The Markets in Financial Instruments Directive II (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) were adopted in May 2014. They were originally to come into force on 3 January 2017. The start date was postponed by a year, to 3 January 2018, after European legislators acknowledged that the industry needed more time to prepare itself for the new regime.
After one false start, the German Federal Ministry of Finance is once again implementing the provisions of MiFID II and accompanying MiFIR.
The new laws will result in significant changes for investment firms, credit institutions and other companies that provide financial services to clients within Germany.
The proposed Second Law for the Amendment of Financial Market Regulations Based on European Legislative Acts (2.FiMaNoG) will adapt German law to the new European regulatory framework.
2.FiMaNoG will introduce new and more onerous obligations for relevant market participants in relation to:
- the manufacture of new financial products
- product distribution
- internal governance and management procedures
- over-the-counter trading
- reporting obligations.
The creation of new financial products (manufacture) and the sale of those products (distribution) are regulated activities. Product governance and more rigorous internal governance requirements have in particular been the subject of much debate and controversy amongst German market participants, so we will comment briefly on these below.
2.FiMaNoG will implement the MiFID II provisions relating to the manufacture of new financial products by amending Sec. 11 of the Investment Services Rules of Conduct Regulation (WpDVerOV-Draft).
Under MiFID II, investment firms which manufacture financial instruments for sale to clients will have to execute a ‘product approval process’ for each financial instrument (Article 16(3), 24(2)).
As part of this process, under Article 16(3)(3), the manufacturer is required to identify a ‘target market of end clients within the relevant category of clients for each financial instrument and…ensure that all relevant risks to such identified target markets are assessed and that the intended distribution strategy is consistent with the identified target market’.
Consequently, a manufacturer will be obliged to identify a group of potential clients and ensure the product ‘fits’. An example of a product that would not meet a client’s needs would be one that carries a high risk offered to clients searching for an investment for their personal retirement scheme.
Manufacturers will also be required to have suitable remuneration policies. For example, employees participating in the creation of new products should not be financially incentivised to create unsuitable, overly-complex products.
ESMA released a consultation paper on 5 October 2016 that contains further suggested specifications on identifying target markets. It is expected that the German authorities will comply with any guidelines prepared by ESMA.
2.FiMaNoG will implement the MiFID II provisions relating to the distribution of financial products by amending Sec. 12 of WpDVerOV-Draft.
Under MiFID II, investment firms which offer and/or recommend financial instruments will be obliged to implement their own product governance processes (Article 10).
One of the essential goals of the product governance process as it relates to distributors is to make sure that financial instruments will only be distributed to such clients that ‘fit’ the target market of the financial instrument. It will be the responsibility of the distributor to specify the target market for the financial instruments he intends to distribute. As noted above, ESMA is currently consulting on draft guidelines which will spell out the methodology for identifying target markets.
Particular challenges arise when an investment firm is a distributor as well as a manufacturer of certain financial products. MiFID II and implementing legislation in Germany stipulate that investment firms implement measures to properly manage conflicts of interest. In this case, the firm would have to ensure that employees distributing its own financial instruments are not incentivised to recommend these in preference to more appropriate third party products.
The implementation of MiFID II will bring increased responsibilities in relation to a firm’s internal management. The increased compliance burden – more time and expense for investment firms – is not proving popular with the industry.
Proposed amendments to Sec. 70 German Securities Trading Act (WpHG) will redefine the duties of an investment firm’s management in line with the Directive.
Particular management responsibilities in the spotlight are the regulation, implementation and supervision of:
- the internal organisation of the investment firm
- training requirements which relate to required employee knowledge
- the remuneration policy of the investment firm.
Implications for investment firms
Investment firms that offer their services in Germany will have to significantly adapt their internal organisation as well as their processes to comply with the future requirements of MiFID II and MIFIR. For those who are still working on introducing new or vastly modified systems to ensure compliance, the deadline of 3 January 2018 is approaching all too quickly.