The Markets in Financial Instruments Directive 2004/39/EC (MiFID) was transposed into Irish law on 1st November 2007 and replaces the Investment Services Directive 93/22/EEC (ISD).
MiFID aims to promote a high level of protection to both existing and potential investors in order to bolster investor confidence and heighten the performance of the financial services sector across the European Economic Area. While this is good news for investors, it imposes more stringent regulatory and compliance obligations on investment firms and it is critical that all solicitors be aware of the scope and application of MiFID when advising clients who carry on investment services.
The wide reaching scope and the obligations imposed by MiFID will be of particular interest to issuers, stockbrokers, portfolio managers, corporate finance firms and derivative providers.
Aims and Objectives of MiFID
MiFID aims to:
- broaden the range of regulated investment services and financial services;
- standardise the procedure for obtaining a "European Passport" and extend its scope, (firms authorised under MiFID will be able to use their MiFID passport to provide services in other EU member states without applying for permission to do so from the local regulator)
- increase competition by the introduction of multilateral trading facilities (MTF) (a platform, other than a regulated market which allows trading between market participants) and systematic internalisers (a firm that executes and processes client orders in-house, outside a regulated market or an MTF);
- provide a higher level of protection for investors, ensuing market transparency and integrity;
- impose defined rules with regard to conduct of business, conflict of interest, transaction reporting and best execution; and
- ensure maximum harmonisation of measures and means implemented by competent authorities within Member States.
When will MiFID apply?
It is important to determine at the outset whether or not a client falls within the scope of MiFID. The general rule of thumb is that all investment firms carrying out investment services/core services will fall within the scope of MiFID. MiFID offers some firms exemptions from authorisation. These relate to insurance, assurance and reinsurance undertakings, persons who provide investment services exclusively for their parent undertakings, subsidiaries, or other subsidiaries of their parent undertakings, persons whose main business consists of dealing on own account in commodities, commodity derivatives or for the sole purpose of hedging positions on derivatives markets.
The concept of "investment firm" is used in order to identify the types of entities that would fall within the scope of MiFID.
An investment firm is any legal person other than a tied agent, whose regular occupation or business is the provision of one or more investment services to third parties on a professional basis or the activity of dealing on own account on a professional basis. This does not include a natural person unless his or her legal status ensures a level of protection for third parties interests equivalent to that afforded by legal persons.
Investment banks, portfolio managers, stockbrokers and broker dealers, investment advisers, some commodities firms and some futures and options firms are likely to fall under the definition of "investment firm".
Investment firms which carry out the following services will fall to be regulated under MiFID:
- the reception and transmission of orders in relation to one or more financial instruments (MiFID extends the definition of "financial instruments" under the ISD to include a broader range of instruments such as derivatives relating to commodities that can be physically settled provided that they are traded on a regulated market or a MTF or cleared and settled through clearing houses, derivative contracts relating to climatic variables, freight rates, emission allowances, inflation rates, contracts for difference and derivative instruments for the transfer of credit risk);
- execution of orders on behalf of clients;
- dealing on own account;
- portfolio management;
- investment advice;
- underwriting of financial instruments or placing of financial instruments on a firm commitment basis;
- placing of financial instruments without a firm commitment basis; and
- operation of MTF.
Non Core Activities
MiFID authorised firms may carry out non-core/ancilliary services. However firms which carry out ancillary services only will not fall to be regulated under MiFID. These ancillary services include:
- safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management;
- granting credits or loans to an investor to allow the investor to execute a transaction, where the firm granting the credit or loan is involved in the transaction;
- advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to mergers and the purchase of undertakings;
- foreign exchange services where these are connected to the provision of investment services;
- investment research and financial analysis or other forms of general recommendation relating to transactions in financial instruments;
- services relating to underwriting; and
- investment services and ancillary services related to the underlying reference of derivative instruments where these are connected to the provision of investment or ancillary services and the underlying reference is not itself a financial instrument.
Key Elements of MiFID
Cross Border Activities and European Passport
While the introduction of a European Passport for authorised investment firms by the ISD was a fundamental innovation for the European capital markets and financial services industries, MiFID seeks to improve and further enhance the operation of the European Passport across the EU single market.
In essence, the European Passport allows an investment firm from any EU Member State to carry out specified investments services throughout the EU under the authority of a single authorisation granted by the home Member State.
MiFID introduces a new framework for a standardised "single passport" procedure for cross-border activities and the establishment of branches across the EU. As noted above MiFID expands the list of activities that will constitute investment services. Consequently providers of such new services can benefit from the right to avail of the European Passport.
The following undertakings can benefit from the advantage of the single European Passport, under MiFID:
- Investment firms from other Member States can provide services in Ireland;
- Authorised MTF providers in other Member States can provide services in Ireland;
- Irish Investment firms can provide services in other Member States;
- Investment firms authorized in other Member States may establish branches in Ireland;
- Authorized investment firms can establish branches in other Member States; an
- Remote access to regulated markets without having to be established in the State.
Key Organisation and Operational Requirements
In the interests of investor protections and to heighten the performance of the financial services sector, MiFID introduces defined rules regarding conduct of business, conflict of interest, transaction reporting, customer classification and best execution. It also sets out new requirements regarding pre and post-trade transparency for equity markets and the establishment of a new regulatory regime for systematic internalisers. The most significant new measures are:
- Client classification - new harmonised EU framework for classifying clients into "three-tier" categories, retail clients, professional clients, and market clients.
- Reporting to clients - an investment firm should provide adequate reports for the services provided to a client, making the necessary disclosures with regard to costs and investment risk.
- Safeguarding client assets - adequate arrangements are required to safeguard client assets and ownership rights.
- Best Execution - an investment firm should take reasonable steps when executing client orders to ensure the best possible results for clients.
- Information to clients - information provided to clients must be in a comprehensible form, clearly disclosing all the potential investment risk.
- Execution-only services - this may be provided only on the clients instruction with regard to certain types of financial instruments, including securities bonds, money market instruments and some equity instruments.
- Pre-trade and post-trade transparency - MiFID introduces new requirements for shares traded on regulated markets and MTFs. It also requires "systematic internalisers" to provide definite bid and offer quotes in liquid shares for orders below standard market size.
- Conflict of interest - Investment firms must take reasonable steps to manage conflict of interest between its organisation, tied agents, employees, parents companies and subsidiaries etc. They must put in place effective organisational and operative arrangements to manage and avoid such conflicts.
- Outsourcing - An investment firm must ensure when relying on third parties for the performance of operational functions to take reasonable steps to avoid undue additional operational risks.
From 1 November 2007, investment firms are required to be compliant with the MiFID regime. It is expected that investors will take great comfort in the extent of regulation MiFID has introduced over business, organizational and operational requirements imposed on investment firms, however it will be a number of years before we can evaluate and fully appreciate how effective MiFID really is.
In advising clients, solicitors should be aware of the ongoing obligations of investment firms to comply with the MiFID regime and the Financial Regulators authorsiation process for applications for authorisation under MiFID.