RSS feedsThe markets in financial instruments directive, a key component of the EU’s financial services action plan, is set to have a significant impact on the financial services industry. That much is known but little about MiFID is so far clear.
New requirements are largely familiar to British firms. But as a recent KPMG-EIU survey into company’s preparedness for MiFID reveals, nearly 50% of board members and senior managers are unaware of its implications.
Level playing field
The intention is to ensure a more efficient operation of the capital markets, given the far-reaching changes that have taken place over the past decade. The aim is also to make sure there’s a consistent level of investor protection across Europe. While it is a laudable objective, many are questioning whether this level playing field is achievable?
Now that the EU legislative process is nearing completion of the level 2 requirements, the Financial Services Authority is facing the task of incorporating MiFID requirements into its own rules.
The regulator is taking this opportunity to move to its stated intention of greater principles based regulation (with less detailed prescriptive rules) in line with their focus on ‘better regulation’ and rule simplification. The EU legislation is tightly framed to try to ensure consistency across Europe and avoid so called ‘gold-plating’ of the rules in certain member states.
There is already considerable activity surrounding this new legislation, but is the financial services industry making a mountain out of a molehill, or are firms right to act now?
Winners and losers
The implementation date of 1 November 2007 sounds a comfortable way off, but given the implementation challenge facing some firms, this means they need to begin planning for implementation.
The FSA agrees firms should be preparing their responses to implementation now, rather than waiting for the regulator’s consultation papers due to be published during 2006.
The impact of the directive on firms could be significant depending on their business and operational model. Firms that fail to address this strategically and take advantage of the opportunities provided risk being on the losing side.
The impact differs significantly by industry segment and country but there is little doubt the equities market will be the most affected. The directive introduces new equity market participants in the form of multilateral trading facilities (similar to existing alternative trading systems) and systematic internalisers.
Firms executing client orders against their own account in certain ‘liquid’ shares will be required to meet MiFID’s systematic internaliser requirements – effectively acting as market makers, and with obligations around quoting prices and publishing details of trades.
This will have a significant impact in many European countries and opens the equity markets to greater competition. The opportunities and IT and other costs could be immense. In other areas, such as derivative trading, commodity derivatives (including credit derivatives and exotic derivatives) will be regulated across Europe for the first time.
Common ground
MiFID also introduces common investor protection requirements across the EU. Investment advice will now be fully regulated and firms will have to assess suitability of that advice to the client’s circumstances.
The directive sets out to achieve investor protection through two means: comprehensive information and disclosure requirements to clients; and the requirement to obtain ‘best execution’ for clients.
Although on the surface it may appear that some of the requirements mirror existing FSA rules, there are numerous subtle differences in how firms will be expected to interact with their customers, for example firms will be required to assess ‘appropriateness’ (different from suitability) in some circumstances and achieve the best possible result for clients (rather than the best price) for best execution.
MiFID adopts the UK position that senior management of firms, not regulators, are best placed to assess risks and design controls to manage those risks. The trade-off for less prescriptive, principle based rules on organisation, governance and controls is that senior management are held responsible for the governance structure and control environment in their firm.
Healthy competition
The directive sets out certain requirements in areas such as risk management, compliance, internal audit, managing conflicts of interest, outsourcing, investment research, inducements, client money and custody.
In attempting to ensure the integrity of the European financial markets, reporting
transactions to the regulator will enable national regulators to monitor the activities of regulated firms. MiFID may extend the obligations to report transactions in new instruments, such as commodity derivatives.
To encourage market integration and competition across Europe, MiFID further entrenches the concept of ‘home responsibility’ for regulation and adds measures to enhance the effectiveness of the European passport (the ability to provide services across Europe once authorised in one of the member states).
Firms and senior management need to consider the challenges the new legislation poses from a business perspective, analysing the potential strategic implications, the widespread operational consequences, the risks to the business and plan a comprehensive response.
Early preparation is essential for firms to take advantage of the greater transparency and openness of European financial markets in a post-MiFID world.
UNDER THE MICROSCOPE: MIFID EXPLAINED
The EU legislation is being introduced under the four stage Lamfalussy drafting process.
• Level 1 is the framework directive (approved in April 2004);
• Level 2 implements directive and regulation;
• Level 3 will be the legal and regulatory requirements set by the regulators in each of the member states; and
• Level 4 will be enforcement.
Implementation of MiFID is currently scheduled for November 2007. The Treasury and FSA plan to have national legislation in place by 31 January 2007. This deadline gives the FSA little time to consult on changes to its rules, and businesses even less time to consider how these changes can be implemented.
The FSA has said it will consult through four consultation papers on changes to its rules and guidance necessary to implement the directive’s requirements:
• Systems and Controls (May 2006) including organisational requirements for MiFID and the capital requirements directive
• Implementing MiFID for firms and markets (July 2006) including market transparency, transaction reporting, authorisation, permissions, passporting, enforcement and cooperation
• Reforming conduct of business regulation (October 2006) including conduct of business requirements and conduct of business simplification
• Marketing communications (October 2006) including wider changes from the FSA’s financial promotions review. In addition to the consultation papers, the FSA has committed to releasing the following informal documents:
• Best execution discussion paper (May 2006);
• Client classification information paper (June 2006)
• Approved persons regime consultation (Quarter 4, 2006)
Bernadine Reese is regulatory and compliance director at KPMG
For more go to www.fsa.gov.uk
