MiFID II, which has been more than 7 years in the making, was brought into force on 3 January 2018. It has been billed as one of the biggest changes to EU markets for a decade.
MiFID II is designed to address the weaknesses in transparency and investor protection which were exposed by the financial crisis. It introduces major changes to the regulation of financial services in the EU including changes to pre and post trade transparency, transaction reporting, corporate governance, product governance, client categorisation, best execution, conflicts of interest, disclosure of costs and charges and investment research.
However, according to the European Commission, only 11 of the EU’s 28 member states have transposed the MIFID II rules in their national laws, although firms can still carry on investment business in those 17 member states that have failed to transpose the MiFID II rules.
It remains to be seen what the implications of the MIFID II changes will be. One of the biggest MIFID II changes relates to research. Prior to the implementation of MIFID II, the provision of research by banks or brokers could be linked to the volume or value of trades executed by those banks or brokers for asset managers. MIFID II requires asset managers to separate out the receipt of research from the execution of trades so that the risk of a conflict of interest is reduced and the duty to act in the best interests of clients is not impaired. Under MIFID II asset managers are prohibited from receiving research unless it is paid out of the asset manager’s own resources or from a separate research payment account (RPA) controlled by the asset managers which is funded by a specific charge to clients. Where research is provided from a RPA, there are detailed rules on the operation of the RPA. However, there is an exemption where the research is commissioned or paid for by the issuer.
These changes apply to firms providing investment services – that is, asset managers, banks and brokers operating in the EU. The changes do not apply to non EU asset managers, although they do apply to their EU affiliates which provide asset management to clients in the EU. The changes also apply indirectly to non EU banks and brokers which provide research to asset managers in the EU because of the restriction imposed on asset managers in the EU receiving the research.
It is unclear what these changes will mean for EU financial services firms and the wider market. It is likely that the amount of research provided by banks and brokers to asset managers will decrease because asset managers will need either to pay for the research themselves or pass the cost on to their clients. This may pose challenges for start-ups and other firms wishing to raise capital unless they are able or willing to pay for the research themselves. However, the increased focus on the value of the research may improve the quality of the research. There are also challenges for banks and brokers pricing the research and it is likely that over the coming months we will see new pricing models (e.g. different pricing models depending on the type of research and the level of access to analysts).
Implementing MiFID II has involved considerable effort and cost for firms. In the case of large firms with major IT and other systems changes, their MIFID II projects have been running for several years. There have also been significant re-papering exercises.
As would be expected, firms are in different states of readiness for MIFID II. In the case of the MIFID II changes on research, a number of banks or brokers and asset managers have not yet managed to agree new research agreements, so there remains uncertainty about the pricing of and payment for research until these agreements are concluded
Given the amount of change introduced by MIFID II, there is a belief that firms will be given a grace period in which regulators will not clamp down so long as they are making efforts to comply. That said, it is unclear how long that will last and there is a risk that firms that have not made adequate arrangements to comply with MiFID II will soon be subject to increased regulatory scrutiny.