Changes afoot? – MiFID II criticism comes to the boil

March 2020  |  FEATURE  |  FINANCE & INVESTMENT

Financier Worldwide Magazine

March 2020 Issue

Hailed as a landmark piece of legislation upon its arrival a little over two years ago, the revised Markets in Financial Instruments Directive (MiFID II) – legislation instituted by the European Commission (EC) to regulate financial markets in the European Union (EU) and improve protections for investors – faces further revision following concerns raised by the financial services (FS) industry.

In its 2017 ‘MiFID II Solutions & Services’ report, Thomson Reuters characterised MiFID II as “one of the most fundamental and far reaching regulations that the industry is addressing”. The report also stated that the Directive “will reach beyond the EU into the global financial industry, impacting all financial organisations that deal with European markets”.

Another report, PwC’s ‘MiFID II: Are you ready for the new regime?’ was equally confident, describing MiFID II as “the most significant change to the conduct of financial services and the market environment since the commencement of the EU Commission’s Financial Services Action Plan”. The legislation, continues PwC, “will affect all categories of dealing, broking, asset management and advisory services undertaken by banks, non-banks, other service providers and also their corporate, institutional and retail customers”.

However, despite these weighty endorsements, MiFID II has been subject to consistent criticism since it came into effect in January 2018, with many FS firms complaining that the Directive’s complexity, as well as inflexibility, makes it difficult for them to comply with its requirements. Across the industry, many firms have struggled to comply.

“FS firms have found it a challenge to implement MiFID II, especially given the short time frame,” says Dr Caroline Herkströter, a partner at Norton Rose Fulbright LLP. “Some firms underestimated necessary efforts. One of the main difficulties was the implementation of the suitability statement. Financial advising has become more complex and mostly requires technical support, which increases the average time per individual case.

“Therefore, some FS firms decided to reduce their services,” she continues. “The extensive requirements on cost information was seen as an additional hurdle but not really helpful information for all types of clients. Moreover, the requirement for telephone recording could lead to serious practical issues.”

Karl Lannoo, chief executive of the Centre for European Policy Studies (CEPS) and general manager of the European Capital Markets Institute (ECMI), notes that, while MiFID II may be complex (and costly), it is leading to broader participation in capital markets by Europe’s savers. “This will far outweigh the costs of unbundling, such as the more reduced investment research on small stocks,” he suggests. “Recent criticism appears to overlook the broader picture, where the advantages of this revision are starting to become visible.

“Earlier versions of the legislation were fundamental in opening up EU securities markets and have seen London become the centre of securities trading, with the provisions allowing remote access for traders all over the EU,” he continues. “But some elements do have to be further strengthened, above all the rules dealing with the protection of investors.”

For its part, the European Securities and Markets Authority (ESMA) is keen to highlight MiFID II achievements so far, but is aware that more work needs to be done, particularly in the area of transparency. “MiFID II has to an extent delivered on its goal to improve transparency in financial markets,” said Steven Maijoor, chair of ESMA, during Euro Finance Week in November 2019. “As an example, trade transparency in asset classes, such as exchange-traded funds (ETFs) and derivatives subject to the trading obligation, has positive effects on the market as a whole.

“Anecdotal evidence suggests that liquidity in ETFs has increased markedly since the introduction of MiFID II. At the same time, it is fair to recognise that there are areas, such as bond market transparency, where we are not quite there yet. I would also like to note that the negative side effects of increased transparency in secondary markets that many stakeholders were concerned about ahead of MiFID II implementation did not materialise.”

Complexity and cost

When one drills down into the key criticisms levelled at MiFID II, complexity and cost are clearly driving the harshest commentary. Bovill has suggested that one in four firms submitting transaction data have been filing returns inaccurately.

“Some of the key criticisms are the breadth of the legislation and the high costs of implementation,” confirms Dr Herkströter. “Furthermore, there is a sense that MiFID II has led to an overregulation of the financial market. Information requirements on costs and charges apply to all clients without significant differentiation.

“Additionally, FS firms would have wished for a more sufficient coordination with other legislation like the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation,” she continues. “Due to the regulation, FS firms are required to provide a lot of product information to clients. It is difficult to predict whether the criticism will lead to any changes since the view of the regulators generally seems to be that MiFID II is an effective tool to strengthen investor protection.”

What, then, are the changes the FS industry is requesting legislators make to the Directive? How comprehensive are they? Furthermore, is there a risk that legislative changes morph into a top to bottom overhaul, perhaps even a MiFID III, and potentially greater compliance difficulties?

In order to verify the nature and extent of FS concerns, ESMA launched a consultation in July 2019. The consultation, proclaimed ESMA, is “on draft guidelines on certain aspects of the compliance function requirements under MiFID II”.

“The compliance function is a crucial function within firms, responsible for identifying, assessing, monitoring and reporting on the firms’ compliance risk,” states the ESMA consultation. “Strengthening the compliance function under MiFID II represents an important step forward, as a strong compliance function reduces compliance risk and facilitates competent authorities to exercise their powers effectively.”

Among ESMA’s proposed guidelines is that any revised legislation should: (i) consider the changes to the compliance function requirements brought by MiFID II; (ii) give relevance to the results of supervisory activities conducted by national competent authorities on the compliance function requirements; and (iii) provide additional details on some aspects that were already covered under ESMA’s 2012 guidelines.

“These guidelines are aimed at helping FS firms to increase the effectiveness of their compliance function, enhance clarity and to foster convergence on the expanded role of the compliance function under MiFID II,” adds ESMA. “The consultation paper includes proposals on the draft guidelines which confirm and broaden the existing guidelines, issued in 2012.”

Once feedback from stakeholders is reviewed (the closing date for responses was 15 October 2019), ESMA aims to publish a final report, and final guidelines, in the second quarter of 2020.

“From an FS industry perspective, policymakers need to take into account the principle of proportionality and narrow the scope of certain provisions, such as implementing waivers for certain requirements which are considered to be too strict or too broad,” says Dr Herkströter. “To meet the criticism of FS firms, the handling of information about products and costs must become easier.

“The German Ministry of Finance publicly consulted on two position papers concerning necessary amendments and revisions to MiFID II, the PRIIPs Regulation and the Markets in Financial Instruments Regulation (MiFIR),” she continues. “The Ministry states that there is no need for a comprehensive review resulting in a MiFID III, but several amendments have to be made. The Ministry has forwarded the position papers to the European Commission (EC).”

Response in waiting

While the FS industry awaits with interest the EU response to the aforementioned consultations, based on dialogue so far, we can surmise how the request for revisions to MiFID II may be entertained.

“While MiFID II’s achievements are certainly positive, we also acknowledge that there are areas where improvements may need to be considered to ensure that MiFID II delivers on its objectives and is applied in a convergent manner across the EU,” says Mr Maijoor. “MiFID II requires a large number of follow-up review reports and we have started working on many of those.

“ESMA also wrote to the EC to suggest a staggered timeline for delivering these reports, considering that Brexit will have a fundamental impact, especially in the markets area,” he continues. “In addition, we also believe that these staggered, and focused, reviews of key provisions in MiFID II will render the overall review more beneficial for the market.”

Ongoing dialogue

Also significant for the revision of MiFID II is that Germany will assume the Presidency of the European Council in the second half of 2020. “As we can see from the recent position papers of the German Ministry of Finance, there could be an appetite to consider the amendment and revision of certain provisions in MiFID II and to work on some possible near- and medium-term changes to MiFID II,” adds Mr Maijoor. “Moreover, considering possible changes to MiFID II, ongoing dialogue with stakeholders will become even more important.”

In Mr Lannoo’s view, the EU, before entertaining any calls for change, needs to implement MiFID II in full – a stance he takes on account of his belief in the legislation and what it has achieved since it came into effect. “Early data on the effects of MiFID II indicate that market opening and integration is continuing apace, with further electronification or platform trading in products that had not been within the scope, such as government and corporate bonds, derivatives and ETFs,” he says. “Banks are also confronted with many more requests for information from clients, as a result of the demand for more transparency on fees and charges, which is where MiFID matters for individuals.”

MiFID II revision in accordance with FS industry requests is the aim, with the desired outcome being a fundamental strengthening of the compliance function. If FS firms do indeed succeed in achieving the regulatory tweaks they seek, the result could be the transformation of MIFID II from a compliance headache into a business advantage.

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Fraser Tennant