The original MiFID regulation implemented in the wake of the Financial Crisis in 2007 was designed as a way of increasing competition in each of the member states of the European Economic Area, and also to increase protection of consumers in the investment industry after the Investment Services Directive (ISD) was deemed out of date.
The legislation brought in the concept of “maximum harmonization” in addition to retaining the EU passport principle from the ISD, which aimed to level the playing field for financial firms operating in the Eurpoean Union.
This was partly achieved by allowing member countries to supervise their own domestic financial institutions, and to provide the EU passport allowing them to operate throughout the European Economic Area (rather than having a few selected countries which had the power to award this golden standard to institutions in other countries).
In addition to the EU passport, consumers were given additional protection by MiFID by categorising their suitability for each investment products.
By categorising either as “eligible counterparty”, “professional client”, or “retail client”, a financial institution can provide the correct amount of protection on this.
The protection aims to help calibrate appropriate levels of consumer advice, or by offering suitable financial transactions with a view to execute the best possible trade for the client.
While MiFID was a great step in the right direction for firm competitiveness and consumer protection in the EU, Steven Maijoor of the European Securities and Markets Authority (ESMA) begun a consultative process to provide even greater protection to consumers, and to increase transparency for the structure of the financial markets in Europe.
This greater protection was the MiFID II regulation.
What is MiFID II?
The MiFID II directive actually comprises of two parts; the MiFID II Level 1, and the “Markets in Financial Instruments Regulation (MiFIR) containing over 100 requirements which had to be adhered to by the implementation date of 3rd of January 2017.
As the blog post is to provide a brief overview, I will not be covering each individual point, instead focusing on what I believe are the key elements of the regulation.
MiFID II: Organised Trading Facility (OTF)
The first important requirement is the creation of the Organised Trading Facility (OTF).
This was designed to be applied to those trading venues which were not authorized as Multilateral Trading Facilities (MTFs) outlined in the previous MiFID regulation.
These were defined as systems allowing the exchange of securities (particularly those without official markets) between eligible market participants.
The key differences between the original MTF and the new OTF, is that the new facility will allow matched principal trading in bonds, emission allowances (not previously a designated financial instrument), derivatives and structured finance products not subject to mandatory clearing, while also being ordered to comply with additional investor protection obligations (similar to the requirement of MiFID to protect consumers based on their categorization) where MTFs do not have to comply.
MiFID II: Market Maker Process Enhancements
Another change targets the high-frequency and algorithmic trading activities of investment firms.
Under the MiFID II rules, firms will have to enhance their systems & processes, in addition to controls (which are fully tested) needing to provide continuous and adequate monitoring of risks.
Where a firm is designated as a market maker, there are additional requirements which state that market making activities need to be provided during the trading venue’s operating times so that there is a stable and predictable flow of liquidity to the trading venue.
MiFID II: Client Categorisation
With relation to the categorisation of clients into the “eligible counterparty”, “professional client”, or “retail client” bands, MiFID II aims to go a step further by clarifying where there could have been any misunderstanding over the previous requirements outlined in the previous MiFID rules.
This expansion of the recommendations would clarify additional responsibilities such as the firm’s responsibility not only to provide investment advice to buy financial instruments, but also for any other aspect of their financial relationship. It also defines that the firm should be the one to carry out the suitability assessment of the individual (rather than an external entity).
Furthermore, as has been demonstrated by the recent scandals where banks have mis-sold products, rigged LIBOR or not identified tax evasion in their firm; the integrity and honesty of management in financial investment firms has been called into question.
MiFID II wants to ensure that members of the management for an institution must have the required skillset to take the position, while also limiting the number of new hires that can be brought in during a certain time period into these positions of power.
MiFID II: Increased Firm Accountability
Any malpractice by a firm will see its management body held entirely accountable to ensure the effective management of the firm going forward.
To further define the importance of management accountability, additional guidelines have been put in place to redefine remuneration rules making sure that performance is linked to pay even more than before (where running the institution with integrity and honesty is aligned with the incentives of its management).
While the points I have covered is by no means a comprehensive coverage of the MiFID II, it demonstrates the clear objective of ESMA to keep up with the various technological developments in the market since the inception of MiFID in 2007, particularly to retain a level playing field between all EU based financial institutions.
For further reading, the relative papers relating to MiFID II and MiFIR are attached here.