MIFID II is the second directive on markets in financial instruments (the first was MIFID I, introduced in 2007) issued by the European Commission. MIFID II has been applied across the EU since January 2018.
MIFID II seeks to "level the playing field" by standardising financial markets and finance industry regulations across all 30 member states of the European Economic Area ("EEA"). The directive covers investment firms, banks, market operators, data reporting services providers and third-country firms which provide investment services or perform investment activities in the EU.
Key aims of MIFID II
The regulations which are in place as a result of the MIFID II directive aim to increase competition, investor protection and level the playing field for market participants in investment services:
Investor protection - ensuring products are appropriate for clients, proper advice is being given and fees are being defined in a clear way; linked to the quality of the service being provided
Trading transparency - ensuring financial markets are operating professionally
Internal controls - more controls on compliance, audit and frequent reporting in order to avoid the many mishaps of the financial crisis (you'll have heard some of the crazy stories by now - if you haven't, it's worth googling "LIBOR scandal"!)
Let's look at each of the above in more detail in order to understand what's going on a little bit better.
Investors should know where they are investing and why, how much it will cost and how it is performing. This means that financial institutions should be aware that their clients understand the level of risk of the investments they are interested in making.
MIFID II aims to harmonize the initial authorization and operating requirements for investment firms including conduct of business rules as well as harmonization of some conditions governing the operation of regulated markets. However, some people believe that MIFID II has the potential to radically shake up how financial institutions work in many ways - considering it to be both an opportunity and a threat.
Why it is an opportunity?
In recent years more investors have become active in financial markets and are offered a variety of increasingly complex services and instruments. In order for financial institutions to offer these servies throughout the EEA in a consistent and uniform manner, it is necessary to make sure the rules, regulations and conditions under which they offer these services are also consistent throughout the EEA.
In practical terms - if a firm is located in Germany and wants to offer its services to clients based in the UK, it becomes much easier to do this if both the firm and its clients are regulated by / playing by the same set of rules in both the UK and Germany. This is where MIFID II comes in - having everyone following the same set of rules regardless of where they are based and who the local regulator is - makes things run much more smoothly and helps to create a more united European Economic Area.
Nevertheless, it can also be considered as a threat as we will see later in this article!
Transparency is one of the main areas of focus for the new rules. The financial crisis highlighted the need to strengthen regulation of financial markets in order to increase transparency, better protect investors, reinforce confidence and take into account potential unregulated issues. This increased regulation is made possible thanks to MIFID II giving regulators the necessary powers to undertrake their work.
For example, regulators have to check whether trading has become more transparent regarding the price of listed securities. This is known as 'Best Execution', meaning regulators are monitoring the prices before a trade takes place and after they have taken place. This enables them to better assess how those prices compare with the rest of the market. Therefore, when MIFID II came into force, a much larger quantity of pricing data has had to be maintained by the regulators in order to better protect investors.
Accordingly, the purpose of this Directive is to ensure that the provision of investment services and/or performance of investment activities is being done on a professional basis.
Suitability, reporting frequency, information disclosure (e.g. details of charges, annual disclosure of total costs and etc.) to the regulators and/or customers are one of the main key areas of MIFID II. The underlying principle is that the more we document / keep in check, the better the end outcome for the consumers of financial services (you!).
Financial institutions have always been required to provide regular reports (to avoid market abuse), such as transaction confirmations, periodic updates and more. MIFID II requires that some documents are sent more often to the regulators - not periodically (which basically means once in a while), but quarterly. Moreover, suitability requirements applicable to financial firms have to be taken into account as well.
So, going back to what we mentioned earlier, why might MIFID II be considered a threat?
Well, information overload is always a risk. Just by providing more information, you aren't necessarily guaranteed to get the best quality of judgment or decision making. Furthermore, the imposition of so many rules can reduce market access and reduce the number of firms who are able to provide financial services which comply with MIFID II regulation - this can ultimately lead to a poor outcome for investors if they have less potential financial service providers to choose from.
The increased costs of complying with MIFID II have to therefore be outweighed by the benefits that it brings. With respect to the benefits - the positive impact of MIFID II is fairly obvious.
As a “single rule” it has reformed trading markets in Europe and helped provide a model for financial services regulation which other countries around the world can use as a solid point of reference when creating their own financial regulations. It has covered almost all the areas from investment decision making to client reporting and made them safer, more transparent and more efficient!
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.
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