Do we need an idiot's guide to MiFID ?

30 October, 2007. MiFID will happen in less than 48 hours from the time I am writing this. How nice of the Financial Times to dedicate one page to MiFID and a full section of the Lex Column to a "Mifidiot's guide".

The conclusion in this guide is that MiFID is a "one-off, back-office event". Well, this is interesting to learn for those who have spent time, efforts and money in other areas of any investment firm. JWG-IT (www.jwg-it.eu) has a very interesting diagram showing all the areas affected by MiFID and it is goes way beyond the back office. I wish I could share the optimism of MiFID being a one-off, it will not be possible to see the effects of some of the major changes brought in by MiFID until way into 2009, therefore we shall see a MiFID II and maybe a MiFID III when it will be possible to assess some of the changes introduced post 1 November (also, there are two major reviews planned for 2008 - commodities and fixed income transparency - so there goes any hope for a ‘one-off' change).

The same guide shows a major lack of understanding of the core impact MiFID will have on the financial industry. Splitting listing from trading mean that you do not have to list in the same jurisdiction that also ‘hosts' the major market for your shares. As I wrote a few months ago "Shares listed in Finland could be traded in Portugal, a company listed in Cyprus could be traded in Iceland and everything of any liquidity will be traded in London." (see my blog "Vision of a post MiFID Europe" ). Some regional stock exchange may emerge as a major "listing hub" for Europe and market concentration may follow different pattern of investment in different parts of Europe.

Major consequences for Front Office people have been overlooked, one of the challenges will be coping with what to say to clients that may occasionally make execution only orders and occasionally seek investment advice and with clients that are classified as ‘retail' for one financial instrument and ‘professional' for another.

Is there a market out there for an idiot's guide to MiFID ? Maybe, but it has to be an accurate one.

A double espresso in the MiFID Starbucks!!!

Just to wake you up!

Time goes by and yet MiFID still refuses to go away (By the way, do you realise there are now less than 100 calendar days to 1 November ?). There are urban legends that are still doing the rounds of city institutions:

· “Professional Clients are exempt from Best Execution”,

· “xyz has a standard MiFID compliance package that will be available in October”,

· “We are not really affected by MiFID, we are the branch of a non-EU institutions and although we do operate investment business from London MiFID is not really our problem”

· “MiFID is just for exchange traded instruments” was still heard last week (although I admit it was the only time in the past four weeks)

… and the award definitely goes to

· “Nobody in *** (put a firm type here) can really comply with MiFID and therefore we are not doing anything yet until we know where the wind blows.

Why is it that three months from a major regulatory deadline (MiFID) and five months from another deadline (CRD) very few compliance officers are worried or even afraid of losing their jobs? What about IT infrastructure? And how will every client facing person will behave if the in-house ‘MiFID guru’ does not share his/her knowledge?

First wake up call: It does not matter what happens to other jurisdictions within the MiFID area. If you are based in the UK, MiFID is the law of the land! So you have to get on with it (amazing how the recent Sungard survey fails to point that out when they ask the relevant question).

Second wake up call: All the relevant authorities are sending out clear messages that there will be no extension of the deadline. The messages are getting clearer and clearer and a lot of jurisdictions are planning summer blitzes to transpose by the end of September (whether they will all achieve it is another matter, but then the first wake up call still applies)

Third wake up call: It is not just MiFID, s****** ! CRD (Basel 2) has to be implemented as well, then you have AML rules, etc., etc… You have better take a comprehensive look at the whole regulatory environment if you do not want to run the risk of starting all over again.

And yet there are still things that need clarification and even more things where confusion reigns due to misunderstandings of clear rules. For instance, market making will change and the role of a systematic internaliser should be examined very closely (some institutions out there may actually have to become one if they want to continue market making), however the buy side has no interest in internalisation (another question that the Sungard survey gets wrong).

All of this should not be an excuse for slow action and lack of preparation. The two surveys recently published by Sungard and Thompson/IFR agree that institutions are not ready (although the population of respondents is not really huge. Sungard claims 300 respondents from Financial Institutions, Vendors and Consultants based in the EU, America, Asia – hardly a cohesive sample - and Thompson/IFR had less than 100 respondents, although from Tier 1 and Tier 2 institutions with the majority based in the UK - a more consistent population of respondents).

One thing is clear. Larger firms are getting ready. Smaller firms need to get a move on. The risk is not decreased competitiveness in the market; the risk is not being able to operate in the market at all. And whose head will roll when that happens?

Vision of a post MiFID Europe

In the past few weeks I have been a member of two panels discussing life post MiFID and I have been in the audience when the same was discussed four more times in different venues in the UK, Germany and Italy.

After a while, it gets boring; you keep hearing the same thing and you wonder how many people have actually missed the point. MiFID separates listing from trading, one of the most important thing that will happen in post MiFID Europe. Shares listed in Finland could be traded in Portugal, a company listed in Cyprus could be traded in Iceland and everything of any liquidity will be traded in London.

Equities are the easier example to make at the moment, bonds and other fixed income instrument (a favourite component of most investment portfolio in Germany, Italy, France and several other European countries) will follow quickly and other financial instruments will follow more slowly.

The London Stock Exchange could be in a fantastic competitive position; it is widely respected, it currently serves the largest financial market in Europe (well, actually in the world) and it currently boasts an acquisitive attitude in Europe (see recent announcement of a ‘merger’ with the Milan Stock Exchange). And yet, all we here from the LSE is how it will compete with Chi-X (something already working), Equiduct (something not really working yet) and other MTFs in London. Why? It should be out there with the most aggressive players in Europe. It has the name and the clout to start trading in large, liquid European Shares from November 1st. And yet, we only hear how its costs will be comparable with other trading venues in the UK. Why is it so inward looking? Also, why does it seem to be so blind to the risk of other Stock Exchanges taking the lion’s share of listing in Europe? That might also happen.

Yes, things will not change much on November 1st. However, the process will trigger changes. New trading venues will appear, it will be more complex to trade OTC and therefore there will be a push towards Exchange Traded Instruments and therefore more financial instruments will find one or more trading venues. It will be easier to start operating in different jurisdictions, so country with a relatively saturated market (e.g. the UK) will see their institution trying to expand in markets with a high degree of savings and therefore a cash rich pool of investors willing to listen to new ideas in wealth management (e.g. Northern Italy, most of Germany, etc.). Institutions based in such countries will have to start looking outside their immediate territory for growth opportunities. Institutions based in tight regulated markets (e.g. Landesbanks in Germany) will find it difficult to compete with newcomers that do not have the same limitations from their home regulator, etc. etc.

This will alter the face of the investment industry in Europe, not the endless conversations about degrees of best execution or where to report transactions or what suitability and appropriateness means in the context of investment advice (actually in some languages there is only one word for both concepts). Equally the main financial pain for financial firms will not be a fine from a regulator but a disgruntled client (or group of clients) taking them to court for breach of best execution principles.

The dust created by MiFID will rise in the European financial world like sand brought in by a desert storm. When the dust will settle we shall see a different financial industry in Europe all the current squabbles will have revealed themselves to be just hot air (which incidentally will extend the time required for the dust to settle)!

MiFID, Y2K and regulators

An anonymous reader of this blog posted a comment to 'MiFID time to stop talking and start acting', where they make an interesting parallel between MiFID and Y2K, they write: "Deadlines that a large number of people/orgs don't take seriously have a tendancy to slip back several months or years until they do." . I disagree.

One of the big question mark in the MiFID saga is the future attitude of regulators. What will they enforce ? Who will they target for enforcement ?

Some regulators run the risk of being the target of enforcement procedures themselves; but will they use enforcement as a way of creating 'hidden gold plates' ? After all if you are determined to preserve concentration, one way out of it is to quietly allow operators in your territory to have just one trading venue. (As somebody else wrote in another blog: Financial TechInsider).

As far as concentration is concerned I am a firm believer that ultimately the market will take care of it but on other part of MiFID the question is perfectly valid. Will regulators follow the example of the FSA (who has recently adopted a much stricter attitude towards November 1st as a deadline) when they themselves are spectaculary late ?

Who will they pick first when they decide to get tough on non compliance ? what will they decide to be tough about ?

Ultimately, I think that the biggest threat looming over non compliance is not a regulator, it is a client loosing money and taking an institution to court for breach of best execution.

Regulatory Cocktail and reference data hangover

I had dinner with a friend currently in London on business. He works for a coffee company who is planning an acquisition in the US. (Be patients, it is relevant). The company regularly trades coffee futures and therefore it will be carrying out investment business under MiFID. To ring fence the main company, they decided to create a trading subsidiary which will seek authorisation from the local regulator and of course by then will have to be compliant with MiFID and CRD (Basel 2). If the acquisition goes ahead SOX will also come into the picture. What are the potential consequences of this regulatory cocktail ? (Other than mass resignation, professional suicides, etc.)

Well MiFID and Basel 2 both call for Risk Mitigation functions and some of the organisational issues must be tackled with both in mind (no point doing one thing for MiFID and then starting all over again for Basel 2). As I pointed out in an earlier blog (Are you pulling up your SOX on MiFID) MiFID and SOX do not really cross path, except they both require an 'audit trail' and one has to be careful that the two live side by side in perfect harmony.

A common ingredient of this regulatory cocktail and possibly the main thing that needs to be considered with all three in mind is data storage. MiFID, Basel 2 and SOX have their data storage implications. Storage in itself is not a major issues, the issues is retrieving those informations in the appropriate way.

The three have different 'retrieval' logic : with MiFID you need to retrieve every information that proves best execution or compliance with your corporate policies without any shadows of doubt (in other words, no cracks that would allow the opposite legal counsel to make mincemeat of yours), therefore you need to save not just the transaction details but all the policies and procedures effective on that date, what conversations you have with your clients, etc. ; SOX is interested in corporate governance and therefore you need to retrieve what proves that everybody at the table had nice manners and did not do anything they should not have been doing (such as sending corporate funds to the Cayman Island or buying a Van Gogh with corporate funds and have it hanged in their living room); Basel 2 needs to build a risk history.

It make sense to create one storage/retrieval policy and the relevant set of reference data. This is where things get really tricky, the coffee company where my friends works has already set up the trading subsidiary and they want to be operational by November 1st. That means being compliant with CRD by January 1st and if the acquisition goes through SOX will join the party.

Reference data are the backbone of a corporate IT system, they have a few months to change their backbone. We should wish them well.

Wake up !

I have already quoted the FSA MiFID Permissions and Notifications guide and how the FSA has clearly changed its message (the paper is full of "If you want this to be effective by November 1st you have to ... by...") several times. Last Friday I was talking to quite a number of bankers in London and around Europe. Some were cold calls for my teleseminars (and therefore their answers could be biased towards getting rid of me), others were arranged conversations for a book I am writing on cross jurisdiction banking in Europe post MiFID and three were conversations with people who had called me. At the end of the day I started thinking that maybe I was on another calendar, if not on another planet.

Too many people from smaller institutions have not started yet! They face some major risks:

1) The client categories do not map 1:1. Retail will stay Retail, but Intermediate may map to Retail or Professional depending on whether the corporate client meets the new criteria to be eligible either to be a Professional Client or to be upgraded to Professional Client. If a company that currently has a permission only for Intermediate (which will be mapped by the FSA to Professional), they need to submit a Variation of Permission Application by August 1st. The FSA quite clearly states that those who need to apply for a permission for Retail Clients for the first time need to have clear evidence of process and procedures being put in place to deal with clients that need more protection. If they only deal with intermediate clients they are unlikely to have those process and procedures. So what is going to happen on November 1st, if they are do not have completed client classification, process and procedures by August 1st ? Well, it depends on the magnanimity of the FSA....

2) They have clients based in other jurisdictions. MiFID has two passporting regimes: physical presence (branch passport) and cross border services (service passports). This means that a firm with clients based in another jurisdiction within the MiFID area should apply at least for a service passport. Existing passport status will be mapped post November 1st but there may be a need to revise it depending on the financial instruments and the services provided. The sticky point here is for firms that operate with agents. Introducer will not be affected but tied agents will be like branches and therefore will require a full branch passport (maximum processing time is five months, so if you are in that situation... better send your agent on holiday between November 1st and the time you have sorted all the paperwork!)

3) They are outside MiFID. Well... MiFID client classification criteria are now part of the new COB. You just have some more time, i.e. the transitional regime will last till July 1st 2008 but if you need to make a VOP (Variation of permission application) you have till January 1st, 2008 to do that. In other words, you have about five to six months to re-classify your clients and see what happens (this is especially important to financial institutions that do commercial loans, trade finance, etc. and have a permission for intermediate clients only)

The second group that shocked me is... non EEA banks. At least a dozen executive I talked to told me that MiFID does not concern them, because they are not a European Bank (some of these banks have large investment banking operations based in London and others have branches all over the MiFID area). Well... first of all this is worse than hiding their head in the sand. If they are based in London, with an FSA supervision...MiFID is the law of the land in the UK ! There are no indications that November 1st deadline will be postponed or otherwise made ‘more flexible' than what it is right now.

Third group... bankers from some EU countries. An Italian banker (Consob has committed to transpose by the end of June and most Italians think it will happen by September) - the head of Legal Services of a major group who called me asked me "Why he should know about MiFID"; a smaller German bank has not started on anything because MiFID "it will not happen"; a Luxembourg based buy side institutions is not doing anything because "very few countries have transposed yet". All of this was supplemented by a conversation with PJ Di Giammarino of JWG-IT where he added a few stories of his own to my list.

In Greek mythology, Cassandra did not end up very well in spite of her ability to predict the future. I am no mystic Meg or Cassandra, but I think we shall see a rush of transposition by the end of September. If the FSA is any indication of the attitude of regulators in Europe there will come a point at their discretion where their attitude will change and they will issue their own guide that says what you need to do by when if you want to be operational by November 1st. So, who will wake up in a cold sweat on November 2nd? Recently NASD fined HSBC $250,000 for breach of best execution is that a harbinger of things to come in Europe for next winter? Will European financial services have ‘A Very Cold Winter' this year? And what will happen to commodity traders (Oil Companies, Energy Traders, etc.)?

Well, my Crystal Ball is getting a bit foggy now but I definitely think it is time to wake up!

MiFID - Time to stop talking and start acting

The MiFID Permissions and Notifications guide recently published by the FSA gives a few indications as to how the FSA intends to manage the transition. So, what could be the potential issues behind a set of very tight deadlines ?

Client categories and mapping of permission. The FSA will map permission in a very clear cut basis, i.e. intermediate = professional, etc. Unfortunately the criteria to place clients in one category or another under MiFID do not exactly match the criteria currently being used under the ISD and BCD rules. Corporate clients usually were classified as intermediate, MiFID sets clear guidelines to decide when a corporate client is a professional client and when it is a retail client. So what happens if some of your client have ‘gone retail' and you cannot justify moving them to professional status? You should submit a VOP (Variation of Permission) application by August 1st, unfortunately the paper also says "If you apply for permission to deal with clients requiring higher level of protection, for example where a firm is dealing with retail clients for the first time, you will need to demonstrate to us that you have the necessary systems and controls in place to do so". Therefore your deadline of August 1st is not just for an application, but it is also for the "necessary systems and controls" that must be in place, or at least on their way to be "in place" by November 1st. The same chapter clearly states that even if you do not do MiFID business you will have to change your classification criteria eventually, with the deadline being July 1st, 2008 and the deadline for VOP applications being January 1st, 2007.

Passporting. If you do not do MiFID business and wish to ‘opt-in' to benefit from the advantage of passporting rules under MiFID or decide to opt-out of the exemptions you have an interesting situation if you want to have your non-UK operations up and running by November 1st. You should send your application immediately (MiFID sets out a maximum time period of five month for both home and host regulator to process a branch passporting notification). If you are already passported and you do not wish to extend your passporting to other financial instrument beyond the FSA mapping, you are fine. Otherwise act now. If you plan to work with tied agent outside the UK, a tied agent is considered a branch and will require passporting (and therefore following the five months maximum processing period, act now). If you are one of the "new" investment business (Commodity broker, spread betting, etc.) and need to passport - even if it is a passport for services, not a passport to open a branch - you should start working at it.

This two examples give you an overall idea of the change of attitude. The ‘transition guidelines' have arrived and it is now time to stop thinking and start talking. Each possible variation of permission application will require policies and procedures to be in place or at least will imply strategic and operational decisions which deserve to be taken with the relevant care and attention.

If the FSA is any indication of what will happen in the rest of Europe we shall probably see a ‘rush to transpose' over the summer and by October 1st a majority of EU countries will be "MiFID compliant". Leaving financial institutions to scramble to meet the November 1st deadline. Since the first tier institutions started earlier, they will be ready (or on their way to be ready). All those that are still ‘talking' rather than acting may have interesting surprises on November 2nd. I sincerely hope I am wrong, but... you read it here first