The Markets in Financial Instruments Directive (MiFID) has finally escaped from the clutches of the legal and compliance departments and now operations have begun to give some serious thought to implementation and compliance. The current market position, however, is almost one of fear or at least doubt about MiFID implementation, given the timescales that have been set by the EU Commission in Brussels.
For the past year, most of the media has been prompted into action by forecasts from various research organisations about the cost of changes to systems required to meet MiFID compliance in November 2007 (the current new date set). The date changed after the market lobbied hard to explain not only the complexities of changes in systems and services caused by MiFID, but also the time required to educate and inform people about MiFID, as well as analyse the effects and business decisions needed to be undertaken. All of which is difficult to begin if business people are sceptical of MiFID and its likely implementation. That aside, the current market view is that MiFID is real and it will be implemented, but most financial services firms are still unsure about what they need to do to comply or what threats and opportunities lie in wait for them.
The market today has been inundated with one regulatory demand following another, including Sarbanes-Oxley, Basel II, operational risk and now political projects, such as the European Union Savings Directive (EUSD). In a market that has become punch drunk with projects all designed around non-business related benefits, it’s not surprising that many firms need a regulatory rest. The end of the second round is near, however, and renewed fortitude is required for the rest of the fight to get that business knock-out blow.
Role of the Vendors
Typically, over the past year, budgetary concerns have taken centre stage, established mainly through hungry suppliers looking for some much-needed new sales, or for that matter any sale.
SOX, Basel II and operational risk established a similar market situation to MiFID, where you could hardly pick up a paper without some software vendor or consultant extolling the virtues of their brand new product or their market expertise to enable companies to comply. It is not a case of ‘buy this product and you will be able to comply’; it is vital that common sense prevails this time and there is no over-marketing or dumbing down of MiFID requirements by vendors. Everybody has to earn a living but it is the vendor community that is the most eager and tends to jump first and over hype when the scent of new revenue is in the air.
The suppliers always tend to operate in the same way: first, building the fear factor and then preying on the worries of the buyer. This tactic has certainly worked in the past and it is no different with MiFID. To gain the attention of the buyers it is normal for over zealous sales and marketing to swamp the media with outrageous claims of cost and size of projects and that, because it is a law and includes regulatory changes, you need to budget now. Consultants will prove that an immediate impact analysis is called for and they dust off an old Y2K methodology and try and resell.
The first market wide initiative to be set up was the MiFID Joint Working Group in April/May 2005, led by Chris Pickles from BT Radianz, supported by Tony Kirby at Accenture and Nigel Solkhon at IBM. They have mainly led the campaign along with Bob Fuller, IT director at Dresdner Kleinwort Wasserstein. There is nothing wrong with this initiative at all, but it was looking at implementation issues, rather than the business decisions that need to be made first. This was clearly the cart before the horse, but it was necessary as the business end has been so slow in mobilising. The chronological order of events was therefore out-of-sync, but has now been rectified through the formation of MiFID Connect. This is a group of 10 market trade associations that together represent most of the securities industry. It has been mainly UK centric to date, but it is not intended to remain that way and a concerted attack on continental Europe to gain wider involvement is ongoing.
MiFID has almost achieved legal reality with its principles at level one virtually assured to be passed through EU parliament and ratified across all EU states. It is at level two, where MiFID is today, that concerns implementation and the changes required to individual EU member states’ regulations to ensure a harmonised rule book across the EU. The latest update of MiFID level two guidelines was in early February 2006 after the most laborious market consultations. Publication was severely delayed from before Christmas, an indication of the complexity and possibly the debates and lobbying by the big investing institutions going on within the EU parliament.
Business Evaluation of MiFID
MiFID is not as bad as it has been painted by many, although it does demand some very serious evaluations at a business level before panic sets in, with IT budgets set and consultants employed. The core principles of understanding, evaluating and making decisions concerning MiFID is to first keep in mind that it is political and not business focussed. This is because MiFID is vitally important in the creation of a single European capital market, a key political objective of the EU Parliament. Therefore, despite its business demands, it has to be compatible with that political objective.
Second, the aim of MiFID is to provide greater protection to the end investor, especially the retail investor. To enable the greater protection of investors, MiFID insists on the transparency of pre- and post-trade information and the formalisation of a best execution policy. Formalising because most investing intermediaries already operate best execution but it may not have been written down or agreed with clients. The best solution of complying best execution under MiFID is very simple.
Best execution compliance
First, write down your best execution policy and check it against MiFID requirements and fill the gaps. At a recent Industry Standardisation or Institutional Trade Communication (ISITC) conference, a representative from the Investment Management Association, who sat next to a representative from the EU commission, stated that providing an existing best execution policy is implemented (even if only one trading venue complies), there would be no need to do any more. Needless to say the representative from the EU Commission went a whiter shade of pale and insisted that this was in breach of the objectives of MiFID, but agreed it was legal. Expect any loopholes to be plugged soon. Adding a best execution policy will not be very difficult unless the insistence of the EU says it is mandatory to search all trading venues, which is not likely.
The transparency issues are not new in the UK but might be in many of the other EU markets, but again one of the core principles in a service industry must be transparency of price, costs and service, to enable clients and customers to choose their supplier of choice. If a market has trouble with this, it should be avoided by investors. Transparency in markets is good and breeds competition with lower prices and improved services.
The creation of systematic internalisers (SIs) in the market place to publish prices of trades that are cross-matched within a single bank and that have been hitherto invisible within a bank is a good thing for investors. The SI will provide competition to the traditional stock exchanges and no doubt some will fold as a result. This is most unlikely to be the case with the main exchanges and absolutely in the case of the London Stock Exchange (LSE), where their business strategy has been kept very quiet. The LSE appears to be best placed of all the big stock exchanges to win new business and continue to be a success story. The German exchange is worst-placed where Euronext are always up for a deal and that may be with the LSE if the terms are right. For once, the LSE appears to be the best-placed and most likely to be the aggressor in the future and MiFID is helping.
A third core principle is record keeping and the ability to prove under inspection the quality of performance of the intermediary. How is this a bad thing? In most firms, the ability to provide evidence in case of dispute or as proof of service quality should be very desirable and if it is not in place now, this is the time to do it.
The fourth principle is client categories and the ability for individual clients to move between retail and professional. This might be a ticking bomb after MiFID if for some reason a legal or class action is taken because a client was wrongly categorised or misrepresented leading to exposure, risk and loss. This MiFID principle should definitely not be treated lightly.
The fifth principle is in the repapering of clients’ contracts and service agreements and here there has been much market confusion and dispute. This is mainly because of the lack of desire for intermediaries to take on a repapering project based on difficulties in similar projects in the past and the EU Commission’s desire to ensure that they do not over burden the market. MiFID does not say you must repaper clients with new contracts but it implies in many of its sections that a firm should.
My concern on the ‘repaper or not’ debate is if legal precedence is set post-MiFID if a client takes legal action because of changes to a service or understanding brought by MiFID that culminates in a client loss. Most of today’s market regulations have been built on cases and disputes where precedences are set. MiFID sets an environment of changes to business practices and procedures that clients need to sign off on. I, for one, would not like to take a chance and be the first firm to be in court as a result of MiFID non-compliance.
One further comment on the ‘repaper or not’discussion is the obvious business value of cleaning databases and contacting clients to market and sell new services. Do not forget that MiFID opens markets up and the competition will be out there chasing somebody else’s client.
MiFID is not a scary directive and does not mean huge budgets need to be set aside, despite what suppliers might say. There is nothing in MiFID that any decent respectable financial services firm is not already doing. It does, however, need to be evaluated at a business level to assess the opportunities and the risk of not taking those opportunities.
MiFID is opening up the EU markets for competition by establishing a new rulebook and passporting capability allowing the setting up of new business in different EU member states. There is a burgeoning market of new investors to target, and with the massive EU-wide problems of pension shortfalls, MiFID can be a big driver in producing increased investment opportunities and ensuring the gap in pension provision is narrowed. It is the biggest business opportunity for financial intermediary firms since the ‘big bang’ in the mid-eighties.
The consolidation of CREST and Euroclear is producing a pan-European clearing and settlement capability with the new SIs providing EU-wide execution facilities. In many cases, the SIs will offer their own in-house clearing and settlement along with execution and custody. The client relationship and advisory services will remain with the wealth managers and independent financial advisors (IFAs) with potentially a massive increase in new IFAs offering pan-European opportunities. Outsourcing will become even more prevalent than today and costs should plummet for execution, clearing and settlement. Margins are likely to be cut within banks and other intermediaries, but volumes should increase massively to more than cover the shortfall.
The big question that remains open is the actual date of MiFID implementation. Will it stay at November 2007 or move again? This time last year it was said the date had no chance of moving from May 2007 only to be moved to November 2007 at the end of last year. At a recent conference, speakers from the FSA, HM Treasury and the European Commission answered the question posed of a further date change in the same way: “There is no appetite for a further delay”. Not a categorical no, which means there is every chance it will be moved if the conditions dictate. If a condition exists, for example, where the UK is already compliant but continental Europe is not, will the EU forge ahead leaving the market open to UK exploitation or will they delay until a level playing field exists?
MiFID is a great opportunity for business to build and develop new services and products into one of the biggest markets in the world. There are costs involved but nowhere near as huge as the vendors are proclaiming. There are risks in any change, but the biggest risk of all is to allow your competition to steal your clients. Firms should understand, plan and take advantage of what MiFID has to offer. Forget the vendors and their cost fears, and concentrate on your future business opportunities.
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