MiFID II & MiFIR: FAQs
In October 2011, the European Commission tabled proposals to revise the original Markets in Financial Instruments Directive (MiFID) with the aim of making financial markets more efficient, resilient and transparent, and to strengthen investor protection.
On 15 May 2014, the second Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) were published in the Official Journal of the European Union.
These FAQs will attempt to clarify some of the key issues surrounding both MiFID II and MiFIR.
Why is there a new legislation?
Since its implementation in November 2007, MiFID has been the cornerstone of capital markets regulation in Europe. Like most European legislation, MiFID contained an obligation on the European Commission to review the implementation and impact of MiFID after a number of years. MiFID II / MiFIR is intended to address the shortcomings of the original MiFID, to extend the scope of MiFID, to respond to lessons learned during the financial crisis and to cater for market and technological developments since 2004.
What is the MiFID II / MiFIR legislation?
MiFID II / MiFIR is an EU regulatory framework consisting of two pieces of legislation: a Directive (MiFID II), and a Regulation (MiFIR) aimed at increasing investor protection by creating a more efficient, risk-aware and transparent market for investment services and activities. MiFID II comprises of 3 levels. Level 1: MiFID II and MiFIR (the framework of the reform) have been finalised. Level 2: RTS and Delegated Acts (the detail of the reform) are expected to be finalised in phases around Q2 2016. Level 3: Q&As and Guidelines (the clarification of the reform) is expected from January 2016 onwards. Many of the rules in MiFID II will also have to be implemented by EU member states into national legislation and regulation.
To whom does MiFID II / MiFIR apply?
Those Financial Services businesses undertaking MiFID business anywhere in the European Union (‘EU’) including:
- Investment firms, such as HSBC Bank plc
- Market operators and firms operating certain trading platforms
- Central Counter-parties (CCPs) and persons with proprietary rights to benchmarks
- Third-country firms providing investment services or activities within the EU
- Certain unregulated entities which enter into commodity derivative transactions
- Data service providers
MiFID II will also affect all counterparties in the EU’s financial markets, whether they are based in the EU or elsewhere, including providers of asset management and custodial services.
When will MiFID II / MiFIR begin?
The European Parliament endorsed MiFID II and MiFIR on 15 April 2014, and the Council of the European Union adopted the legislation on 13 May 2014. The MiFID II legislation was published in the Official Journal on 12 June 2014. Both MiFID II and MiFIR entered into force on 2 July 2014 (20 days after publication). EU Member States are required to implement MiFID II in their national legislations within 24 months after the entry into force of MiFID II (currently June 2016).
Firms must comply with MiFID II / MiFIR from 3 January 2018.
What are the significant changes proposed by MiFID II / MiFIR?
The significant changes proposed to the Markets in Financial Instruments Directive include:
- MiFID II seeks to extend price transparency, by imposing a range of requirements on firms which trade European financial instruments.
- It seeks to ensure that trading platforms in the EU are regulated, either as Regulated Markets (RMs), as Multilateral Trading Facilities (MTFs) or as a new venue type, the Organised Trading Facility (OTF), which is a multilateral trading facility system (with some discretionary characteristics) for non-equity instruments.
- It extends the scope of the existing MiFID ‘Systematic Internaliser’ category (SI) and increases transparency requirements for SIs across a range of financial instruments including bonds and derivatives.
- There is a requirement for investment firms to trade EU listed and EU traded equities on a RM, MTF, OTF or as an SI. The legislation also envisages a similar requirement in relation to certain (yet to be defined) standardised and liquid OTC derivatives.
- It aligns requirements for RMs, MTFs and OTFs.
- It introduces compliance obligations on firms undertaking algorithmic trading, high frequency trading and/or providing direct electronic access (comprising direct market access and sponsored access).
Transparency and Transaction Reporting
- MIFID II increases equity market transparency by significantly restricting the scope for dark pool trading.
- New pre- and post-trade transparency requirements will apply to trading in fixed income instruments and derivatives. The extent of requirements will be determined by reference to deemed liquidity of the instrument type.
- It widens the scope of obligations in relation to transaction reports made to regulators for market abuse monitoring purposes (wider scope of transactions, extension to include orders which were passed to a broker for execution, extension of the level of detail required in the reports).
Business Conduct, Supervision and Product Scope
- Stronger investor protection is achieved by introducing strict organisational requirements in relation to product governance, conflicts of interest and inducements which also require more detailed involvement by the firm’s management body.
- Regulatory scope is extended to cover structured deposits for investor protection purposes.
- Regulators will have the ability to ban products or services that threaten investor protection, financial stability or the orderly functioning of markets.
- Administrative sanctions strengthened to ensure effectiveness and harmonisation.
- To meet G20 commitments, MiFID II provides additional supervisory powers and a harmonised position-limits regime for commodity derivatives to improve transparency, support orderly pricing and prevent market abuse. This regime applies to users of relevant commodity derivatives, including unregulated users, with no specific end-user exemption.
Non-EU (or ‘Third Country’) Investment Firms
- Certain Member States may require non-EU firms who wish to service retail and elective professional clients to establish a branch (which will have to be MiFID-regulated) in that Member State. Please note that any such requirement will likely apply where seeking to provide services to local authorities or municipalities in such Member States.
Are there changes to the MiFID exemptions?
A number of exemptions on which many entities rely are being amended or restricted within the MiFID II / MiFIR reforms. Among others:
Dealing on own account exemption
- This exemption has been amended so that it will no longer be available to persons who deal on own account in commodity derivatives or emission allowances. Members of and participants in an RM or MTF, persons who have market access to a trading venue, and persons engaged in high frequency trading will also be unable to continue to rely on this exemption.
Commodities dealer exemption & ‘Locals’ exemption
- Both have been removed under MiFID II.
Commodity related systems
This has been amended to include persons acting as service providers on behalf of transmission system operators, and limited to relevant activities in commodity derivatives.
Are there changes to the MiFID client classifications?
Under MiFID, clients can be categorised as i) eligible counterparties ii) professional clients or iii) retail clients. MiFID II does not change the category of a client, or the various monetary thresholds and experience levels that eligible counterparties and professional clients are required to meet. However, there is a change in relation to municipalities and local authorities.
Municipalities and local authorities are now required to be treated as retail clients, although they can elect treatment as a professional client if they meet certain qualitative and quantitative tests. Therefore, some re-classification may be required in relation to these clients.
What should HSBC clients be doing to prepare for the new reforms?
- Clients should start planning towards January 2018, despite the fact that until the Level 2 legislation is in final form and published in the Official Journal, exact details are unclear. Even then, additional information will be provided by ESMA through Level 3 guidelines and Questions & Answers, some of which will likely be issued after 3 January 2018.
HSBC therefore recommends clients to continue navigating through the expected reforms via their respective Legal teams.
What are the key challenges for HSBC clients?
MiFID II and MiFIR represent both a considerable challenge and a significant opportunity, for firms to improve their organisation and their way of doing business. The regulations are extensive and very complex, presenting three major hurdles:
- Provisions for investor protection will require firms to reshape their business models and cope with major new demands.
- Provision for pre- and post-trade transparency: Companies will need to take appropriate steps to master the greater transparency requirements demanded by MiFID II / MiFIR and to account for any consequential changes to liquidity in the markets.
- Internal organisational set-up and risk control.
In addition, there could be a need for significant systems build from scratch to assist with the new requirements, including the transparency requirements in relation to fixed income and derivatives, or where a line of business becomes subject to a new set of regulatory rules, such as the commodity derivatives position limits regime.
Re-papering is also inevitable due to new legal requirements and compliance procedures.
Clients and internal staff may not know exactly what is required from the legislation until relatively late in the process, potentially leaving firms with little time to implement and comply.
What is a Systematic Internaliser (SI) and how are the criteria changing for MiFID II?
The definition of a Systematic Internaliser (SI) is unchanged from MiFID: An investment firm which, on an organised, frequent systematic and substantial basis deals on own account when executing client orders outside a regulated market, an MTF or an OTF without operating a multilateral system. However, under MiFID, there was no specification of the individual key terms and firms were generally able to conclude that they were not SIs.
The specific thresholds and tests introduced by MiFID II will mean more firms are likely to find they meet the criteria of an SI. The SI category is also broadened in terms of scope, capturing trades in a variety of instruments including depository receipts, exchange-traded funds (ETFs) and also non-equities, such as bonds, structured financial products and derivatives.
What is a Regulated Market (RM)?
A Regulated Market is a multilateral system, (as defined by MiFID), which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments in a way that results in a contract. For example, the London Stock Exchange (LSE).
What is a Multilateral Trading Facility (MTF)?
A Multilateral Trading Facility is any system or facility operated and/or managed by an investment firm in which third party buying and selling trade interests are able to interact in the system.
What is an Organised Trading Facility (OTF)?
An Organised Trading Facility is a new concept under MiFID II. The OTF is a multilateral trading system operated by an investment firm or a market operator which allows trading in non-equity instruments (MiFID II does not permit trading of equities on an OTF). In contrast to the MTF, an OTF operator may exercise some discretion over execution; however the discretion is limited to (a) when deciding to place or retract an order on the system they operate; and (b) when deciding not to match a specific client order with other orders available in the systems at a given time.
How does MiFID II / MiFIR align with other regulations?
The revised EU Market Abuse Regulation (MAR) and Criminal Sanctions for Market Abuse Directive (CSMAD).
MiFID II and MAD/MAR both seek to ensure the competitiveness, efficiency and integrity of EU financial markets. They have been updated in tandem to ensure that they are fully coherent and support each other's objectives and principles. MiFID II and CSMAD / MAR have therefore been given the same extension of scope in terms of instruments. CSMAD imposes criminal liability for market abuse. It requires implementation into local law.
MAR and CSMAD come in to force on 3 July 2016.
Title VII Dodd-Frank Act
MiFID II covers areas addressed by various pieces of US financial markets regulation such as the Securities Exchange Act and the Commodity Exchange Act. Like Title VII of the Dodd Frank Act, which amends these texts in order to implement G20 commitments made in the wake of the financial crisis, the review of MiFID both amends provisions already in force and adds measures in light of the financial crisis and other market developments. MiFID II and EMIR (European Market Infrastructure Regulation) together seek to implement the post-financial crisis G20 commitments which are implemented by Title VII Dodd Frank Act, although the implementation is in a number of areas not consistent between the EU and US.
Interrelated regulatory reporting requirements
Many regulations impose reporting obligations on firms; there are instances where there are interrelations between the two, whereby clients will only need to report once to meet both requirements however there are some cases when firms will have to comply separately with both. Firms must keep up to date of each of the regulatory reporting obligations to ensure they adhere to their obligations.
An example whereby the regulators are attempting a level of alignment for reporting obligations concerns a transaction which has been reported in accordance with EMIR to a trade repository, which operates as an Approved Reporting Mechanism (ARM) for MiFID II purposes, and where the report contains the details required by MiFID II and is transmitted to the competent authority by the trade repository within the time limit set in MiFID II. Such a report should be deemed to satisfy both the EMIR and MiFID II reporting obligations.