
MiFID II also requires a significantly increased level of transaction information to be reported.
Again, you will need to work out how you will manage this reporting.
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.
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.
Aggregation of costs and charges
Under MiFID II, all costs and associated charges related to investment or ancillary services and financial instruments have to be disclosed to clients.
This encompasses a wider range of costs than the original MiFID requirements demanded.
What steps should firms take now?
The FCA, on its MiFID II web page says ‘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’.
Understanding the regulations and what they mean for you is the first step in complying.
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.