From 3 January 2018, MiFID II radically overhauls the legal and regulatory framework governing the way investment services firms operate in the European Economic Area (EEA), being broadly the EU plus EFTA countries.
It imposes new requirements on investment firms designed primarily to increase investor protection. It is leading firms to engage with their clients over their new obligations.
MiFID II is the “Markets in Financial Instruments Directive and Markets in Financial Instruments Regulation” together and is arguably the most significant piece of financial services legislation in the last 10 years.
Some of the changes will affect pension scheme trustees.
Key issues for trustees
1. Legal entity identifiers
These are unique 20 character identifiers stored on a global database that are used to identify a body when it invests or when an investment firm trades on its behalf. The aim is to allow regulators globally to monitor trading and police market abuse. Where a client is required to obtain a Legal Entity Identifier (LEI), managers and other investment firms that are subject to MiFID II transaction reporting requirements will not be able to execute trades on their behalf until they have one.
If trustees are uncertain whether they require an LEI they should discuss this with their investment adviser or managers. In many cases, managers will have already identified whether there is a need and may be willing to apply for an LEI on the trustees' behalf. Alternatively, trustees may need to apply to the London Stock Exchange via an online application with a typical turnaround time of between 1 to 3 working days.
2. Fees, charges and research
Some of the key changes brought about by MiFID II involve greater transparency around the fees and costs investment firms charge for their services and greater restrictions on inducements they may receive. Investment firms are required to 'unbundle' their charging structures so that it is clear to investors where charges are incurred and their cost. Regulators anticipate that this will allow investors to make better comparisons between providers.
New rules on the cost of investment research have attracted particular industry attention. Previously, this cost has been bundled with the cost of other services from investment banks and brokers to investment managers. In future, managers may only pay for research either directly (from their own profit and loss account) or otherwise via ring fenced client research payment accounts that must be operated to stringent requirements.
Trustees may wish to check their appointed managers’ policy regarding research.
3. Information requirements
Investment firms are subject to wider reporting and disclosure requirements with a view to greater transparency. Trustees can expect to be contacted by their appointed firms with requests for additional information or consents to new policies (e.g. around execution). While in many cases this will be necessary for the parties' ongoing compliance with MiFID II, trustees should take care that they are not being asked to agree to provisions that are more onerous than necessary or to assume additional responsibilities.
4. Local authorities
A significant issue in the latter stages of the MiFID II consultation process was the FCA’s proposal to no longer automatically categorise local government pension schemes as professional clients. This could have had serious consequences for authorities unable to satisfy the more stringent MiFID II opt-up tests to access services from investment advisers that provide advice only to professional clients.
In response to lobbying, the FCA has used a discretion under MiFID II to create a new opt-up test, namely that the local authority is using investment services in order to administer a pension scheme within the LGPS framework.
This list of issues is not exhaustive and the pervasiveness of MiFID II means that different investment agreements will be affected differently.