| Author: |
Cristina Muntean, Pavel Beran |
| Publication: |
Czech business weekly |
| Date: |
29. 10. 2007 |
| Strana: |
50 |
The European Commission’s (EC) Markets in Financial Instruments Directive (MiFID) should have been implemented this week in the Czech Republic. Instead, a postponement of MiFID for 2008 is leaving local investment firms confused, with no clear estimates of implementation costs.
Firms also face threats of being sued by foreign clients unhappy that they are not getting similar treatment on the Czech market as they do in other European Union member states that were quicker in adopting the directive. MiFID implementation costs could range from a few million to a few hundred million Czech crowns, depending on the size of the firm, said Pavel Beran, manager of the advisory services department with consultancy PricewaterhouseCoopers Èeská republika. The regulation will have to be applied by brokerages, banks, asset managers and any other types of investment companies across the 30 member states of the European Economic Area (EEA), which includes the EU-27 plus Iceland, Norway and Lichtenstein.
The new directive has three objectives—to complete the process of creating a single EU market for investment services; to respond to changes and innovations that have occurred in the securities markets; and to protect investors by making markets deeper, more competitive and more robust against fraud and abuse. But the client protection principle preached by the MiFiD could turn against investment firms. Clients might get annoyed by the high amount of private information disclosure requests, Beran said, increasing pressure on firms to communicate to clients the necessity of their requirements.
Costs will also go up, led by the necessity to redefine clients according to new categories such as professional, nonprofessional and eligible counterparties, and to keep detailed records on clients and deals. Pre-trade transparency requirements will grow for liquid shares and post-trade requirements for all listed shares.
Experts say that MiFID will essentially alter the market dynamics, changing the competitive landscape and increasing complexities for companies. Yet, the same issues that are perceived by some players as threats can become opportunities for other players. Beran said that the new rule might increase investment market consolidation, but there are no signs of it for the moment. Other opportunities and threats deal with a greater concentration on processes such as back-office operations or call-centers; increased outsourcing; increased competition with new entrants and strategic change. MiFID should bring more transparency on processes, but it is difficult to estimate its full impact, as long as Czech lawmakers do not communicate the new law more openly and as long as its implementation deadline still remains undefined, he said.
Q: When will the Czech Republic start to apply MiFID?
A: It is a hot question these days. There is a directive issued by the EC that says that all member states should have these MiFID standards in their national legislation. This incorporation into a national law should be done in such a way that there are no changes [compared to the original version]. Local states should implement it almost with the same wording as the EC issued. MiFID should be implemented in the Czech national law and applied starting Nov. 1, that is what the EC expects. The problem here—and in other EU member states as well—is that we have implemented all these requirements within our new Act on Capital Markets, however the new version is still sitting with Parliament. This new law is to be discussed in December in the lower chamber of the Parliament. If we are lucky and the lower chamber approves it, then it will go to the Senate, which will take another month and [by then it will be] January. Then it will take another month to send it to the president, another month till the president signs it and then another month to publish it in the official monitor Vìstník. We are talking about March or April as a date when we can have an actual valid law in accordance with MiFID. There is disharmony between the Czech Republic and the EC on this deadline.
Q: What caused this postponement?
A: There are a couple of factors, but probably the most important problem is the general implementation of EU legislation into local legislation. The EU does not allow for individual definition within the specific national law, for example, definition of security, investment services and so on. Therefore the implementation of MiFID will take a longer time than expected.
Q: What is the consequence of this postponement for Czech companies?
A: It is a little bit difficult for companies here. MiFID has a huge impact on brokerage companies, banks and so on. Many of our clients are asking us what they should do from Nov. 1. Should they start to behave as [if they were operating] under MiFID requirements or should they just ignore it and postpone their projects? Before it became obvious that MiFID would not become valid here from November, many companies started with its implementation because there are a lot of tasks involved. They started, but now they do not know if they should launch it or if they should wait. Based on the opinion of a couple of attorneys, Czech banks and companies here are not required to be compliant with MiFID as of Nov. 1. But there might be a problem because an international client can complain about not being treated [as if it was] under MiFID requirements in December, for example. Such clients could file a lawsuit if they feel that a Czech broker or bank did not treat them as they would have been treated if MiFID had been valid. Clients could therefore sue the Czech state—because the Czech state wasn’t able to implement the law—or sue the Czech company, which could later sue the Czech state. But this scenario is quite improbable based on attorneys’ opinions. Czech companies are not required to do anything before a law becomes valid in the Czech Republic. Anyway, many companies started this project months ago—they did not wait for the new law to be issued. Right now, many companies are almost ready to launch it; large banks or brokerages … are all waiting for the Czech law and will not probably do much for now.
Q: What is the probability of lawsuits against the Czech state?
A: Based on two opinions I read, the probability is very limited. There should be some kind of big claims for this to happen. MiFID is mainly about customer protection, about protecting clients of brokerage firms. So there is a possibility that a client might feel that he was not treated properly and maybe did not get the best deal as he expected and the way he was dealt with brought him some losses. But the general view is that suing could be quite complex and it should be a really big claim to make sense to file such a case. Nobody expects there would be such a problem. Right now, our market is really small and to have a big claim means that you have a big client, while these big clients are quite aware of what business they are doing and understand their counterparties. Besides, they usually have long-term relationships with their big counterparties such as banks. I would not expect these big fish to sue these big banks to try to leverage on the fact that there isn’t some Czech law in place. This would affect their relationships, and investment is about relationships. I would not expect such lawsuits.
Q: When could MiFID begin to be implemented, in realistic terms?
A: If you look at the MF Web page at the MiFID section, the last article is from April 2007. They don’t want to talk about it. If you look at the Czech National Bank (ÈNB), which is the regulator of this, there is only some basic information about the new law, but you cannot see any schedule anywhere. If I talk about the most optimistic schedule like April, this is something that no one says in public. April is a very optimistic and unofficial version. We also should not forget that in this new law that should be discussed in Parliament, there is a nine-month transition period when companies should get ready to start implementing it. This is natural because if you issue a new law, you should give companies time to implement it. The EC really does not like these nine months because now we are talking about being fully compliant with MiFID by the end of 2008, which is something different from what the EC expected at the beginning. The question is whether this optimistic scenario will be realized because there is potential that it won’t be. It is not just about taking the MiFID wording and putting it in a Czech law.
Q: How will the market look after the new law is in place?
A: Once MiFID is implemented, clients should expect to be treated very similarly across the EU. They should receive similar statements with similar content, they should expect to sign similar contracts and to be asked similar questions across Europe, which is in accordance with the whole EU harmonization effort, which is [the rationale] behind MiFID. But most of these clients are already dealing here; this is quite easy, as the world is a small place for investments.
Q: Is there any estimate of financial benefits clients will get from MiFID?
A: There are many estimates of costs for banks and brokerage firms, but I have not seen any expected financial benefits for clients. Honestly, I would not expect any financial benefits except that clients should feel better, more confident; it should increase the faith in the capital markets as they should be more transparent. It should also avoid some improper behavior of some brokerage firms. But in terms of money, I have not seen any study or heard about anything.
Q: When you say clients, are you speaking about both corporations and individual clients?
A: MiFID is a new thing. One of its requirements is to classify clients into three categories. There are professional clients, nonprofessional clients and eligible counterparties. There are strict definitions [for] professional and nonprofessional clients. If you imagine a large corporate company, you would immediately think that it is a professional client because it is large. But, as there are quite strict definitions of what these clients should look like and do, sometimes these big corporations can be considered as nonprofessional clients, which means that they will be treated in the same way as classical retail clients. I guess that for some of them it can be quite surprising what questions they are asked. There is a process called ‘know your customer’ so you can understand his financial situation, his needs, investment objectives and so on. After you complete this interview and questionnaire you should be able to assess what is the good investment strategy for him before you make any investment advice. This relates to the situation when a client wants some investment advice from you. If you call your broker and he tells you that for example [energy producer] ÈEZ shares are quite low today and you should go for it, this is investment advice. Brokerage firms have to be very careful because they most often provide investment advice and if they do, then they should do all these processes like knowing your customer. I guess that some clients such as corporations might not feel comfortable with being asked all these questions about their fortune, property, financial situation and so on. But it is not just about corporate clients. Right now we are developing a questionnaire for retail clients and there are questions such as what is their education, what is their annual salary, how much money do they have in fixed assets, or how many months do they have to work to earn what they are going to invest right now. Those questions are not prescribed by the EC, but they are considered as best practice. Some banks are worried that these questions might affect their business because some clients might not feel comfortable.
Q: For whom does it make sense to have all this information?
A: MiFID requires that the broker must know their customers and assess the customers’ understanding of financial products, their financial positions and objectives. To do that, an investment firm must file some evidence that they made an assessment.
So, they prepare some questionnaire.
This is a good practice that many banks accept right now. The EC does not say to ask for education, but this is one question you can ask to assess the client’s ability to consider investments.
You can imagine that in some cases it might not bring benefits for clients, but scare them a bit. The immediate answer from banks will probably be that if clients go to some other banks, they will be asked worse questions. It will be very sensitive for how brokers or banks explain the reasons for asking those questions. That is why banks do not want to be the first to launch these new products; they want to wait until it is compulsory.
Q: Is this information about clients available only for the broker or for the whole investment firm?
A: I believe that definitely this is just for the broker and someone else from the group, unless the client signs a disclosure form to approve sharing that information. There is a data protection act in place and we are talking about quite sensitive information. The banks and institutions have to invest a lot, and one of the investments is into systems to protect all this information. But besides communicating why this questionnaire is important, collecting information and storing it, there are a lot of further requirements. For example, the client classification: you must define the different types of processes for each type of clients. There are not only different types of clients, but they also have different levels of understanding of financial markets.
Even if you have the category of nonprofessional clients, you still have to distinguish between retail clients and institutional clients, then a physical person or corporate person that you also have to place in subgroups and so on. For this segment you should develop your own procedures and train people on how to deal with these clients. You can imagine the implementation costs. There is also the principle of best execution, which means that the investment institution should develop a policy to describe how individual types of deals are executed, which counterparty was used and why. Investment firms have to list all the products they do. For example, if we speak about Czech bonds, they are settled through the Prague Stock Exchange (PSE)—that is clear. But if they do foreign bonds, they are settled through local brokers. So, how do you select these brokers? When clients ask, you must be able to provide them with some kind of evidence that the deal was handled according to this best execution policy and the policy was based on some research. There is no fixed form of best execution or of what kind of information you have to provide, but the requirement is that you must be able to prove your best execution policy if requested by the regulator or client. Everything must have an algorithm behind it. This is another cost for companies. They have to redraft their contracts to include all these new conditions and when you have, for example, some 100,000 retail clients with whom you have to sit and sign new contracts, this can be quite expensive.
Q: What is the estimated cost to Czech banks or brokerages for MiFID implementation?
A: The costs of implementation estimated to be similar to costs of the recent Basel II implementation [concerning banking laws]. For example, for bank operations on the Czech marketplace the costs are estimated ranging from Kè 10 million to Kè 50 million, depending on the size and complexity of the individual bank. But even for small firms it is a question of millions of crowns. It is not just the implementation cost—there are also the IT costs for the data protection. All these changes will be reflected in companies’ budgets.
Q: Might these growing costs lead to more consolidation of Czech investment firms?
A: That is something I would expect, especially if you have small firms who cannot afford to invest so much, but until now, especially on the Czech market, I have no signs of it. I think that, while many big banks started to implement it already, many little firms think that in the meantime there is no law, there will be just some kind of MiFID, we will change some policies and that will be fine. I do not think they are aware of the huge impact [this will have] on their processing and, as a result, they assigned this implementation project to someone just sitting with the organization because they do not expect this new law to affect the entire organization.
Q: Will MiFID increase the activity of Czech brokers with foreign investors?
A: If some foreign investors want to invest with a Czech investment firm and right now they see that this firm is not MiFID compliant, this might be a barrier. As soon as local firms start to apply MiFID, and foreign investors learn that they will receive the same type of treatment as their domestic brokers, it will be easier for their decision making. It definitely may help to increase the activity of foreign investors on the Czech market.
Q: Will MiFID bring more transparency to the European capital market?
A: It should. That is its objective. MiFID contains one stream about pre-trade and post-trade transparency. It is about increased and improved, standardized reporting of all transactions done on all markets. Right now, there are many transactions done over the stock exchanges. That’s fine, but there are also so many between two counterparties without any intermediaries or publishing, and all these transactions have to be reported somehow. MiFID is quite strong in these terms. These facts, together with the best execution policy, should definitely increase the transparency of how deals are executed.
Q: Does MiFID apply to investment firms that aren’t located in Europe?
A: It does if they are operating here and working with EU partners. For example, a bank in Honk Kong that has branches in the EU will have to follow this rule if they want to do business in this market. If Czech people come to its local branch and try to buy some shares and if this is settled through a Hong Kong broker, this broker has to be able to prove that the deal was executed according to their best execution policy. It isn’t that everybody around the world must start to implement something right now, but these brokers should have some evidence that their processes are under control. The whole responsibility lies with the local branches because these branches guarantee clients that the deal was settled and reported in the best way.
Q: Could this reduce trade between European clients and investment firms outside the MiFID coverage?
A: I think nobody believes in any real impact on [trade volume]. When you look at the system, someone might say that it would be tempting to do more business with European firms. That might be one of the effects if a client does not trust non-EU players, he would prefer to do business with someone here rather than outside the EU. But the question is why do I do business with this foreign broker? It might be because I would like to buy some shares in Kazakhstan—if I want this, then I have to go there.
Q: Will there be risks for Czech investors after MiFID implementation across the EU?
A: There will be an increased faith of Czech clients in foreign players. If Czech clients know that a German investment company is MiFID compliant, then they should expect the same type of service and the faith should increase.
Q: Will it be the same if the investment firm is coming from one the new member states such as Bulgaria or Romania as from Western Europe?
A: It should. Right now if you say a ‘Bulgarian broker,’ you mean someone who is acting on a market that is now emerging and probably suffering from all the diseases we had a few years ago. I think those companies can leverage a lot on this MiFID implementation. If you are considering Eastern Europe, that might be a challenge and an opportunity for them.
Q: Will transparency increase for all types of investment services, for example for hedge funds?
A: Hedge funds are a current topic because the amount of money going there is increasing, and it looks that it is not really under control. I do not think MiFID will increase transparency for what is inside of these funds. MiFID will increase transparency in how to buy hedge funds, in how to process the purchase, but not in what is inside. It is the same as if we expected MiFID to increase faith in ÈEZ or [telecom firm] Telefónica [O2 Czech Republic] shares. MiFID does not say anything about what fund managers should present to the market, it is not about presenting the financial results on a monthly basis, it is about the processes on how to purchase and sell these shares. MiFID puts requirements on processes, not on the companies that issue these shares.
