Time is running out to prepare for MiFID. Its implications are enormous and change is already under way. By Neil Tyler.
In less than 10 months’ time, one of the most significant changes to the regulatory environment affecting financial services in the EU will come into effect. It promises huge economic gains from a more integrated EU capital market. It will allow investment firms to offer their services across borders, and stock exchanges will face direct competition from banks in trading both equities and bonds.
The Markets in Financial Instruments Directive (MiFID) is the second step in the harmonisation of the European capital markets industry and is set to drive some of the most far-reaching changes to the financial markets seen in the past 10 years.
Coming into force
MiFID forms part of the European Financial Services Plan and was ratified by the EU Parliament in April 2004. The Implementing Directive and Regulation was passed in 2006 (providing detailed implementation guidelines across all member states). At present, local regulators are working on the third level of this new regulation, focusing on specific and local implementation measures that are due to come into force in November 2007.
The impact of MiFID is considerable. It has implications for markets, products and services. Financial institutions from the largest to the smallest, from international banks and asset managers to the smallest stockbrokers, will have to comply.
For example, MiFID will allow direct competition against stock exchanges. As a direct result, leading City firms are already developing a rival trading platform to the London Stock Exchange. Project Turquoise involves seven leading investment banks – Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS – and interest in the platform appears to be growing.
Wide-ranging effects
But that is just one aspect of the new regulations associated with MiFID. They will affect all internal processes and procedures, from an organisation’s IT and documentation through order handling and execution to record keeping and marketing and promotional campaigns.
The directive will provide a consistent regulatory framework that will recognise the existence of new forms of execution and the need to include all participants in the execution cycle. Its impact goes far beyond equity markets and will affect all market participants, buy-side, sell-side and exchanges.
MiFID is about transparency. It is about defining a clear execution policy, documenting it and informing the client of all the policy’s details. It has been designed to establish an open and competitive market for execution and other investment services.
Participants will be liable and accountable for implementation failures from November onwards. Those who have not even begun to address implementation should be aware of the serious prospects of legal action.
Competition benefits
Increased competition is expected to give firms direct benefits in terms of falling compliance costs and transaction fees, although there are concerns that the costs of implementation, put at more than £1bn ($1.94bn) for the City of London alone, could outweigh the financial benefits of MiFID, at least in the short term.
The directive introduces a ‘passportable’ operating framework for execution services that can be provided by regulated exchanges or multilateral trading facilities, or internalised by the financial institution.
It will end the concept of central exchange and obligation of order concentration (that is, the obligation in certain member states to route all negotiations through a central regulated market). Regulators will need to ensure that the development of new execution venues, systematic internalisation and the end of the concentration obligation will not lead to a less efficient or transparent market that ultimately harms the investor.
The opening of the execution process to full competition will be balanced by a series of obligations that intend to increase transparency and client protection. These obligations are designed to enable European markets to provide a price discovery mechanism that remains effective and fair. It aims to guarantee the markets’ integrity despite the prospect of greater fragmentation.
Companies will need to ensure that their compliance programmes meet the regulatory timetable if they are to reap the benefits both operationally and competitively.
