Markets in Financial Instruments Directive 2014/65/EU (“MiFID II”)

Introduction

We will explain here the scope of MiFID II, update you on the approach we are taking in relation to the transposition and implementation of MiFID II and set out the expectations for firms in terms of their preparation for MiFID II.

We expect that all relevant institutions will carry out a detailed review of MiFID II and that they familiarise themselves with the provisions and changes that MiFID II will implement.

Background

Since the implementation of MiFID in 2007, the financial markets have changed significantly rendering MiFID ineffective. Events such as the financial crisis, the evolution of the financial markets, and the advances in the technology being used have exposed weaknesses in the functioning and transparency of financial markets. The implementation of MiFID II and Regulation (EU) No. 600/2014 (“MIFIR”) is intended to strengthen the weaknesses exposed in the current European legislation to ensure better functioning of financial markets and to strengthen investor protection in the European Union.

When does it apply?

On the 18th May 2016, the Permanent Representatives Committee (Coreper) approved, on behalf of the European Council, an agreement with the European Parliament to delay the transposition of MIFID II into national legislation by one year. Under the new approach agreed with the European Parliament the deadline for member states to transpose MIFID II into national legislation has now been set for the 3rd July 2017. The date of application of both MIFID II and MIFIR will be set for the 3rd January 2018.

Who does it apply to?

MiFID II and MIFIR will apply to the following institutions:

  • Investment firms;
  • Credit institutions when providing investment services and/or performing investment activities;
  • Market operators including any trading venues they operate;
  • All financial counterparties as defined in Article 2(8) of the European Markets Infrastructure Regulation (“EMIR”) and to all non-financial counterparties falling under Article 10(1)(b) of EMIR;
  • Central Counter Parties and persons with proprietary rights to benchmarks; and
  • Third-country firms providing investment services or activities within the European Union.

What are the main changes?

MiFID II and MIFIR will strengthen investor protection by improving organisational requirements for investment firms on topics such as client asset protection or product governance, and the role of management bodies.

MiFID II also strengthens conduct of business rules such as an extended scope for the appropriateness tests and improves the information to be provided to clients. Independent advice is now clearly distinguished from non-independent advice and limitations are imposed on the receipt of commissions (inducements).

MiFID II introduces a framework to deal with cross-selling practices (investment services offered together with another service or product as a part of package) in order to ensure that investors are properly informed and that these practices are not detrimental for them.

MIFIR, amongst other things, introduces harmonised powers and conditions for ESMA to prohibit or restrict the marketing and distribution of certain financial instruments in well-defined circumstances.

What are the main provisions?

The following is a summary of the main provisions introduced or changed by MiFID II and MIFIR:

Governance

Product governance – Product governance procedures are required for product manufacturers and distributors.

Inducements - Firms that provide advice on an independent basis or provide portfolio management are banned from accepting or receiving fees, commissions or any monetary benefits paid or provided by any third party in relation to the provision of the services to clients.

Regulatory Powers

Product intervention - MIFIR gives European Union and competent authorities new powers to temporarily or permanently prohibit or restrict the marketing, distribution or sale of certain financial instruments and structured deposits, financial activities and practices, in case of significant investor protection concern or a threat to financial stability or the orderly functioning and integrity of markets (subject to a number of legal conditions being fulfilled).

MiFID II introduces two types of trading obligations for different financial instrument classes:

  • Shares in the future have to be traded on a MiFID II multilateral venue or via a so-called systematic internaliser, except for a limited set of irregular or technical trades; and
  • Derivatives which are eligible for clearing under EMIR and pass a liquidity test have to be traded on one of the MiFID II multilateral venues only. This will move trading in these instruments onto well regulated platforms.

Furthermore, MiFID II introduces a new multilateral trading venue, the Organised Trading Facility, for non-equity instruments to trade on organised multilateral trading platforms.

Sanctions – MiFID II strengthens the existing regime to ensure effective and harmonised administrative sanctions. The use of criminal sanctions is framed so as to ensure the cooperation between authorities and the transparency of sanctions.

Conduct of Business

Telephone recordings and e-communications - Firms need to record relevant telephone conversations, face-to-face meetings and electronic communications relating to own accounts and client transactions. Clients must be notified that telephone conversations will be recorded. These records must be sufficient to establish the terms of any order placed by a client as well as to detect potential market abuse. Such records will need to be provided to the client on request.

Investment advice - Firms are required to inform their clients of the basis on which their advice is being provided and whether the investment firm provides the client with a periodic assessment of suitability. The competence and knowledge of individuals providing advice will need to be demonstrated to the competent authority.

Suitability and/or appropriateness - Firms providing investment advice or portfolio management have to provide suitable personal recommendations to their clients or have to make suitable investment decisions on behalf of their clients. Suitability has to be assessed against clients’ knowledge and experience, financial situation and investment objectives.

Cross-selling - MiFID II introduces requirements on firms offering an investment service together with another service or product as part of a package to inform clients whether it is possible to buy the different components separately, and to provide evidence on the costs and charges of each component parts as well as information about the risks involved in those component parts and in the package.

Information requirements on costs and charges - MiFID II strengthens information requirements on costs by requiring the information about all costs and charges, including costs and charges in connection with the investment service and the financial instrument, which are not caused by the occurrence of underlying market risk, to be aggregated to allow the client to understand the overall cost as well as the cumulative effect on return of the investment. Where the client so requests, an itemised breakdown shall be provided and where applicable, such information will be provided to the client on a regular basis, at least annually, during the life of the investment.

Best execution - MiFID II introduces several changes for investment firms executing client orders. The execution policy must be provided in sufficient detail and in clear, easy to understand language.

Systems and Controls

Safeguarding clients assets - Firms shall, when holding financial instruments and client money, make adequate arrangements to safeguard the ownership rights of clients, especially in the event of the investment firm’s insolvency, and to prevent the use of a client’s financial instruments on own account.

Trading

Increased equity market transparency – For the first time, MiFID II establishes a comprehensive set of transparency rules for non-equity instruments such as bonds, structured finance products, emission allowances and derivatives.

High-frequency trading – MiFID II will introduce controls for algorithmic trading activities, and in particular for firms using high frequency trading techniques, which have dramatically increased the speed of trading so as to limit any potential risks these activities may entail.

Enhanced consolidation and disclosure of trading data – Rules have also been introduced enhancing the effective consolidation and disclosure of trading data through the obligation for trading venues to make pre-trade and post-trade data available on a reasonable commercial basis and through the establishment of a consolidated tape mechanism for post-trade data. These rules are accompanied by the establishment of approved reporting mechanisms (AMRs) for trade reporting and approved publication arrangements (APAs) for publication of over the counter data.

Commodity derivatives markets – MiFID II provides for strengthened supervisory powers, and a harmonised position limits regime for commodity derivatives, to improve transparency, support orderly pricing and prevent market abuse.

Competition in trading and clearing – A new framework will improve conditions for competition in the trading and clearing of financial instruments. This is essential for the integration of efficient and safe EU capital markets.

Cross-Border Activity

Third country access – MiFID II establishes a harmonised regime, to grant third country firms access to European Union markets, which is based on an equivalence assessment of third-country jurisdictions by the European Commission. This only applies to the provision of cross-border investment services and activities provided to professional and eligible counterparties.

Regulation (EU) No 1286/2014 (“PRIIPs”) – Packaged retail and insurance based investment products (“PRIIP”)

PRIIP is a term used for certain financial products which may be sold to retail investors. Such products include investment funds (with exceptions, notably for UCITS at least initially), insurance-based investment products and structured term deposits.

PRIIPs defines a PRIIP manufacturer as the following:

  • any entity that manufactures PRIIPs;
  • any entity that makes changes to an existing PRIIP including, but not limited to, altering its risk and reward profile or the costs associated with an investment in a PRIIP.

PRIIPs has applied from the 31st December 2016. It lays down uniform rules on the format and content of the key information document to be drawn up by PRIIP manufacturers, and on the provision of the key information document to retail investors in order to enable retail investors to understand and compare the key features and risks of the PRIIP.

PRIIPs is complementary to measures on distribution in MiFID II, therefore, institutions must also familiarise themselves with PRIIPs to ensure compliance.

What do institutions need to do?

With the implementation date for MiFID II now set it is important that institutions develop a detailed gap analysis of anticipated shortfalls against the requirements of MiFID II as a basis for establishing their implementation plan.

The GFSC will be communicating with individual institutions in January 2016 regarding their MiFID II implementation plans.

Useful Links

More information can be found in the following ESMA and European Commission webpages: