How to Achieve MiFID II Compliance

Posted by

Lynne Callister

on 15 Nov 2017

The Markets in Financial Instruments Directive arrived in response to the market crash. Following the PPI scandal, it was strengthened with the introduction of MiFID II.

How to Achieve MiFID II Compliance

The Markets in Financial Instruments Directive arrived in response to the market crash. Following the PPI scandal, it was strengthened with the introduction of MiFID II.

MiFID (or the Markets in Financial Instruments Directive) is a legislative framework designed to regulate financial markets in the European Union (EU). Its aim is to standardise practices across the EU, strengthen protections for investors and restore confidence in the industry.

What is MiFID II and who does it affect?

Markets in Financial Instruments Directive II (MiFID II) was implemented in January 2018. It brought with it significant changes, including a tighter product governance regime, unbundling of investment research from execution fees and appropriateness and suitability tests.

MiFID II revised the original legislative requirements in several areas including:

  • New market structure requirements
  • New and extended requirements in relation to transparency
  • New product governance requirements for manufacturers and distributers of MiFID ‘products’
  • New rules on research and inducements
  • Introduction of a harmonised commodity position limits regime

What is the impact of MiFID II?

MiFID II means that bankers, traders, fund managers, exchange officials, brokers and their firms all must abide by its regulations, as well as institutional and retail investors. This legislation places restrictions on inducements paid to investment firms or financial.

Banks and brokerages cannot charge for research and transactions in a single bundle for greater transparency. Brokers will also have to provide more detailed reporting on their trades and must store all communications, including phone conversations.

MiFID II Product Governance Regime

MiFID II introduces a new product governance regime covering the way that financial products, services and activities are manufactured and distributed across the EU.

This will have implications for product manufacturers and product distributors.

Product manufacturers must have a product approval process which ensures that:

  • Products they design meet the needs of an identified target market of end client prior to distribution and any risks are assessed
  • Their distribution strategy is compatible with the target market
  • Steps are taken to ensure the financial instruments are delivered to the target market

They must make this information available to distributors so they can in turn can meet their responsibilities.

Product distributors must use this information to verify that products are:

  • Compatible with clients’ stated needs
  • Only offered or recommended if this is in clients’ best interests

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How MiFID II Affects Investment Research Fees

Research costs can vary considerably. According to reports by Bloomberg, Bank of America plans to charge asset managers $80,000 per user, per year, while UBS Group AG will offer five users basic access for $40,000.

Under the investor protection framework within MiFID II, money managers will be required to pay for research separately from broking services, meaning that asset gatherers will need to decide who pays for the research that helps them make their own investment decisions.

Firms have two choices in relation to investment research

  • To make direct payments out of their own resources (which may or may not be reflected in higher fees to clients)

  • To charge clients for research from separate Research Payment Accounts (RPA's), controlled by the firm

Whichever approach is favoured and whatever the reality, it's clear that all firms will be thinking much more about getting value-for-money and that all-important ROI.

Best practice suggestions for investment research

If you intend asking clients to make contributions towards the cost of research via a separate Research Payment Account follow these steps.

  • Familiarise yourself with company policies
    You must be certain that any charges, budgets, and the quality and extent of research is in line with company policy.
  • Make appropriate disclosures to clients ex ante and ex post
    Firms must provide a breakdown of research charges and agree any changes in fees in advance with clients.
  • Implement systems and controls
    To ensure any surplus is reimbursed to clients or offset against future charges.
    Firms are not allowed to keep this surplus.
  • Keep records of all payments
    Be sure to provide regular statements to clients.
  • Document relevant evidence
    Remember, you must be able to demonstrate that research is in the clients' best interests and benefits them.

Suitability Tests Under MiFID II

Former investment banker, Christopher Niehaus, was fined £37,000 by the Financial Conduct Authority (FCA) for disclosing confidential information on WhatsApp.

In response to scandals like the mis-selling of PPI, the EU introduced MiFiD II, requiring those offering investment advice to make sure that it is suitable and appropriate.

According to figures released by the Financial Conduct Authority (FCA), over £27bn has been paid out already to those who were mis-sold PPI, with an estimated 64 million PPI policies mis-sold in the UK from 1990 to 2010.

Under the MiFID II rules, firms are obliged to ensure that when providing investment advice and/or portfolio management, anything that is recommended to their clients must be suitable and appropriate for their needs. To do this, firms must carry out suitability assessments for all recommendations (including buy, as well as sell or hold investments).

Checks to ensure suitability under MiFID II

    1. The client's knowledge and experience - i.e. the sorts of service, transactions and regulated investments they are familiar with; the type, volume and frequency of transactions; and their level of education or profession.
    2. Their investment objectives - i.e. risk preferences, risk profile and tolerance, and the purpose of the investment.
  • Their financial situation - i.e. the source and extent of their income, assets (including liquid assets, investments and property), ongoing financial commitments and their ability to bear losses.

And remember that all of this information must be reviewed and updated at least annually for firms providing ongoing advice.

Free MiFID II Training Presentation

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