The potential impact of the Markets in Financial Instruments Directive (MIFID) is of such significance that all financial institutions engaged in the provision of investment services need to urgently assess the impact of the proposed requirements on their business.
What is MiFID?
The Markets in Financial Instruments Directive (MiFID) establishes Conduct of Business requirements for all investment services firms, regulated exchanges and Multilateral Trading facilities in EU Members States. It replaces the Investment Services Directive (ISD) which is the current basis upon which firms are able to passport between EU member States.
The key objective of MiFID is to develop a single, transparent European capital market which operates under a harmonised set of regulations, thus promoting the growth of cross-border trading and creating deeper more liquid markets.
The underlying aims of the Directive are to
- Improve transparency of price formation for equities
- Create a harmonised definition of best execution
- Require investment firms to make costs transparent and explicit to their clients.
- Improve the quality of client data and consequently client advice, giving investors better information and greater choice.
- Require all European investment businesses to establish independent compliance frameworks.
- Removal of the existing concentration rules for equities.
- Thorough conflict of interest assessment and management.
Which firms and what products will be impacted?
MiFID will have repercussions predominantly for Investment Firms, Regulated Markets and Multilateral Trading Facilities (MTFs), Investment Advisors, Commodity Derivative Brokers and Execution-only Brokers, Tied Agents (partially) and those Credit Institutions with securities businesses. The key products captured by the Directive include Transferable Securities, Money-market Instruments, Units in Collective Investment Undertakings, Financial Derivatives, Credit Derivatives, Commodity Derivatives and Financial Contracts for Differences.
What are the main areas of focus?
The MiFID requirements will affect many of the business functions within all EU investment firms. Some of the key changes are in the following areas:
- Pre-and Post-trade transparency for equities
- Customer agreements
- Client agreements
- Client classification
- Conflicts of interest
- Assessment of client suitability and appropriateness
- Provision of investment advice
- Information to clients
- Information about financial instruments
- Client assets (external audit verification required)
- Best Execution
- Organisational requirements including compliance and risk control
- Outsourcing of critical operational functions
- Record keeping
- Passporting rights
What are the key impacts for my client dealings and client assets?
Under MiFID, firms will need to reclassify their clients under the new definitions of retail, professional and eligible counterparties (although clients may “elect” to be classified differently). The quality of data kept by firms must be sufficient to demonstrate that the firm can effectively satisfy the revised suitability and appropriateness tests. The firm will also need to make certain that retail clients are provided with adequate information both in respect of the investment contract and ongoing products. The safeguarding of client assets will involve all firms having to review their procedures around client assets and these procedures will need to be signed off by external auditors. Finally, the provision of investment advice will be captured as a regulated activity under European law for the first time.
What are the key impacts for my trading business?
Investment firms will be required to demonstrate Best Execution based on price, costs, speed of execution, likelihood of execution and the quality of the “execution venue” – firms will now need to consider where they carry out trades and why and justify this to their clients. Client limit orders not immediately executed must be made public for implementation. ‘Systematic Internalises’ (i.e. firms that make over the counter markets using their own capital, and deal with customers off their own books) will be required to publish firm pre-trade prices on a continuous basis and post-trade prices “as soon as practicable” for liquid shares. The Directive also sets out the key standards for managing the aggregation and distribution of client orders, as well as other aspects of client order handling.
What are the key impacts for my governance and infrastructure?
Under the Directive, all firms will need to assess existing and possible conflicts of interest across their businesses and create controls where they do not already exist. Where firms outsource “critical operational functions”, they will need to establish a suitable control environment and processes. All firms caught under MiFID will be required to establish a “permanent and effective compliance function” with associated controls and procedures. The Directive requires firms to establish and implement “adequate risk management policies” and also requires the maintenance of an Internal Audit function to establish and implement an audit plan and monitor recommendations. The process for, and criteria around, transaction reporting will need to be reviewed so that the firm can meet MiFID requirements.
Is this purely a compliance issue?
Although the compliance department will be heavily involved in implementing the MiFID requirements, there is also likely to be a significant effect on firms’ IT systems, particularly for client data management and record keeping. Above all the involvement of senior management will be critical to the MIFID implementation project so that strategic opportunities during this period of change are identified and addressed.
Identify your stakeholders.
As a result of the complexity of the changes and the interdependency between IT architecture, procedures and compliance controls, getting the early involvement of stakeholders from all relevant areas of the business will be critical to achieving a fully integrated solution to the challenges presented by MiFID. The initial brief for stakeholders is to provide senior management with an assessment of the areas of the business that will be most affected and the way in which the current business model needs to be altered to meet the new requirements. This should result in the firm identifying the budget and resources that will be required for 2007 and an initial timetable.
How significant will the change be to the business overall?
Even with grandfathering or other transitional measures, MiFID presents enormous organisational challenges, affecting key areas of the business. It will also impact the way markets operate. Firms need to consider not only changes to their internal procedures and systems but also to the procedures by which, and the systems through which, they interface with the new market structure and other market participants.
What is the timetable for MiFID?
The 31 January 2007 is the date by which all member states and regulators had to introduce MiFID into their law and regulations. The Department of Finance transposed the Directive via Statutory Instrument No. 60 of 2007 on 16 th February 2007. 1 November 2007 is the final date by which all financial firms engaged in the provision of investment services must be MiFID compliant, and when the ISD will be repealed.
What should firms do next?
In order to determine which areas of the business will be most significantly affected by the changes, firms should be carrying out a gap analysis between the existing Ireland Conduct of Business requirements and the proposals in the Directive. This will allow senior management to understand which areas of the business will be most affected and therefore target resources most effectively. Many firms have established MiFID ‘drivers’ or steering groups to co-ordinate the process and report to the project sponsor at Board level.
The road ahead
MiFID should not be considered solely as a regulatory change, but needs to be understood in the wider context of a fundamental business change which will need to be embraced across the firm. It is only in this way that regulated investment firms will be able to make a successful transition into the new MiFID world, avoiding the pitfalls as well as taking advantage of those opportunities that may result from this process.
This is a critical change management process that will need to be driven from the highest management level and that will require training for a wide range of key staff across the business to certify that the firm continues to meet regulatory requirements.
