Heralded as the most significant European Union legislation for the financial
services sector since the Investment Services Directive in 1995, the Markets in
Financial Instruments Directive (MiFID) will fundamentally change the
relationship between investment firms and their clients.
MiFID represents the final stage in creating a single market in financial
services. It extends the number of services that can be passported to other EU
member states without additional local approval, as originally outlined by the
Investment Services Directive (ISD), and brings the governing of regulated
markets into greater harmony.
ISD-compliant firms will be affected, along with investment banks, commodities
firms, futures and options firms, corporate finance firms, stockbrokers, broker
dealers and portfolio managers. Retail banks and building societies will also
fall under MiFID’s scope, but to what extent is currently unclear, as it will
only affect specific parts of their business, such as the sale of securities.
The directive, which is due to be implemented in November 2007, will also
mean that the Financial Services Authority (FSA) will have to review and amend
much of its current regime, which could have ramifications for firms not
directly affected by MiFID.
New growth model
According to consultants Capgemini, the number of equity trading venues could
rise as a result of MiFID. Multilateral trading facilities and systemic
internalisers (investment firms that trade off their own account with clients in
an “organised, frequent and systemic manner”) will rapidly emerge as the new
pan-European trading model.
Other models focusing on specific stock sectors will also experience
increased growth and popularity. Although issuance and admission will continue
to be carried out by regulated markets, the consulting firms predict that
liquidity in top stocks could move elsewhere, encouraging competition between tr
ading venues. On the downside, existing exchanges may find their liquidity
eroded by new entrants not hampered by legacy business practices.
MiFID also aims to offer increased regulatory protection to clients. Not only
will the category of client currently private customer, intermediate customer
and market counterparty be re-classified to retail client, professional client
and eligible counterparty (ECP), the level of regulatory protection will be
different as MiFID imposes more obligations on firms when doing business with
those which have chosen professional status. Even business with ECPs will be
Additionally, clients will be able to choose overall, or on a deal-by-deal
basis, whether to be treated as a professional, retail client, or an ECP. As a
result, customers could fall into different categories in respect of different
services or products.
As long as a treasury department is trading for its own business, it will be
excluded from MiFID’s scope. But although the directive’s impact on
non-financial sector firms will be minimal, it looks set to alter the
relationship between treasury departments and suppliers. According to the
Association of Corporate Treasurers (ACT), the new levels of regulatory
protection could represent an increased administrative burden for treasurers and
a slowing down of standard procedures, such as buying foreign currency, as banks
will be obliged to seek an alternative rate associated with “best execution”.
However, the ACT believes that as most large companies in the UK are equipped
with professionally staffed treasuries, ECP status still represents the fastest
and most cost-effective status and, as such, should be open to as wide a range
of companies as possible.
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In a response to the directive’s draft proposal, John Grout, ACT’s technical
director, said that even smaller firms should be able to opt for ECP if
confident, as it will avoid extra costs and delays associated with “best
execution” of professional status. He added that although very small companies
may opt for higher costs and delays associated with retail status, most should
be competent enough to opt for professional status.
Impact on costs
The directive represents a significant compliance challenge for financial
services firms. Companies must consider the efficiency and effectiveness of
compliance and risk management, robustness of systems and internal controls,
record keeping and transaction reporting, together with arrangements for
identifying conflicts of interest. There will also be new requirements focusing
on the outsourcing of critical and important functions.
The costs of achieving such high level transactional transparency will be
Suppliers will need to apply an execution policy that ensures the best result
for the customer each time they deal.
Professional clients may wish to negotiate the contents of this policy, in
terms of the relative importance it places on various criteria (such as price,
speed, likelihood of execution and settlement) and the range of execution venues
where the deal may be done. For retail clients, the most important factor must
Suppliers must understand their client’s knowledge and experience in the
investment field relevant to the specific type of product or service, their
financial situation and investment objectives, so as to enable the firm to
recommend investment services and financial instruments that are most suitable
for that particular client. The firm must warn its client if it considers an
instrument or service not to be suitable, but the client may still go ahead if
Reporting and providing information to customers
MiFID sets out detailed rules for the type of information that must be
provided and the way it is represented, particularly where retail clients are
Roger Chidwick, senior consultant, Capgemini