| D-Day has arrived - MiFID in practice |
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| From November 1st, Irish companies have had to comply with the Markets in Financial Instruments Directive (MiFID). For investment firms, the Directive signals significant changes in how they can sell their products, with passporting across the European Union now possible, write Peter Fahy and Patrick Collins. |
Since 1995, the Investment Services Directive (ISD) as implemented in Ireland by the Investment Intermediaries Act, 1995 (the IIA) has regulated the activities of financial intermediaries, stockbrokers and portfolio managers in Ireland.
In 2001, insurance policies became a regulated investment instrument under the IIA, and insurance intermediaries thus came to be regulated under the IIA. This predated the introduction of EU legislation regulating the sale and mediation of insurance policies. In 2005 the European Communities (Insurance Mediation) Regulations 2005, (the IMD Regulations) were promulgated, implementing the Insurance Mediation Directive, (2002/92/EC). These regulations regulate insurance mediation activities.
There is a strong overlap between the activities regulated under IMD and the regulation of insurance intermediaries under the IIA Nevertheless, the insurance intermediary provisions of the IIA continue in force, and insurance intermediaries are currently regulated by a dual process of authorisation under the IIA and registration under the IMD Regulations. MiFID is intended to replace ISD, and repeals ISD. However, in Ireland, the IIA has not been repealed and will continue in force post November 1st 2007.
The new operational requirements
MiFID updated and upgrades the operational requirements applying to former ISD intermediaries.
1. New conduct of business requirements
The conduct of business requirements set out by the MiFID Regulations include areas such as client classification, best execution and client order handling, assessment of suitability and appropriateness, provision of information to clients, inducements and conflict of interest.
• Client classification: there are three categories of client - retail, professional and eligible counterparty, with different degrees of protection for each category, e.g., retail clients are afforded the greatest degree of protection. Under IIA there were only two categories - private client or professional client.
The categories are explained more fully in Appendix I, but in summary:
- Retail investors are all clients who are not either professional clients or eligible counterparties.
- Professional investors are clients who possess the expertise to make their own investment decisions (institutional investors, large companies and public bodies).
- Eligible counterparties are certain defined types of professional investors, e.g. banks and insurance companies. However all professional investors may be treated as eligible counterparties if they request such treatment.
The MiFID Regulations provide for a much greater gap between the protections afforded to professional clients and retail clients. Investment firms are required to notify clients of the new categorisation or their right to choose a different category. Investment firms must also decide whether they will allow clients to seek a higher level of protection. Record keeping systems will have to be able to keep track of clients’ changing categorisation.
• Best execution and client order handling: firms must take all reasonable steps to obtain the best possible result for their clients, taking into account factors such as price, costs, likelihood of execution and settlement, when executing orders and must establish an execution policy.
• Assessment of suitability and appropriateness: when providing advice or portfolio management services, a firm must obtain certain information from clients so to enable the firm to recommend services and products that are suitable. When providing other services, firms must determine whether the service or product is appropriate.
• Provision of information to clients: information provided must be clear and in such a form that clients are reasonably able to understand the risks of the service or product offered.
• Inducements: the MiFID Regulations contain criteria in relation to the acceptance of fees, commissions and non-monetary benefits.
• Conflicts of interest: firms must monitor conflicts of interests and establish a conflicts of interest policy.
2. Market transparency
MiFID creates obligations for regulated markets and other trading venues such as systematic internalisers, and operators of multilateral trading facilities to provide greater transparency to the financial markets.
Under the ISD regulated markets provided transparency but other trading venues such as firms that matched clients’ trades were not required to disclose the price at which they concluded trades on behalf of their clients. One of the aims of the MiFID is to ensure that all trading venues are subject to similar requirements and these include both pre and post trade disclosure requirements in respect of shares admitted to trading on a regulated market. The information to be made available publicly includes disclosures in relation to prices and interests advertised through the trading venue’s systems, price, volume and time of any transactions executed on the systems.
3. Transaction reporting
MiFID requires investment firms (including credit institutions when providing investment services) who execute transactions in financial instruments, to report all transactions to the Financial Regulator in respect of financial instruments admitted to trading on EU regulated markets. The Irish transposing regulations have extended this requirement (as permitted by the European legislation) to include other markets operated by MTF operators such as IEX and AIM.
This requirement replaces the old regime under the ISD, whereby the Financial Regulator relied on the Irish Stock Exchange for information on trades, which the Stock Exchange would supply on request, based on the information supplied to them by their members.
4. Execution only
In certain circumstances, firms may provide execution only services or receive and transmit orders without obtaining information from clients or assessing appropriateness, e.g., services related to non-complex instruments. Non-complex instruments are typically listed liquid securities.
5. Capital adequacy
The initial and ongoing capital adequacy of investment firms must be compliant with the EU Directive 2006/49/EC (Capital Requirements Directive), as implemented in Ireland by SI No. 660 of 2006.
EU/cross border effects
There are two major improvements to MiFID over the ISD/IIA regime.
Harmonisation
Firstly, unlike the ISD, MiFID is a maximum harmonisation directive. Therefore, the Member States’ legislation to transpose MiFID cannot alter the substance of MiFID or impose requirements which are stricter than MiFID. A MiFID firm should, in theory, know exactly how it will be regulated in other EU member states in which it might wish to conduct business. In addition most firms that fall within the scope of MiFID will also have to comply with the new Capital Requirements Directive.
Cross border services
MiFID operates in a similar manner to ISD, in aiming to achieve a single market. Firms within the scope of MiFID are authorised and subject to ongoing supervision by their home member state. An investment firm can ‘passport’ its services, for which it is authorised, into any other EU member state without being subject to regulation by those host states.
However, the facility to provide cross-border services has been significantly improved. For practical purposes the changes can be summarised as follows, using the provision by an Irish investment firm of financial services to UK/Northern Ireland customers as an example:
1. Establishing a branch in UK/Northern Ireland - there is no huge change here from the old ISD/IIA regime. Client money handling requirements will now be regulated by the Financial Regulator, rather than the FSA, but these arrangements are harmonised under MiFID in any event. The Irish firm will be subject to local supervision of its transaction reporting and conduct of business requirements
2. Passporting into UK/Northern Ireland - this is where the most significant improvement has occurred. The Irish firm will be regulated wholly by the Financial Regulator, and will not have to deal with local transaction reporting or conduct of business requirements at all.
3. Establishing a representative office - a representative office is a pure marketing operation, without authority to actually conduct business in the host Member State. The purpose of this would be to establish face to face relationships with potential customers, which is important in financial services. Again, a representative office, so long as it is not classified as a branch, will be wholly subject to regulation by the Financial Regulator, making the conduct of business much easier. |
Peter Fahy is a partner and Patrick Collins is a solicitor in O’Donnell Sweeney Eversheds.
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| Article appeared in the November 2007 issue.
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