Introduction

After its implementation in 2004, Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments has developed into Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 ("MiFID II"), with MiFID III already in the oven (the European Commission has already published a legislative amendment to MiFID II on 25 November 2021).

While waiting for the European Parliament and the Council to analyze the European Commission's latest proposal, it should be useful to take a further look into the most recent and significant changes to the MiFID framework: on 26 February 2021, the so-called MiFID II “Quick Fix”, Directive 2021/3381 , was published in the Official Journal of the European Union. This Directive was implemented in Portugal by Decree-Law no. 109-H/2021 of December 10, which entered into force on February 28 2022.

The goal of this Directive was to (without jeopardizing investor protection) simplify certain regulatory requirements and promote investment while reducing compliance costs and investment firms' bureaucratic burden in the aftermath of the COVID-19 pandemic, therefore amending MiFID II as regards information requirements, product governance and position limits.

The Quick Fix relied on flexibility and downplayed the concerns that have been raised in the past about MiFID II such as its excessively burdensome or redundant distribution rules, its failure to adequately account for the unique characteristics of each investor category and the inflexibility of the position limit regime. This Directive allows for a revision of MiFID II-related processes and its compliance procedures are placed at the appropriate level. However, since its targeted amendments came into effect (on 28 February 2022), switching off certain reporting standards has proven to be far more complicated than anticipated.

Main features of the Quick Fix 

The Directive simplified, in particular, MiFID II’s information and reporting requirements. 

Firstly, the Quick Fix shifted from paper form to an electronic method of communication (any durable medium other than paper). Retail clients, on the other hand, may still demand investment firms to provide the required information on paper. Investment firms must notify retail clients of this change and the right to opt-in at least eight weeks before transmitting the information electronically.

Although this switch has led to cost savings, ecological harm reduction and improved security, firms remain worried about the overload of having to operate both with paper and electronically.

Secondly, the following requirements are no longer applicable to professional clients (and in the case of reports, it is also not applicable to eligible counterparties), unless they decide in writing to opt-in:

i. the requirement for investment firms to provide cost-benefit analysis (a suitability test) and to inform the client whether the advantages outweigh the disadvantages when providing either investment advice or portfolio management that involves the switching of financial instruments, and

ii. the requirement of ex-post reports on transaction services (which include the type and the complexity of the used financial instruments, the nature of the service provided and the associated costs).

These changes were aimed at facilitating and encouraging professional clients to alter their investment strategies and products, as well as reducing mandatory reports that were excessive and even counterproductive. The disadvantage, on the other hand, is the all-or-nothing system that has been designed for professional clients who can opt-in and then either choose not to receive anything or choose to receive all reports. 

In addition, the Quick Fix also introduced exemptions from the obligation to disclose costs and charges: investment firms are exempt from disclosing cost and charges information to professional clients and eligible counterparties if they provide services other than portfolio management or investment advice. Professional clients will continue to be able to opt-in. 

Unfortunately, the logic employed by the legislator is difficult to comprehend: if these clients can negotiate contracts on their own terms with tailored and detailed information and do not need to be protected by standardized cost and charge information requirements, it is not clear why should they be protected when receiving portfolio management or investment advice services.

Furthermore, in order to lighten formalities, the Quick Fix has suspended until 28 February 2023 MiFID II Art. 27 (3)’s best execution disclosure obligation for execution venues (under RTS 27, Commission Delegated Regulation (EU) 2017/575). In other words, the periodic reports on data concerning the quality level of transaction execution, which allowed market participants to compare the quality of execution on various platforms, are suspended. 

Furthermore, in order to lighten formalities, the Quick Fix has suspended until 28 February 2023 MiFID II Art. 27 (3)’s best execution disclosure obligation for execution venues (under RTS 27, Commission Delegated Regulation (EU) 2017/575). In other words, the periodic reports on data concerning the quality level of transaction execution, which allowed market participants to compare the quality of execution on various platforms, are suspended. 

Also, the Quick Fix allowed for the transfer of cost and charge data to be postponed (without undue delay after the conclusion of the transaction) when using distant communication channels to an agreement to buy or sell a financial instrument when two conditions are fulfilled: i) the investment firm has the client's agreement; and ii) provided for the option of postponement of the agreement's execution until the data was delivered to the client.

This new exemption from the requirement to provide ex ante cost and charge disclosures allows faster order processing, reducing the risk of price fluctuations between the provision of information and the execution of orders. 

Another important novelty was that investment services provided related to corporate bonds with a make whole clause (non-complex bonds are not included) are now exempt from product governance requirements (for example, applying for an authorization for any type of financial instrument as part of its development and/or distribution). This innovation aimed at making these corporate bonds, which have a simple structure and a uniform pattern, easily accessible to retail investors, reducing their issuers’ costs, and allowing issuers to access a wider range of investors. 

Moreover, eligible counterparties are exempted from the product governance requirements applicable to financial instruments exclusively marketed or distributed to them. 

In the area of commodities markets, position limits are now only applied to significant or critical commodity derivatives that are traded on trading venues and agricultural commodity derivatives. Whereas OTC derivatives contracts are not excluded from the regime, securitized commodity derivatives are. 

It can be argued the general abolition strengthens the regime by making it more effective, as position limits were preventing some derivative markets from growing, limiting their liquidity.

Also, a hedging exemption was introduced: position limits are not applied to derivatives held by or on behalf of financial entities that offer liquidity to non-financial counterparties in a predominantly commercial group and whose objectively measurable positions lower risks directly connected to the non-financial entity's commercial activity. This introduction reduces structural drawbacks while maintaining financial system stability. 

Additionally, it should also be noted that the ancillary activity test was simplified. Market participants who are exempted from the requirement to be authorized as investment firms to participate in emission allowance markets if certain requirements are met (e.g. ancillary activity to the main business at group level).

Previously, market participants were required to notify the relevant national competent authorities of their reliance on the exemption on an annual basis, as well as provide specific data to satisfy specific complex quantitative tests. The Quick Fix decided to simplify by removing the notification requirement and returning to a new qualitative ancillary activity test criteria. Following this alteration, MiFID II’ RTS 20 will be replaced by a new Delegated Regulation for the ancillary activity test. 

Finally, the unbundling rule suffered a “re-bundled”, as third-party research may now be obtained by certain investment firms (small and mid-cap companies whose market capitalization is less than EUR 1 billion) that offer clients portfolio management or other investment services without having to pay separately from execution services. This innovation enhanced the availability of issuer research as well as their ability to obtain funding. 

However, to reap its benefits, the parties must have a signed agreement determining the part of the joint charges that is research and must inform their clients of these joint payments.

Lastly, ESMA was directed under the Quick Fix directive to create a new required set of regulatory technical standards that concern, for example, position management controls and the application of position limits to commodity derivatives.

All in all, these amendments were welcomed and provided a glimpse regarding the latest changes to MiFID II. 

MiFID II Review 

Yet, it is worth noting that the Quick Fix did not pretend to replace the ongoing MiFID II review. However, the Commission has perhaps recognized the undeniable importance of reviewing MiFID II while concentrating on the need to protect investors, the transparency demands for different types of execution venues, as well as the creation of the “consolidated tape”. 

In fact, the European Commission, in its proposal for a Directive amending Directive 2014/65/EU on markets in financial instruments, intends to structurally change MiFID II to improve the transparency and competitiveness of EU capital markets, the robustness of the market infrastructures, and the access, availability and quality of market data. 

In particular, this “MiFID III” proposal includes measures to assist the establishment and implementation of a centralized database, which has now been moved from MiFID II to the Market in Financial Instruments Regulation (MiFIR). This so-called consolidated tape will eventually aid in the creation of an integrated view of EU trading and the improvement of process transparency with regard to trading venues. The ultimate goal is to increase market liquidity and the potential for capital markets to fund companies, thereby leveling the playing field between execution venues. 

Unfortunately, while a step forward, the proposal falls short of what was expected and anticipated after the Quick Fix, with the incidental legislative changes being mostly MiFIR-related and targeted amendments. The MiFID’s amendments are intended to harmonize its current text with the changes made in this proposal to MiFIR. For example, the proposal includes penalties for failing to comply with MiFIR's new provisions.

All things considered this proposal will not be the final change to the MiFID framework as there is still a long way to go. While waiting for the wider MiFID review (still to come), it is prudent to focus on the live date of the Quick Fix.