MiFID out of a molehill

The markets in financial instruments directive, a key component of the EU’s
financial services action plan, is set to have a significant impact on the
financial services industry. That much is known but little about MiFID is so far

New requirements are largely familiar to British firms. But as a recent
KPMG-EIU survey into company’s preparedness for MiFID reveals, nearly 50% of
board members and senior managers are unaware of its implications.

Level playing field

The intention is to ensure a more efficient operation of the capital markets,
given the far-reaching changes that have taken place over the past decade. The
aim is also to make sure there’s a consistent level of investor protection
across Europe. While it is a laudable objective, many are questioning whether
this level playing field is achievable?

Now that the EU legislative process is nearing completion of the level 2
requirements, the Financial Services Authority is facing the task of
incorporating MiFID requirements into its own rules.

The regulator is taking this opportunity to move to its stated intention of
greater principles based regulation (with less detailed prescriptive rules) in
line with their focus on ‘better regulation’ and rule simplification. The EU
legislation is tightly framed to try to ensure consistency across Europe and
avoid so called ‘gold-plating’ of the rules in certain member states.

There is already considerable activity surrounding this new legislation, but
is the financial services industry making a mountain out of a molehill, or are
firms right to act now?

Winners and losers

The implementation date of 1 November 2007 sounds a comfortable way off, but
given the implementation challenge facing some firms, this means they need to
begin planning for implementation.

The FSA agrees firms should be preparing their responses to implementation
now, rather than waiting for the regulator’s consultation papers due to be
published during 2006.

The impact of the directive on firms could be significant depending on their
business and operational model. Firms that fail to address this strategically
and take advantage of the opportunities provided risk being on the losing side.

The impact differs significantly by industry segment and country but there is
little doubt the equities market will be the most affected. The directive
introduces new equity market participants in the form of multilateral trading
facilities (similar to existing alternative trading systems) and systematic

Firms executing client orders against their own account in certain ‘liquid’
shares will be required to meet MiFID’s systematic internaliser requirements –
effectively acting as market makers, and with obligations around quoting prices
and publishing details of trades.

This will have a significant impact in many European countries and opens the
equity markets to greater competition. The opportunities and IT and other costs
could be immense. In other areas, such as derivative trading, commodity
derivatives (including credit derivatives and exotic derivatives) will be
regulated across Europe for the first time.

Common ground

MiFID also introduces common investor protection requirements across the EU.
Investment advice will now be fully regulated and firms will have to assess
suitability of that advice to the client’s circumstances.

The directive sets out to achieve investor protection through two means:
comprehensive information and disclosure requirements to clients; and the
requirement to obtain ‘best execution’ for clients.

Although on the surface it may appear that some of the requirements mirror
existing FSA rules, there are numerous subtle differences in how firms will be
expected to interact with their customers, for example firms will be required to
assess ‘appropriateness’ (different from suitability) in some circumstances and
achieve the best possible result for clients (rather than the best price) for
best execution.

MiFID adopts the UK position that senior management of firms, not regulators,
are best placed to assess risks and design controls to manage those risks. The
trade-off for less prescriptive, principle based rules on organisation,
governance and controls is that senior management are held responsible for the
governance structure and control environment in their firm.

Healthy competition

The directive sets out certain requirements in areas such as risk management,
compliance, internal audit, managing conflicts of interest, outsourcing,
investment research, inducements, client money and custody.

In attempting to ensure the integrity of the European financial markets,

transactions to the regulator will enable national regulators to monitor the
activities of regulated firms. MiFID may extend the obligations to report
transactions in new instruments, such as commodity derivatives.

To encourage market integration and competition across Europe, MiFID further
entrenches the concept of ‘home responsibility’ for regulation and adds measures
to enhance the effectiveness of the European passport (the ability to provide
services across Europe once authorised in one of the member states).

Firms and senior management need to consider the challenges the new
legislation poses from a business perspective, analysing the potential strategic
implications, the widespread operational consequences, the risks to the business
and plan a comprehensive response.

Early preparation is essential for firms to take advantage of the greater
transparency and openness of European financial markets in a post-MiFID world.


The EU legislation is being introduced under the four stage Lamfalussy
drafting process.

• Level 1 is the framework directive (approved in April 2004);

• Level 2 implements directive and regulation;

• Level 3 will be the legal and regulatory requirements set by the regulators
in each of the member states; and

• Level 4 will be enforcement.

Implementation of MiFID is currently scheduled for November 2007. The
Treasury and FSA plan to have national legislation in place by 31 January 2007.
This deadline gives the FSA little time to consult on changes to its rules, and
businesses even less time to consider how these changes can be implemented.

The FSA has said it will consult through four consultation papers on changes
to its rules and guidance necessary to implement the directive’s requirements:

• Systems and Controls (May 2006) including organisational requirements for
MiFID and the capital requirements directive

• Implementing MiFID for firms and markets (July 2006) including market
transparency, transaction reporting, authorisation, permissions, passporting,
enforcement and cooperation

• Reforming conduct of business regulation (October 2006) including conduct
of business requirements and conduct of business simplification

• Marketing communications (October 2006) including wider changes from the
FSA’s financial promotions review. In addition to the consultation papers, the
FSA has committed to releasing the following informal documents:

• Best execution discussion paper (May 2006);

• Client classification information paper (June 2006)

• Approved persons regime consultation (Quarter 4, 2006)

Bernadine Reese is regulatory and compliance director at KPMG

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