The Markets in Financial Instruments Directive (MiFID) II
MiFID II aims to protect investors and make sure that financial markets operate in the fairest and most transparent way possible. Building on stock and investment trading regulation introduced in 2007 it sets to ensure a more integrated financial market.
In 2007, a key EU legislation was introduced aimed at regulating firms who provide services to clients linked to financial instruments, as well as the venues where those instruments are traded. Commonly referred to as MiFID, it created a single market for investment services and activities and ensured a high degree of coherent protection for investors in financial instruments.
Amongst other things, MiFID set out:
• conduct of business and organisational requirements for investment firms;
• authorisation requirements for regulated markets
• regulatory reporting to avoid market abuse
• trade transparency obligation for shares, and
• rules on the admission of financial instruments to trading.
The original MiFID was a great contribution to a more competitive and harmonised EU financial market; however, rapid technological advances and the increasing diversity in financial instruments and methods of trading called for the need of an extensive review. These issues have been tackled with the new MiFID II directive and the Markets in Financial Instruments Regulation (MiFIR) which came into force in January 2018. MiFID II relates to the framework of trading venues/structures in which financial instruments are traded. MiFIR is concerned with regulating the operation of these trading venues and the processes, systems and governance measures adopted by market participants.
In general, MiFID II only applies to investment firms that are physically present in EU members states or countries that are regulated by a European regulator. However, third country investment firms that manage European mandates or compete for European clients' assets will face competitive pressure as clients come to expect the level of transparency that they are receiving from investment firms in Europe.
The Key Aspects of MiFID II
Market infrastructure and transparency
MiFID II makes a range of significant changes in relation to market infrastructure. It introduces the concept of an Organised Trading Facility (OTF) which captures trading in non-equity instruments which previously operated outside the scope of MiFID.
The rules around Regulated Markets (RMs) and Multilateral Trading Facilities (MTFs) have been aligned, and a range of organisational requirements currently applying to RMs and MTFs have been extended to the newly introduced OTFs. There are also new requirements for high frequency and algorithmic trading in relation to pre- and post-trade transparency.
Rules on inducements
Pursuant to the MiFID II general inducement rule, most incentives, including commissions and rebates for independent advisors have been banned, with few exceptions, such as where the payment or benefit is designed to enhance the quality of service to a client.
MiFID II also seeks to unbundle the purchase of research from execution services.
Transaction reporting which had been introduced under MiFID I and concerns trade detail reporting which is provided by investment firms to regulators has been strengthened, now allowing regulators to better monitor for market abuse. The scope of products which need to be reported has been extended with transaction reporting now being required for all products traded on European RMs, OTFs and MTFs. Additional data needs to be provided by investment firms including amongst others details of the person executing the transaction, details of the algorithm used to make trading decisions, whether the transaction is a short sale and whether any illiquid instruments are being engaged.
Transaction reporting will no longer be an issue only for sell-side firms, such as brokers and dealers, but will also become the responsibility of the counterparty who initiates the transaction, typically buy-side firms.
Investor protection and best execution
MiFID II seeks to enhance the best execution framework which was introduced under MiFID I, whereby MiFID II requires investment firms to take all sufficient steps to obtain best results for their clients.
Investment firms are also required to publish data relating to execution quality (i.e. cost, speed, etc.) at least annually without charge. Investment firms will have to publish, on an annual basis, their top five execution venues for the previous year, along with specific data relating to the quality of execution of transactions on that venue.
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