Financial markets operate in a highly elaborate and complex environment. As such, governments have created regulatory bodies and regulations to ensure economic stability through a mechanism that provides oversight to detect and prevent activity that could damage markets and harm investors.
The Markets in Financial Instruments Directive (MiFID) came into force in the European Union (EU) in November 2007. MiFID replaced the Investment Services Directive that had been in place since 1993. As the foundation of the EU’s financial market regulations, MiFID was intended to make European financial markets more competitive by creating a single investment services market as well as provide greater protection for investors.
However, the global financial crisis that ensued later in 2008 as well as other significant financial events in later years revealed some key weaknesses in MiFID. For example, new trading platforms have been developed that operate outside of the regulatory regime. The European Commission (EC), which oversees EU legislation, understood the need to close the loopholes in MiFID and boost investor confidence by strengthening the existing regulations to address the current situation.
What is MiFID II?
Following a review of MiFID, the EC published a proposal for MiFID II in October 2011, which was then adopted by the EU Council in April 2014. From a high level perspective, MiFID II covers three main areas.
MiFID II further improves the competitive environment for financial instrument trading by establishing open access to the market for trading platforms. There are also new rules concerning high-frequency trading that will put in place a strict set of requirements on investment firms and trading venues. Another new requirement is that firms need to know what business they are in, what they are not in, and what business they would like to be in.
With MiFID II, there will be more rigorous requirements for reporting commodity derivatives trading, thus increasing the level of transparency. In addition, information regarding a trade must be recorded both before and after the transaction for a greater number of financial instruments than with MiFID in order to provide greater accountability. Also, shares and certain derivatives will be required to be traded only using regulated platforms rather than over the counter.
Investors and their capital are better protected under MiFID II through improved disclosure and transparency that is being introduced. Under a new best execution requirement, asset managers will have to clearly show how they are serving their clients in the best possible way, such as stating their policies, monitoring performance, and regularly reporting to clients. Much stronger reporting requirements for trading in financial instruments presents potentially less risk to investors, as securities trading firms are being held more accountable.
In order to implement the changes required by MiFID II, there is not a one-size-fits-all approach, as every firm will have to structure a program that addresses the challenges specific to their business. As a result of the difficulties being faced by both regulators and market participants, the EC announced in February 2016 that it would delay the implementation of MiFID II by 12 months to January 2018.
While regulators such as the UK Financial Conduct Authority (FCA) and industry associations are pleased with the EC announcement, they are also keenly aware that there is still much work yet to be done to meet the new deadline.
“Despite the delay, firms need to continue to press ahead with their implementation work,” said an FCA spokesperson. “There’s still a lot for them to do to be ready in time for the new implementation date.”
Paul Stanfield, Chief Executive of the Federation of European Independent Financial Advisers, agrees with the FCA’s assessment and adds that the extra time should be spent wisely.
“It would be dangerous if such businesses saw it as an opportunity to slow the pace of the changes that most of them need to make,” Stanfield said. “I feel that they should see it as a chance to more fully ensure that these developments are appropriate for the significantly different operating environment that will face them from 2018 onwards.”
Despite the implementation challenges for MiFID II, there are also potential opportunities for some companies. As the proposed regulations will place restrictions on how asset managers pay for investment research, they will be forced to take a hard look at their research budgets due to greater scrutiny. This could open the door to independent research companies that have until now been unable to access the multi-billion dollar equity research market that has been traditionally the exclusive domain of brokerage firms and investment banks.
“MiFID II aims to level the playing field in the equity market and to provide transparency so that investors can make more informed decisions,” said Jon Jones, President at Trulioo. “An effective MiFID II program involves a thorough review of existing regulatory technology solutions that provide a more strategic approach for addressing regulatory challenges.”
What challenges and opportunities do you see for financial markets as a result of MiFID II?