MiFID has a way of impacting all side of operations: from changing the meaning of best execution to affecting the way a financial institution sources market data; from the concept that process and procedures behind an execution of an order on every financial product traded has to be shared with clients (and ultimately getting their approval) to transparency of trade reports. Companies will have to create process and procedures, review them on a regular basis and prove to clients and to the regulators that these procedures are followed.
MiFID expands the coverage of the old Financial Service Directive, that means that a whole new group of companies (e.g. commodity traders) that were outside the FSD are now included in MiFID
A lot of experts have discussed MiFID; law firms, experts, professionals have all discussed the big principle behind MiFID. Very few have discussed practicalities and the implication of becoming MiFID compliant; probably because the final Instruments were published by the FSA only a few weeks ago. In the meantime a few myths and a few dangerous claims have appeared in financial markets around Europe.
Myth number 1: Best execution in MiFID only refers to equity. In a survey of compliance officers of London based brokers, hedge funds and commodity traders, over 60% have implied that MiFID does not really affect them because they do not trade in equity. Well, Annex 1, section C of MiFID lists the financial instruments under MiFID[1] and they cover far more than equity. Now, within the boundary of reasonability, each instrument traded needs a best execution policy that has to be regularly updated and shared with clients. It could be argued that there must be policies for retail clients and policies for professional clients. OTC products do not escape that completely, since they are unique and taylor made they may require agreement with the client as far as execution policy is concerned. Now best execution under MiFID means more than just best value, it also means lowest costs, likelihood of execution and settlement, and any other relevant factor that may influence the execution of the order. Financial instrument traded in regulated markets and or in Multi-lateral Trading Facilities (MTF) will require listing venues regularly used and why and that list will have to be regularly updated (and shared with clients).
Myth number 2: Clients will have to be classified in each instrument, this is partly correct but in practical terms it will be far simpler for a company, especially smaller institutions, to reach a common classification for clients.
Myth number 3: bolt-on solutions. A lot of MiFID compliance requirements involve process and procedures. In many ways, these represent some of the features that allow a business to differentiate from the competition. The FSA in his translation of the EU rules has increased the emphasis of process and procedure; unfortunately this negates a standard, good for all solution. Some part of MiFID could be standardised;on the other hand, trade reports are strictly related to processes and procedures that define best execution. MiFID will also have to live side by side with existing regulatory requirement. That will have an impact on reference data, how market data are sourced and used within the companies, all the trading software, and a lot more within a company.
Myth number 4: Client classification is straightforward. On one hand, it is true. On the other hand, MiFID allows trading outside regulated markets, therefore an institution may conceivably find itself executing both sides of the trade. For this reason a conflict of interest policy has to be in place and… of course, shared with the client.
MiFID is not all pain. MiFID will make it easier to operate in other EEA markets, it defines the relationship between the ‘home’ regulator and the ‘host’ regulator. This is a huge contribution to the single market for financial services. MiFID will also allow institution to trade beyond the obvious regulated market in their jurisdiction, it opens up the competition between exchanges, it creates the role of Multi-lateral Trading Facilities (MTF) and ultimately will bring down the cost of trading. Exchanges (from stock exchanges to derivative markets, from commodities exchanges to FX exchanges) will loose the ability to exclusively influence the value of the financial instrument traded.
MiFID has been compared to Big Bang 2. There is too much to gain by London as a financial centre for the FSA to become flexible on November 1st. The time for practical action is now. There is little time to wait. Being compliant with MiFID will not be particularly onerous, becoming compliant will not be cheap, quick or easy.
[1] The products listed include: transferable securities, money market instruments, units in collective investment undertakings, options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies interest rates or yields, derivative instruments for the transfer of credit risk, financial contract for differences, etc. etc. etc.
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