OpinionDec 19 2017

Five key changes under Mifid II

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Five key changes under Mifid II
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Mifid II is one of the EU’s most ambitious and contentious regulatory reform in decades, with far reaching consequences for nearly all aspects of Europe’s financial industry.  

In the wake of the 2008 financial crisis, the scheduled update to the original Markets in Financial Instruments Directive (Mifid), became the “beast” of a vehicle it is now (with thousands pages of rules and guidance) seeking to address key financial stability issues identified by the G20. 

After seven years in the making and a year’s extension, Mifid II will come into force in just under two months on the 3rd January 2018. Here are the key changes I believe the market should be aware of:

Product governance 

The new product governance requirements, introduce a new concept of “target market”, meaning managers must aim to ensure that their products are designed with particular categories of end-investors’ needs in mind.

They extend to all Mifid firms involved in the manufacturing and distribution of financial products, but also indirectly apply to non-Mifid firms that distribute to, or collaborate with, Mifid firms.

Managers will now have to state the intent of their funds, while providing detailed information of the target market and distributors will be responsible for providing information regularly to managers to ensure a continual dialogue and exchange of information among themselves. 

Best execution 

In a similar vein, the demand to seek best execution under MiFID I has been bolstered as part the new directive. The requirement to take all ‘reasonable steps’ to see best execution, when carrying out transactions on behalf of clients, has been elevated to taking all ‘sufficient steps’. 

A potential unintended consequence may be these changes will lead to a dramatic reduction in the production and consumption of research.

This is more than just a semantic shift and will involve a strengthening of front-office accountability, as well as systems and controls to identify any potential deficiencies. 

Additionally, firms will have to publish data on the quality of each execution and further customise and simplify their execution policy. 

Transaction reporting

The considerably heightened new requirements on transaction reporting fall under the implementing regulation MiFIR, which forms part of the Mifid II package. It demands that firms report granular details of the transactions they execute to regulators as quickly as possible, and no later than the close of the following working day.

The scope of assets that firms will have to report on is also far broader than before.

Obligations will now apply to transactions conducted on any ‘trading venue’ and not just on European Economic Area (EEA) regulated markets, as was previously the case. Furthermore, the amount of data that must be reported will greatly increase, from 23 to over 65 reportable fields.

Trade reporting 

There are also new trade reporting obligations, which are not to be confused with the changes above. A key difference between the two is that unlike transaction reporting, trade reporting occurs in near real-time.

Under Mifid I, pre-and post-trade transparency obligations were limited to trading in equities, but under new rules this will be extended to include: shares, depositary receipts, exchange-traded funds, certificates, bonds, structured finance products, emission allowances, derivatives; trading on any EU trading venue.

A key point of contention is over whose obligation it is to carry out reporting on trades. Previously, the regulator left it up to the parties involved in a transaction to agree whose responsibility it was to report; sell-side firms usually assuming this duty.

New rules instead dictate that the buy-side is responsible for reporting, unless the buyer is a “systematic internaliser” (SI). In all other instances, the buyer must take on this obligation.

Needless to say, a new cottage industry has sprung up providing solutions to assist with a manager’s reporting requirements. 

Research – an insight into the cross border impact of regulation 

Most disruptive for the industry as a whole is the move to ‘unbundle’ the cost of brokerage research and clearly defining the amount of this fee transferred onto investors.

Under the new model, research provided by a third party to an investment firm must be paid of out of either the firm’s own pocket or a research payment account (RPA) funded by specific charges to investors.

In many cases, but by no means all, asset managers are choosing to absorb research costs. There have been a number of reports that a potential unintended consequence may be these changes will lead to a dramatic reduction in the production and consumption of research and squeeze mid-sized funds. 

Much of my year has been spent collaborating to develop industry guidance to address the cross-border impact of the Mifid II rules on research and no doubt the discussion around cross-border impact of regulation shall continue for a long time coming. 

Monica Gogna is financial regulation partner at Dechert LLP