MiFID II Resource Centre
Dechert offers a suite of information to keep investors updated on the Markets in Financial Instruments Directive II (“MiFID II”) and Markets in Financial Instruments Regulation (“MiFIR”) which will redefine financial markets and must be transposed into national law by 3 July 2017 and adopted by Member States by 3 January 2018.
The MiFID reforms cover a number of key topics. We summarize the changes and potential impacts for MiFID-regulated businesses in the topic pages below.
How Can Dechert Help?
The new requirements in MiFID II / MiFIR will require many asset managers to review their business and understand the changes they need to make to comply. At Dechert we have already helped many clients plan their implementation and MiFID II and MiFIR will continue to be a key focus for us during the next 12 months. We have held a series of MiFID II seminars that focus on the preparation for and implementation of MiFID II. If you would like assistance or further information please contact one of our MiFID II team or your usual Dechert contact.
Firms carrying out algorithmic trading will be subject to a range of obligations deriving from MiFID II, ranging from establishing new systems and controls to regulatory reporting. Firms that use a market making strategy will have to take into account the liquidity, scale and nature of the specific market and the characteristics of the instruments being traded. In addition to the introduction of new algorithmic trading obligations, firms engaging in high frequency trading must store in approved form accurate and time sequenced records of all placed orders. This will include cancellation of orders, executed orders and quotations on trading venues. All of this information must be made available to the firm's regulator upon request.
The requirement to seek best execution under MiFID I will be built upon under the new directive. Key changes such as a requirement to take all sufficient steps to obtain best execution and publishing data on the quality of execution will be introduced. Consequently a gap analysis of your firm’s existing order execution policy against the new requirements, in combination with an assessment of how to disclose and monitor the new disclosure requirements should be undertaken to comply with these new requirements.
The requirements under MiFID II relating to conflicts of interest imposed on investment firms remain substantially the same as those imposed under MiFID I. However, while MiFID I emphasized the requirement to identify and manage conflicts of interest, MiFID II also provides for more extensive disclosure and oversight requirements.
Under MiFID II an investment firm needs to consider whether its approach to conflicts is overly reliant on disclosure as a method of managing its conflicts and whether it has taken adequate steps to prevent such conflicts. At the same time UK investment firms will need to retain sufficient disclosure to comply with potential fiduciary conflicts arising as a matter of common law.
Provisions established from the Capital Requirements Directive (CRD IV) in regards to governance requirements will be extended to investment firms under MiFID II. With this extension, management bodies will be required to be of sufficiently good repute, possessing collectively sufficient knowledge, experience and skill in addition to committing sufficient time to performing their functions. Institutions which are significant in terms of their internal organization, size and complexity of their activities must also establish a nomination committee composed of non-executives. This will be to review and make recommendations in respect of the composition of the management committee under the new rules.
The organizational requirements from the new directive will aim to ensure that investment firms operate with a high level of competence, soundness and integrity. MiFID II will include a new product governance regime that will increase the scope and detail of the compliance, risk and audit functions that a firm’s internal policies and procedures need to cover.
The current MiFID obligation on firms to provide clients with an appropriate level of information on investment strategies and financial instruments are expanded under MiFID II. The changes being brought about for investment advice is not to its definition. It is instead adding a further concept of the provision of investment advice on an independent basis. This will impact the way in which managers distribute their products going forward.
Under the new framework, for a firm to provide independent advice it must define and implement a selection procedure. This procedure will assess and compare a sufficient range of financial instruments that are available on the market. Firms that are providing independent advice but which focus on certain categories or a specified range of financial instruments will have to comply with additional restrictions.
Contracts traded on trading venues and economically equivalent contracts will be subject to position limits set by national regulators using a methodology set out in yet-to-be finalized regulatory technical standards. The reason for position limits being introduced is to support orderly pricing and settlement conditions, in order to prevent both market distorting positions and market abuse. MiFID II will therefore require Member states to establish and then impose a maximum quantitative threshold on a firm’s net position. Trading venues will cover not only regulated markets and multilateral trading facilities, but also organized trading facilities going forward.
The new product governance requirements apply to investment firms which create, develop, issue and/or design financial instruments and to investment firms which distribute financial instruments, structured products and investment services, including individual portfolio management, to clients. An investment firm involved in both the manufacture and distribution of the relevant financial instruments will need to apply both sets of requirements. AIFMs and UCITS management companies, which are otherwise outside the scope of these rules, will be affected by virtue of the requirements attaching to distributors. This is also true for investment firms that collaborate (including entities not subject to MiFID II) in manufacturing financial instruments which are now required to outline their product governance responsibilities in a written agreement, as are third country investment firms marketing financial instruments through an EEA MiFID investment firm. In addition, the FCA’s PROD sourcebook applies these rules as non-binding guidance to UK AIFMs and UCITS management companies.
Investment firms should be reviewing products they currently manufacture/distribute/recommend, including assessing their respective target markets and client types.
MiFID II introduces new remuneration rules which aim to reduce the risk that a firm’s remuneration and incentive practices may give rise to conflicts of interest with its clients, and from having remuneration, sales targets or other arrangements that could provide an incentive to its staff to recommend a particular financial instrument when that firm could otherwise offer another financial instrument more appropriate to a client’s needs. The MiFID II requirements are broadly similar to ESMA’s existing remuneration guidelines under MiFID I, but now give them legislative status.
Some investment firms currently use commission sharing agreements (CSAs) where a broker retains a portion of the commissions connected to execution. The balance is then held to the investment firm’s order which is used to pay for external research. This is referred to as the “soft dollar” model. The objection of this method from the FCA to soft dollar arrangements is that they amount to a “hidden cost” for investors.
In contrast MiFID II introduces a new model under which research provided by a third party to an investment firm must be paid for. Under the new “hard dollar” model the research must be paid out of either the firm’s own resources or a research payment account (RPA) funded by a specific charge to the client and controlled by the investment firm. The changes represent an aim to achieve greater transparency and reduce conflicts of interests.
Under MiFID I, transaction reporting applied only for transactions executed in financial instruments admitted to trading on a regulated market, plus any OTC contract which derives its value from any such instrument. Under the new directive and implementing regulations, instruments fall in scope if executed on a “trading venue” (i.e. regulated market, multi-lateral trading facility or organised trading facility) and “execute” and “transaction” are now defined. Further, the amount of data that must be reported is greatly increased, now to 65 reporting fields. As a result it will broaden the scope of transaction reporting data to capture, in a variety of different ways.