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MiFID (II): The EU Financial directive explained

Post Series: European acronyms

Acronyms, who doesn’t love ’em? From the United States with agencies such as FBI, CSI, NCIS, FCC, etc. To Europe with ESMA, OPCW, or NATO. In turn, institutions and organizations like to use them too for their rules. It are these regulations that I’d like to clarify. Since there are quite a few that specifically impact investors/traders, I created this series.

“European Acronyms” is pretty straight-forward. In the coming weeks and months, I’ll be going over various terms that appear often in the news and media, and that also have an impact on us investors.
In this post, I’ll clarify MiFID (II) or Market in Financial Instruments Directive and Regulation. I’ll answer the following questions:

  • What it is
  • Why it was created
  • Who it’s for
  • What impact it has on (retail) investors
EU directive: MIFID II - Markets in Financial Instruments Directive
EU directive: MIFID II - Markets in Financial Instruments Directive

Mi-what?

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 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.

Breaking it down

  • Rules of business conduct for investment firms
  • Authorization requirements for regulated markets
  • Regulatory reporting to avoid market abuse
  • Trade transparency obligations for shares

However, One of the issues in the original version was that each member state could interpret and apply the rules in their own way, and that led to some firms outside of the EU having a competitive advantage due to regulatory oversights of different countries.

The why: improving 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 got implemented recently, at beginning of January 2018.

While implemented not long ago, the first idea of a new version started in 2014 by the European Commission, the European Parliament and the Council of the European Union who 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 and MiFIR

Like referenced above, besides MiFID II, 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.

Directives vs. Regulations

Regulations have binding legislative act throughout every country and enter into force on a set date. For example, when the EU wanted to make sure that there are common safeguards on goods imported from outside the EU, the Council adopted a regulation.
Directives lay down certain results that must be achieved. However, it is up to the individual countries to devise their own laws on how to reach these goals. An example is the EU consumer rights directive, which strengthens rights for consumers across the EU, for example by eliminating hidden charges and costs on the internet, and extending the period under which consumers can withdraw from a sales contract.

sourceeuropa.eu

graphical representation of the different versions of MiFID/MiFIR.
From MiFID I, the updated regulations MiFID II and MiFIR were. MiFIR is an updated version of MiFID I's reporting rules.

A broader scope to reach all financial firms

Thanks to a broad overhaul of the first directive, MiFID II/MiFIR significantly increases the scope if implementation and now includes a broader group of companies – insurers, mutual fund providers and banks alike – and products.

The main focus of MiFID II/MiFIR are 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 it all means for you

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. I’ll describe the main ways you as a retail investor can be impacted below.

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 from them such as 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 here.
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.

This Post Has 2 Comments
  1. To comply with the evolving regulatory processes, every financial firms and the trading participants needs to stay familiar with the MiFID II’s reporting processes.

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