MiFID 2 has been on our radar since 2011, but since implementation was delayed, many firms have placed their preparations on hold. With the deadline for adoption now steadily approaching, many clients are restarting preparations to ensure compliance by 3 January 2018. This summary sets out the key aspects of MiFID 2 and how firms can ensure their compliance.
What Has MiFID Achieved?
The first Markets in Financial Instruments Directive was considered necessary to harmonise European financial markets, offer investors a high level of protection and allow investment firms to provide their services across the EU. The European Commission has highlighted MiFID’s success in bringing greater protection and cost-efficiencies to investors; however, the financial crisis exposed the need to strengthen the framework for market regulation so as to increase transparency and better protect investors.
MiFID 2 aims to strengthen European financial markets, reducing systemic risk and the dangers of market disorder. It also aims to increase the efficiency of such markets and reduce unnecessary costs for participants, thereby bolstering investor confidence.
MiFID 2 creates new investment services (for example the operation of an Organised Trading Facility (OTF) being a platform where the OTF operator plays an active role in bringing together buying and selling counterparties and helps negotiate the terms of the trade), new investment activities (for example new data service activities) and new instruments (including emission allowances and commodity and FX derivatives (excluding FX spot contracts).
In addition, the exemption for proprietary trading firms will be narrowed so that High Frequency Trading firms and those who engage in algorithmic trading will be regulated.
Authorisation and operating conditions
The conditions build further on the organisational requirements for algorithmic trading set out in the automated trading guidelines published in 2012 by the European Securities and Markets Authority.
This introduces the following provisions:
- prohibition on the receipt of all but minor non-monetary benefits from third parties in relation to services provided to clients.
- execution venues to publish standardised information on the quality of order execution.
- investment firms to meet a higher standard of best execution, taking “all sufficient steps” to achieve the best possible result for the client instead of “all reasonable steps”. Firms will also, when handling client orders, need to provide information on the execution venues used, publishing their top five venues, and the quality of execution they obtain.
- requirement to record telephone conversations and electronic communications when receiving and transmitting orders, executing orders for clients or dealing on their own account. These requirements cover all communications resulting in or intended to result in a transaction, including internal communications. Every firm which is part of the transaction chain must record these calls and records must be kept for at least 5 years.
These are requirements related to the operation of trading venues including regarding the suitability of management, conduct rules and best execution as well as new rules ensuring proper governance, testing and continuity arrangements around algorithmic trading. OTFs will not be able to trade shares or Exchange Trade Funds (ETFs).
Market Transparency and Integrity
A new regime for instruments like shares (such as ETFs), bonds and derivatives, new transaction reporting requirements expanding the range of instruments to be reported, including those admitted to trading on MTFs and OTFs. HM Treasury believes this will increase the number of transaction reports sent to the FCA each day to 20 million and triple the number of fields a firm has to complete. These reporting requirements remain distinct from the obligations placed on firms by the European Market Infrastructure Regulation and under the Market Abuse Regulation.
Shares and derivatives will be subject to further obligations as to what markets they may be traded on and derivatives in particular must be cleared through a Central Counterparty Clearing House (CCP). Access to market infrastructure and benchmarks will be improved, facilitating the access to trading venues for CCPs and vice versa. New third country regime allowing firms in equivalent jurisdictions (as determined by the European Commission) to provide investment services from their home country to per se professional clients based in the EU. They may also be permitted to have a branch in the EU to provide services to such clients, but the UK has no plans to implement this new system, relying instead on its existing regime.
The FCA announced on the day after the Brexit referendum that firms should continue with their MiFID 2 preparations.