Thursday 3 January 2019 represents the first anniversary of MiFID II. What follows is a review of the relative success of the legislation, what implementation looks like for regulated firms, and the areas that are still considered a work in progress.
The Markets in Financial Instruments Directive (MiFID) is the EU legislation that regulates firms providing investment services to clients linked to financial instruments (shares, bonds, units in collective investment schemes and derivatives) and the venues where those instruments are traded. The new rules combine MiFID II and MIFIR, (the Markets in Financial Instruments Regulation), and was so daunting in its scope with some 30,000 pages, that initial implementation was delayed by a year.
MiFID I was first introduced in November 2007 and its revision in January 2018 extended the original provisions with some wide-reaching changes relating to the way that firms operate with specific focus on transparency, conflicts of interest, particularly research and inducements, product governance and the introduction of a harmonised commodity position limits regime.
All in all, MiFID II aims to enhance efficiency and provide greater resilience and integrity across the 31 states of the European Economic Union (the 28 EU member states plus Iceland, Norway and Liechtenstein) with the key aims of improving market transparency and offering greater customer protection for both retail and some smaller professional clients.
So what has happened in practice over the last eleven months since implementation? There are four key changes highlighted below. Rather than representing an exhaustive list of everything covered under MiFID II, they are focused on investment management as distinct from other areas such as equivalence decisions on trading platforms, systematic risk in derivatives or how more complex issues such as trading outside of regulated markets are dealt with.
Has MiFID II been a success?
The short answer is yes and maybe. Yes, because greater transparency for clients at every level of the service proposition coupled with the pressure to reduce fees and improve investor protection should deliver positive and improved client outcomes. Maybe because, in a number of areas, the detail has been less clear leading to further delays and uncertainty. A couple of examples highlight the issue. First, from an investment perspective, the shift to unbundling research costs and trading commissions has led to a fear of a fundamental reduction in the breadth and quality of sell-side broker analyst research.
While it seems counterintuitive to argue that cost transparency is a bad thing, in this specific instance it may remove the competition between research analysts to produce the highest quality research due to the advance payment of research. From a trading point of view, unbundling commissions has led to greater clarity when aligning broker relationships to the fundamental factors of best execution without muddying the waters around research costs. On the face of it two major changes to the liquidity landscape happened as a result of the MiFID II objective to improve transparency and quality. Periodic auctions and block venues absorbed flow from the outlawed broker crossing networks, and systematic internalisers were introduced to replace the majority of off-exchange trading. As we approach the first anniversary of the updated legislation, the jury is still out on whether the opportunity to source liquidity has improved, but it feels like there is more structure to the avenues of opportunity.
On another positive note, much of the regulation has injected a more concentrated and consistent approach across the industry, with shared working groups who meet on a regular basis and are overseen by industry bodies.
What areas are still being worked on?
As with many regulatory publications, not only will a review of its effectiveness be undertaken but revisions to the rules are already planned or underway leading to the outlines and provision of a new MiFID III publication in the near future. Various authorities have launched impact assessments with a particular focus on small and medium sized enterprises (SMEs) and European firms’ competitiveness with North America and Asia. The FCA is further researching how firms are complying with the rules and whether research markets are functioning as well as had been expected.
MiFID II represents one of the most significant regulatory changes in history. The requirements are broad and extensive covering wide areas of market practice which have had a material impact on the structure of how firms trade and disclose information across all asset classes. At JH&P we have risen to the compliance challenge that MiFID II brings. Rather than seeing it as a regulatory burden, we have acted on the opportunity to strengthen our internal procedures, operate in a totally transparent manner with specific reference to our costs and charging structures and have enhanced client reporting capabilities.
While there is still more to do for all participants, the core pieces of the legislative jigsaw are in place leading to more clarity around client outcomes, greater transparency on costs and charges and a restoration in confidence. After all, it has been ten years since the financial crisis.
Nicola Barber is a partner and head of charities at James Hambro & Partners
Charity Finance wishes to thank James Hambro for its support with this article