The Markets in Financial Instruments Directive (MiFID II) is regarded as one of the most significant and far reaching regulatory initiatives undertaken since the economic crisis of 2008 and the last ten years.
In 2009, when the G20 committed to manage the risk associated with OTC derivatives trades, the European response was European Market Infrastructure Regulation “EMIR” (into effect as of August 16, 2012) and MiFID II. Eight years on, it’s pretty reasonable to ask – are we there yet?
MiFID II was originally scheduled to come into place as off January 2017. Due to concerns over the tight timeframe to implement the directive, its complexity and the necessity to build IT infrastructure systems, the implementation date was delayed a further year to January 3, 2018. Where previous regulatory changes often had a phase in period, MiFID II is a kind of ‘big bang’.
MiFID II is going to impact the overall business. From transaction reporting, product governance, general inducement rule and unbundling of research to best execution and market infrastructure, its aim is to reshape the European capital markets. The impact will be felt way beyond Europe. For example, third country firms providing investment services or activities in the EU will have to submit transaction reports to the regulator which authorised them.
What are some of the key challenges companies are and have been facing when implementing MiFID II?
The financial services industry is known for its legacy systems and challenges it faces in handling the multitude of data needed to comply with the requirements of MiFID II. Fit for purpose IT systems are easier said than done. This very thing has already caused significant headaches for many companies even for what is considered to be the “simplest” increase of client reporting with now 65 data fields instead of previously 29. It is not only the increase of data which is a challenge, but equally the correctness of data when extrapolated from legacy systems or in general.
Adequate oversight and governance
According to Don Scott, Director, KPMG Regulatory Advisory Services in the recently published report ‘MiFID II The Time To Act Is Now’, “industry practice will continue to change until a market standard has evolved”.
But MiFID II has far reaching oversight and governance changes. Within the product management cycle, manufacturers and distributors become both responsible for ensuring that investment products are distributed to a target market of end clients. This does not stop with the design, development and launch of a product but needs continuous oversight throughout the life cycle of a product. The responsibility lies with the manufacturer as well as the distributor to prove products are and have been distributed to the target market. Equally they need to prove clients remain fitting the target audience and this is achieved through ongoing verification of the suitability of the clients profile.
Equally, the responsibility of companies for showing they have adhered to “best execution” of trades has changed from taking “reasonable steps“ to “all sufficient steps”. This previously applied to equity asset classes and has now been extended to non-equity asset classes combined with a significant reporting obligation on where these trades have been executed. Clearly this will bring significant challenges for companies to show and “evidence” their compliance, not on a trade by trade basis, but through a robust set up of processes, procedures and governance over it. A 2016 asset management market study by the FCA has highlighted that investment managers are still failing to ensure effective oversight of best execution.
Accountability and conduct
This is most felt through the inducement rule and the unbundling of investment research and execution. Some EU countries already banned commission payments for retail clients (UK, Retail Distribution Review) with MiFID II making this more generally prohibited across the EU to avoid conflicts of interest.
The unbundling of investment research and execution aligns very much with the rule of “best execution” of trades and sets clear rules for when investment firms use “broker commission” to pay for research. Ultimately it is up to the investment firm to show that the research which is being paid for from broker commission is to the benefit of the investor.
Creating transparency of the overall financial market aims to better understand, from a macro point of view, the risk(s) that investment markets in general pose to the stability of the financial markets and as such better protect investors. Reporting requirements are increased and broadened significantly and the capital markets playing field is made more balanced by bringing more asset classes and instruments within a regulated market environment as well as tightening the rules around it.
So are we there yet?
While this weighty agenda has been with us now for some time, the implementation date of January 3, 2018 is clearly not the end date of MiFID II.
The rules will continue to be interpreted and understood and therefore develop and evolve. Looking back at MiFID I – which came in to play in April 30, 2004 and into national law as of January 31, 2007 – it’s fair to say there have been ongoing developments ever since. MiFID II and its outcomes will therefore very likely also impact companies and markets alike and remain on our collective agendas over the next five to ten years.