Find out what MiFID II is, how it will work and how companies can ensure compliance.
The Markets in Financial Instruments Directive II (MiFID II) is a new EU regulation coming in January 2018. If your business operates in the financial and investment sector, it’s almost certainly going to affect the way you work. The changes range from which products are now covered by the directive, how you deal with other companies, and the way in which you handle day-to-day communication with your customers.
MiFID II is primarily aimed at expanding transparency requirements for the industry. The original MiFID regulation, introduced in 2004, was part of the European Commission’s Financial Services Action Plan and was regarded as a major shake-up of the way financial markets within Europe operated.
MiFID set out the way investment firms conducted their business and which organisational requirements were needed for these firms to operate correctly. It also outlined authorisation requirements for regulated financial markets, the reporting needed for regulators to avoid market abuse, the need for trade transparency in buying and selling shares, and the guidelines for requirements for financial instruments to allow them to be traded in the first place.
MiFID II builds on existing foundations and is designed to reflect changes in the trading environment since the initial directive was introduced. In addition, it is designed to improve the functioning of financial markets, aiming to make them more efficient, more resilient and more transparent in the wake of the 2009 global financial crisis.
What is MiFID II?
MiFID II does a number of different things. Where MiFID was aimed largely at the equities market (the buying and selling of company shares), the new regulation also brings the majority of non-equity investment products into a regulatory regime of more robust proportions. It is also set to move a large part of Over the Counter (OTC) trading onto platforms which are regulated in order to bring it into line with the rest of the market.
Overall, MiFID II aims to introduce markets that are fairer, safer and more efficient. This will have the effect of bringing some firms under the umbrella of MiFID even if their primary business isn’t financial.
It will achieve this by using tests to determine if a non-financial firm’s investment activities – in particular, speculative activity – are so great that it should be subject to the Mifid regulations. Therefore, if such businesses are involved in investments in some way, even if it is not the main focus, they will need to take time to understand whether this new legislation is going to affect them and what they need to do in order to comply.
MiFID II introduces a new EU-wide limits regime for commodity derivatives, along with rules relating to high-frequency trading. These will impose stricter sets of prerequisites on both investment firms and on trading venues such as exchanges.
These provisions will help ensure that companies aren’t subject to discrimination when accessing trading venues and central resources in order to promote greater competition. Exchanges and other trading venues will also need to make any disaggregated data available and this needs to be done on a commercial basis that’s reasonable.
MiFID II also seeks to promote greater transparency, achieving this in a number of ways including through use of thresholds for both pre-trade and post-trade transparency regimes. These will be extended beyond equities to cover other investments including bonds, structured finance products, derivatives and products such as carbon emission allowances.
As part of this, non-equity investments will be subjected to a new liquidity assessment. Plus, there will be an obligation for shares and some types of derivatives meaning that the trading thereof will be limited to regulated platforms. In the case of OTC transactions, this means that they will have to use a regulated platform. There is also a cap mechanism aimed at limiting dark trading along with new reporting requirements for commodity derivatives.
When will it happen?
Though MiFID II is in some ways less drastic than its predecessor, it does have more of an impact on communication and IT systems which businesses are advised to prepare for. Indeed, it is likely to affect a number of areas of business operation including trading, transaction reporting, client services and back office functions such as information technology and human resources systems.
The original implementation date for MiFID II was set for January 2017. However, recognising the complexity of the changes required in order for companies to become compliant, the European Commission has now pushed this implementation date back to 3rd January 2018 to give businesses more time to prepare and to introduce the new systems that will be needed in order to comply with the rules.
The new regulatory framework is designed to take into account all of the developments that have taken place in the trading environment since the original MiFID directive came into force. In addition, it covers a broader range of investments and it widens the scope of which investment services need to have authorisation from national regulators in order to operate their businesses.
One of the major implications is the requirement for the recording of all telephone calls and SMS (text) messages between advisors and clients, with the data needing to be retained for five years. This has understandably caused some controversy within the industry.
The Association of Professional Financial Advisors (APFA) has described these measures as ‘disproportionate’. “The taping measures are intended to combat market abuse and make sense in the context of trading conditions, where timing is crucial to the outcome and you need to know who said what and when,” says APFA Director General Chris Hannant, adding that “The proposals are disproportionate in an advisory context.” To read more from the APFA, click here.
For smaller firms offering financial advice, there are concerns that the cost of installing call recording technology could be crippling and could end up being passed on to customers. This seems to run contrary to the Financial Advice Market Review conducted jointly by the Treasury and the Financial Conduct Authority, the objectives of which are to make financial advice more accessible to everyone. However, the FCA has said that technology now exists to allow advisers to record and store calls effectively at low cost.
The FCA has produced a 524-page policy statement setting out how it sees businesses complying with the recording requirements of the new rules. The FCA’s general position is that while advisors won’t have to record face-to-face meetings with their clients, they will have to either record phone calls or provide a written note of them. Under the new directive, these calls are ones that involve, ‘the reception, transmission and execution of orders, or dealing on own account’.
As well as shaking up the way the industry works, MiFID II aims to offer improved investor protection. This will provide improved disclosure to make sure that trades are executed using the appropriate regime. It will also mean new standards for brokers and other firms involved in trading financial products to record their transactions with customers in more detail involving recording phone calls and SMS communications in certain circumstances and storing that information for a period of five years.
In the case of ‘independent’ financial advisors, a ‘sufficiently diverse’ view of the market will be required when offering advice to clients. The directive restricts inducements – such as fees or commissions – for independent advisors in order to ensure that they don’t affect the firm’s ability to treat customers fairly.
Companies that offer portfolio management services are similarly barred from accepting third-party inducements unless they are sufficiently minor that they don’t affect the way business is conducted, or enhance the service that’s being provided to the client. Interestingly, the provision of research may be seen as an inducement under MiFID, meaning that firms dealing in investments will need to pay for research either from their own resources or a specially constituted Research Payment Account (RPA).
How will it work?
MiFID II is made up of 27 different regulatory technical standards (RTS) along with a single implementing technical standard (ITS). The technical standards are directly applicable in all of the EU member states and are legally binding. This will certainly apply to the UK since Brexit won’t have taken effect before the current implementation date.
When the 27 regulatory technical standards come into force, they will automatically become part of a member state’s national law with no implementation required. It’s therefore important that businesses understand the importance of these regulations and what is going to be needed to implement them.
What is involved in doing this shouldn’t be underestimated; it’s a major task. The technical standards alone comprise 553 pages. In addition, the European Securities and Markets Authority’s (ESMA) final report, and the accompanying cost benefit analysis are 402 and 577 pages respectively.
The ESMA has made it clear that this introduction is a move towards the creation of one, single EU-wide rulebook for financial services that will ultimately lead to a harmonised regime of regulations for investment services across the European Economic Area (EEA). Again, UK companies need to take note as it’s quite possible that the UK will remain in the EEA after Brexit on a so-called ‘Norway model’.
For companies operating in the financial services arena, the new regulation represents a significant change. The requirement to record communications applies where there is an ‘intention to conclude a transaction’, or where products are being ‘recommended’. This will affect different parts of the financial industry in different ways, but it’s generally safe to assume that the majority – if not all – of client conversations will need to be recorded and stored.
Recording calls made via a landline-based telephone system isn’t particularly difficult; the facility may well be built into existing PABX systems. However, things get more complicated where mobile phones are used as the main means of communication. This is increasingly the case where workforces are mobile, particularly in the financial sector where advisors may spend much of their time away from the office visiting clients.
There are ways around this; cloud-based systems allow the recording of calls and also give access to additional facilities like IP and WiFi calling. Such systems make recordings available to administrators and compliance staff via a website portal so they can be accessed from anywhere.
However, it is important to note that recording the call itself is only part of the requirement. The record also needs to show the date and time of the call which can be captured automatically by the recording system. It also requires the location, the people taking part in the conversation and who initiated the call.
Finally, details of any transaction that takes place as a result of the call need recording too. The FCA’s recommendation, therefore, is that firms need to ‘capture all the main points of the full conversation that are relevant to the order’.
The FCA’s view is that calls also need to be recorded even where the order under discussion does not proceed. However, in the case of advice being given, the call does not need to be recorded unless it ‘leads to or is clearly intended to lead to a subsequent ‘order’ from the client.’