Key Changes Under the New Markets in Financial Instruments Directive (MIFID II)
27 October 2018
Following the serious economic crisis of 2008, the European Commission (EC) considered as being necessary the recast of MIFID I and the introduction of an amended version of it, the MIFID II. The MIFID II along with the Markets in Financial Instruments Regulation (MIFIR) constitutes the new legislative framework regulating the trading of financial instruments across the EU and the operation of financial institutions providing financial services within the European Union (EU). MIFID II will be implemented from 3 January, 2018 and its main objectives are the attainment of a greater degree of harmonisation by establishing “a single rulebook applicable to all financial institutions within the internal market”; the significant increase of investor protection; the minimisation of the risks of a disorderly market; the increased efficiency of financial markets and the decrease of superfluous costs for the participants. Moreover, the new MIFID II aspires to encourage competition across the EU financial markets and introduce reinforced supervisory authorities ensuring compliance with the relevant legislative regulations. The purpose of the present publication is to briefly explain what are the key changes MIFID II is about to bring and how these changes will contribute to the realisation of its objectives.
MIFID II placed particular emphasis on strengthening investor protection. As a consequence, many of the MIFID II provisions aim to serve this purpose. Specifically, one of the most significant provisions of MIFID II is article 27 which provides that investment firms are compelled to take “all sufficient steps” when executing client orders to achieve the best possible outcome for them (best execution provision). For these purposes, investment firms shall take into consideration prices, speed, costs, nature, size, “likelihood of execution and settlement” or any other aspect relevant to the execution of a client’s order. It is noteworthy that where there is more than one trading venue capable to execute an order relating to a financial instrument, investment firms shall examine and compare the results for the clients if the order was executed in each one of the different execution venues that are listed in the firm’s execution policy. The investment firm’s costs and fees shall also be taken into consideration in that assessment.
Moreover, a particularly significant provision aiming to safeguard client’s interests is article 27(2) which prohibits the acceptance by investment firms of any sort of discount, remuneration or non-monetary benefit “for routing client orders” to a specific trading or execution venue, as this may result in a conflict of interests. Furthermore, article 23 provides that investment firms are obligated to take all necessary steps to “identify, prevent and manage any conflict of interests” between the clients and themselves including any member, employee or manager thereof or any person directly linked with them. Article 23(1) explicitly bans the receipt of inducements by third parties as well. If, despite the fact necessary steps have been taken, the conflict of interests may not be avoided the firm is obligated to disclose to the clients the character of conflict of interests and any measures taken to mitigate the risk.(art.23(2)
In addition to the aforementioned, the MIFID II imposes onerous reporting obligations on investment firms. More specifically, the requirements relating to transaction reporting are now expanded to more trading venues and to a greater number of financial instruments including equity like instruments such as exchange-traded funds and depositary receipts, and non-equity instruments such as bonds, structured finance products and commodity derivatives. All transactions shall be reported to Approved Reporting Mechanisms (ARM). It is noteworthy that the number of data fields that shall be reported has been remarkably increased from 24 to 65. By the extended application of rigorous reporting requirements, MIFID II aims to increase the degree of transparency and fairness within the EU financial markets.
A particularly important change introduced by the MIFID II is that investment firms will no longer be able to report trading transactions for clients that are eligible for obtaining a Legal Entity Identifier (LEI) and they do not possess one. This basically means that eligible clients will be forced to obtain a LEI in order to be able to report their transactions. By this measure transparency is significantly increased as legal entities participating in financial transactions such as trading of financial instruments will be identified in any jurisdiction by the relevant supervisory authorities.
Furthermore, the application of MIFID II is expected to significantly increase competition within financial markets as firms are now provided with open access meaning that they are able to select the clearing house of their preference, irrespective of where they have traded, and are not compelled use the clearing house of the trading venue.
Articles 16 and 18 are also of paramount importance since they provide that Over-the-counter (OTC) trading must move to trading venues meaning Regulated Markets (RM), Multilateral Trading Facilities (MTF) and Organised Trading Facilities (OTF) decreasing by this way opacity and bilateral risk. OTF is a new category for the trading non-equity financial instruments which permits some degree of discretion by operator over the execution of a transaction. However, some restrictions are applicable in relation to the use own capital.
Last but not least, firms using high-frequency trading (HFT) methods will be subjected to controls and restrictions. These include among others, the testing of algorithms by the participants, the existence of circuit breakers where the use of high frequency algorithmic techniques affects market integrity and efficiency, and permitting trading venues to adjust fees for cancelled orders.
In conclusion, the implementation of the new MIFID II will significantly affect the trading of financial instruments and the way investment firms conduct businesses. While MIDIF II is expected to significantly increase the degree of transparency, fairness and efficiency within the EU financial markets, it is certain that it places some quite challenging requirements on investment firms in order to comply, especially in relation to their reporting obligations.
For further information on MIFID II and regulatory compliance please do not heistate to contact Varnavas Playbell at firstname.lastname@example.org
Authors: Varnavas Playbell, Eleni Louka
The above is only for informational purposes, does not constitute advice and should not be relied upon.