MiFID II: towards greater consumer protection and transparence in European financial markets

TRANSLATED BY JOYCE CHEN AND PROOFREAD BY CARA EVANS-GILLEN

The Markets in Financial (MiFI) Directive was launched on 3 January 2018 throughout the European Economic Area (EEA). MiFID II – Markets in Financial Instruments Directive – completes as well as differs from its predecessor from 2007, MiFID I. The directive aims to reinforce regulation of financial intermediaries and to protect private investors.

The need for MiFID II (2014/65/EU) reveals a certain lack of confidence in the financial sector. Through this new directive, European legislators aim to oversee relationships between stakeholders and better protect private investors. Having been officially pushed back for a year by the European Commission in 2016, it has still not been fully implemented in national law of all member states.

A classified clientele

Client protection is reflected in a more conservative classification under MiFID II. Already analysed according to their knowledge of financial products, their experience in the markets, their capacity and willingness to take risks, and their investment goals, clients are also divided up equally according to the nature of their investment: non-professional, professional, and eligible counter-parties. The new directive reinforces distribution in the latter category. Therefore, according to Annex II of MiFID II, a private client is automatically classed as non-professional or retail clients. If a client wants to be considered as a professional, they must prove their knowledge, experience of financial products, and their volume of assets.

This classification allows the financial products that the client could acquire, or those that they were advised on, to be determined. By becoming a professional, an investor therefore has access to riskier products and additional services, but they must give up part of their protection. As for trading, clients are equally protected during the transaction by the ‘best execution’ principle (the obligation to execute orders to give the best possible result), made obligatory by Article 27 of the MiFID.

Product surveillance

Organisations who design and create financial products must explicitly define their intended clientele. Those who have direct contact with their clients, such as banks and asset managers, must take into account the client’s classification and the nature of their product.

As stipulated in Article 49 of MIFID’s (2017/65/EU) Delegated Regulation, each of their advisors must include a general description of the risks and the product performance in different market conditions. According to Article 25 of MiFID II, all investment and management advice must come with a suitability report. This assesses the compatibility of the potential transaction with regards to both the client’s risk profile and investment goal. If an order is placed without prior advice, an appropriateness test is carried out, evaluating the compatibility of the transaction in relation to the client’s knowledge and experience.

More protection for private investors

MiFID II also aims for more transparency in relationships and to overcome the issue of information asymmetry between institutional market stakeholders and private clients. Consequently, regardless of what category a client belongs to, they must know all the service costs and fees, as outlined in Annex II of the MiFID Delegated Regulation. Article 24 of the Directive seeks to minimise any conflict of interests by banning retrocessions: management fees that the issuers of products give back to distributors of those products. The regulator thus ensures that financial intermediaries inform private investors of their commissions and make their activities more transparent.

The Swiss example

Due to its globalised and interconnected nature, the financial sphere is extraterritorial. The European standards hence heavily influence the behaviour of international actors and the legislation in other countries. Switzerland, for example, already follows the MiFID rules on investor protection for their clients residing in the EEA. In addition, since 2012, Switzerland has been preparing two pieces of legislation to regulate the financial sector and bring it closer to international standards: the Financial Services Act (FinSA) and the Financial Institutions Act (FinIA). The first text will aim to protect the client, in particular, their classification. The second will focus on the supervision of financial service providers, such as independent asset managers, collective asset managers, and trustee-administrators. Through this flexible version of the MiFID, the Swiss Confederation seeks to create a level playing field. Both laws are still under review and should take effect in 2019.

The cost of changes to adapt banking systems and meet MiFID II standards is estimated to reach over €2.4 billion. The question of how and who will finance this cost remains unanswered. Perhaps MiFID II will encourage outsourcing, already very present in the banking sector. Or perhaps an alternative is passive management by dividing clients into groups and grouped advice for each of the categories.

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