A Single Passport to Europe's Financial Markets
To put it in simple terms, MiFID is about transparency: in the way financial institutions organise themselves, handle clients and conflicting interests, execute orders, disclose the level of risk in the products and services offered and how personal advice is provided.
All countries within the European Economic Association (EEA), which is the EU countries, Norway, Iceland and Lichtenstein, are subject to the new rules and we believe the new regulation will increase competition among exchanges, multilateral trading facilities, and investment firms.
Before the directive, different markets had different rules for similar products and financial institutions were not only monitored by their national financial regulator but also the financial regulators in all other countries in which they had business. By opening up the European common market to all financial companies, this regulation can help improve customer satisfaction through increased transparency and lower prices.
MiFID’s focus on operational risks should be understood as going hand in hand with best execution. In order to enable best execution in the full meaning of the term, you need to manage operational risks and deal with related outsourcing issues as seen from the customer’s point of view. Only then can you provide the customer with full best execution and investor protection, which will be a key competitive parameter in the future.
One of the main objectives of MiFID is to ensure that all clients have the necessary knowledge and experience in order to understand the risks involved for a product before investing in it. This is also called the appropriateness test. This means that all clients must be divided into three new client categories: ‘eligible counterpart’, ‘professional’ and ‘retail’. These three categories define the level of investor protection, with retail receiving the highest protection, and eligible counterpart receiving no protection (because they are typically other financial institutions).
Banks are obliged to ensure that retail clients have been informed of the potential risks connected with trading financial instruments, which are not necessarily appropriate for them. MiFID does not restrict clients from trading in any product; it only sets the level of information to be disclosed to clients prior to trading. Retail clients may become more experienced over time and therefore might want to be treated as a professional client for one or more product areas. If they meet certain criteria, their classification might change.
Another and far more extensive assessment of the clients’ situation is the suitability test. It is a strict requirement that this test must be conducted before a financial company can give any personal investment advice to its retail clients. Contrary to the appropriateness assessment, which is aimed at disclosing the clients’ experience and skills, the suitability test goes even further to cover the whole situation of a client, covering both experience, educational background, and the financial situation, but also the attitude and time horizon of investments.
The result of this assessment also goes further than the more general appropriateness test in the sense that if it shows that a certain investment is not suitable for a client, the financial company must not advise a client to enter into that investment. Furthermore, financial companies are obliged to document the suitability and frequently re-assess and react to changes in the client’s situations.
With MiFID in force since 1 November 2007, it is unlikely that there will be a major impact on the market as a whole immediately. However, we expect that regulators will naturally include MiFID compliance in their inspections going forward and that non-compliance will be a priority. The Danish FSA indicated that all inspections from 1 November onwards will include MiFID, and we have no doubt the same will apply to the rest of Europe.
Having said that, although MiFID is essentially concerned with investor protection, it will take time before we see customer complaints based on non-compliance. It always takes time for new legislation to mature because there is a natural delay before legal actions and case law materialise. The bottom line here is really whether you have the right products and can provide the right services to your customers. If you do, MiFID is certainly an advantage. If you don’t, you will face problems in the future.
We don’t believe that there are loopholes in the directive that will allow institutions and countries to do the bare minimum in terms of compliance. The percentage of firms not ready for MiFID is difficult to estimate but industry rumours point to as many as 50%. When firms begin to receive customer complaints and face liabilities this number may change rapidly. At the end of the day, we will all be judged by our respective customers so either we perform well or we don’t. It’s as simple as that. Customers will quickly recognise and expect full MiFID protection and firms that choose minimal solutions will soon lose out.
The European Commission stated that MiFID could play a central role in creating a robust, common regulatory framework for Europe’s securities markets. We believe that institutions that have made a significant investment, acted in a timely manner and see MiFID as a business opportunity will enjoy ‘first-mover’ advantage.