MiFID expands the concept of ‘investment business’ – Part 2

This is the second of three parts that look into specific issues of trading in instruments that are in the list of MiFID and were not in the list of the ISD. Institutions dealing in those financial instruments face the need to implement MiFID and CRD (Basel 2) at the same time and therefore becoming compliant means a lot of work, with issues related to the specific nature of some of the businesses involved. This article looks at spread betting companies.

Annex I of the level 1 Directive published in 2004 lists contract for differences as one of the financial instruments within the scope of MiFID. Therefore dealing in contract for differences is an activity deemed to be an investment business.

This provision brings all the spread betting companies under the MiFID umbrellas. This presents a few challenges and several advantages. For once lets start with the positives.

A spread betting company is an online business 99% of the time. Once they are passported under MiFID they will be able to operate all over the EU (plus Norway, Iceland and Liechtenstein). Being an online business they do not really need branches, all they need is a telephone number for customer service in the relevant language and nowadays this can physically be arranged from their home country. Without a branch in a territory they can operate into that territory with the home Conduct of Business, therefore they will be able to advertise for the first time throughout the EU, proactively seeking clients in other European countries (rather than passively waiting for the clients to find them) and still work under UK conduct of business rules. Isn’t that great ?

The flip side of the coin is having to be MiFID compliant and CRD compliant. This present some interesting issues, first of all what are they ? Most of them write their own contract for differences (the spread bet) and have their own policy for margin calls, etc. They also tend to hedge their exposures but the two sides are completely independent from one another. So, you have an online platform for retail trader that trades only contract they have prepared. Are they a trading venue (e.g. a systematic internaliser) or are they an investment business engaged in proprietary trading? I leave it to the legal eagle to answer that.

Being on line they need to have a client execution policy that includes notices as to suitability and appropriateness of investing in contract for differences (most of their clients will be classified as retail clients anyway) and it could be argued that most of their transaction are on an execution only basis (nobody advises ‘me’ to bet one way or another, my own ‘bet’ defines the contract for difference that will be written and therefore there is no specific advice given). The relationship with their client is mostly online, therefore they need to post their policies on line and have to find a way to make sure that the client ‘pro-actively’ acknowledges them and agrees with them (this could be part of the registration process for new clients). Interestingly enough these issues are shared with any on line trading platform available to the general public irrespective of the financial instrument traded.

Their capital adequacy also presents interesting issues especially in the criteria used to mark to market their exposures. Another interesting side that covers both MiFID and CRD is Risk Mitigation and I wonder how they can relate their hedging policies to mitigation of financial risk and their business continuity solution to mitigation of operational risk.

Overall, this is a business sector that will have a lot to gain from MiFID (mostly thanks to passporting) and that explains why a number of industry professional I spoke to had an interesting upbeat attitude towards the whole thing (attitude that may not necessarily be shared by their compliance manager)