I talked about investing in specific trackers when covering 5 thematic funds for the future. I now want to go a bit deeper into my top pick: investing in water.
2. MiFID II explained: How EU is trying to protect its investors
Post contents hide
5 What MiFID means for you as investor
Last Updated on September 22, 2020 by Mr. FightToFIRE
In this post, I’ll clarify MiFID (II) or Market in Financial Instruments Directive and Regulation (so not MiFID (II) Directive). I’ll answer the following questions:
- What is MiFID II?
- Why was MiFID II created?
- Who is MiFID II for?
- What impact does MiFID II have on (retail) investors?
What does MiFID II mean in simple terms?
MiFID stands for Market in Financial Instruments Directive. It’s a set of rules that aims to increases transparency across the European Union’s financial market.
The first version of MiFID implemented new measures, such as pre- and post-trade transparency requirements, and created rules of conduct for the EU’s financial firms. The first version of MiFID was primarily focused on Over The Counter (OTC) transactions.
You might think that MiFID was created after the 2008 financial crisis, but it actually came into effect prior to that. The EU did make changes in light of the crisis.
What MiFID does for you
Why was MiFID II created? To improve the rules
The issue of oversight and other issues found after the implementation were addressed with the introduction of MiFID II (2014/65/EU). This second version MiFID 2 got implemented at beginning of January 2018.
The first idea of a new version MiFID II started in 2014 by the European Commission, the European Parliament and the Council of the European Union. They agreed on a revision and a more extensive version of MiFID following the financial crisis.
By improving and widening the scope of the existing version, they wanted to create a more efficient and resilient European financial market and level the playing field within it. To give you an idea of how much has been added, the original MiFID has 73 articles vs. 97 for MiFID II. In addition, much of the trade reporting requirements were published in a separate document called, Markets in Financial Instruments Regulation (MiFIR). It has another 55 articles of its own.
Linked together: MiFID II and MiFIR
Like referenced above, besides MiFID 2, the trade reporting regulations got improved as well with the introduction of the Markets in Financial Instruments Regulation (MiFIR). While MiFIR was technically passed as its own regulation. It works in combination with MiFID II to extend the codes of conduct beyond shares to other types of assets, including contract-based assets and more advanced things like structured finance products. This is due to much of MiFIR’s content being an updated version of reporting rules that existed in the original 2004 MiFID document.
MiFID impacts all financial firms
Thanks to a broad overhaul of the first directive, MiFID II/MiFIR significantly increases the impact it has. Now it includes more companies: insurers, mutual funds, and banks for all their products.
The main focus of MiFID II/MiFIR is including but not limited to:
- Achieving greater exchange transparency through the introduction or strengthening of rules regarding pre- and post-trading information.
- Mandatory trading of derivatives on regulated exchanges. The introduction of position limits and reporting requirements for commodity derivatives, broadening the definition of an investment firm to capture firms trading commodity derivatives as a financial activity
- Enhancing investor protection by e.g. banning the receipt of inducements, i.e., hidden costs, safeguarding independent advice, or introducing new product governance rules. This is most likely one of the rules that will have the most visible impact on (retail) investors.
- Trade reporting: trade transparency rules applicable to investment firms and systematic internalizers. It’s another rule that will have a noticeable impact on investors. For the first time, investors get a detailed and transparent overview of all the major costs.
- Adapting to technological progress with the regulation of high-frequency trading (HFT) by introducing requirements on exchanges and firms using HFT.
What MiFID means for you as investor
You might have understood from reading the above that MiFID’s main focus is not the retail investor, but it does have an impact on us indirectly. The indirect impact MiFID 2 has on retail investors is:
Clear cost overview
Bankers and brokers now have to send you an annual detailed cost overview of the investments you had in your portfolio during the last calendar year.
You do not even have to be an active investor to receive the overview. The cost report is drawn up as soon as you had at least one MiFID investment product in the course of the previous calendar year. MiFID products include shares, bonds, investment funds, structured products, and derivatives.
Although the general principles of reporting are clear, like always, certain points in the law leave room for interpretation:
- Representation of the impact of the costs on the return. It needs to be mentioned but it’s not stated how it needs to shown to the client.
- Included products in the cost overview. As indicated above, you have at least the MiFID products, but it’s possible for some financial companies to go further since it is not prohibited to extend the reporting with non-MiFID products.
- The reporting of the taxes. It is a fact that transaction taxes, such as stock exchange taxes, must be reported. This tax is explicitly mentioned in the MiFID II regulations. Other (local) taxes are not clearly defined.
More personal information required
A second important impact a retail investor will see is their bank needing more personal information. It required e.g. the national registration/insurance number. It’s clear the goal of this “big data” push is to allow regulators to closely monitor trading activity within the EU. It also allows them to identify individual traders and prosecute them more easily when market abuse is discovered.
Ever changing regulations
I hope you now understand what MiFID II/MiFIR means and how it has a varying but nonetheless major impact on every financial company within the EU.
MiFID II is just one of the regulatory changes the EU has created and impacting all the financial firms operating in Europe.
Together with other regulatory initiatives like the General Data Protection Regulation (GDPR), the EU aims to create more transparency, rights, and protection for EU citizens.
Just like national governments continuously tweak their laws, so is MiFID II an improvement on its first version. Some of these tweaks, like the appointment of a single officer responsible for protecting client interests from within the firm, are now explicit requirements for companies wanting to do business in the European market.