It's going to be different this time
The Markets in Financial Instruments Directive (MiFID) is expected to have some of the greatest impacts of all financial services legislation introduced in the last decade. It is scheduled for implementation on 1 November 2007 and is the successor to the 1993 Investment Service Directive, a key component of the EU’s Financial Action Plan.
MiFID is expected to change the financial market landscape. Cross-border operations within the EU should become easier, pricing should be keener and liquidity deeper. Investor safeguards and compliance requirements are intended to be consistent everywhere.
Unlike Basel and CRD, MiFID is outward looking, with potentially major implications for a wide variety of a firm’s relationships, with clients, counterparties, service suppliers and others.
The impacts differ significantly by industry segment and by country and MiFID has an effect on a wide range of activities and operations in regulated firms. These will affect functions right across an organisation, from marketing, client management, through trading execution to strategy, IT, risk, internal audit, HR and, of course, legal and compliance.
Main areas of impact can be summarised broadly in the following categories: organisational requirements (eg governance, compliance, risk and internal audit functions, conflicts of interest and systems and controls); conduct of business requirements (eg client classification, sales process, client documentation and reporting and marketing); and market activities (eg best execution and transparency). Some instruments, for example commodity derivatives (including credit derivatives and exotic derivatives), will be regulated across the continent for the first time.
To encourage market integration and competition across Europe, MiFID further entrenches the concept of ‘home responsibility’ for regulation and adds measures to enhance the effectiveness of the European passport (the ability to provide services across Europe once authorised in one of the member states).
Common investor protection requirements are also introduced across the EU. Investment advice will now be fully regulated. MiFID sets out to achieve retail investor protection through two main means: comprehensive information and disclosure requirements to clients; and the requirement to assess and demonstrate the ‘suitability’ of any advice given or portfolio management decisions taken, as well as (new even in the UK) a requirement to assess appropriateness to a retail investor of any unadvised ‘execution only’ transactions in derivatives or other ‘complex investments’.
MiFID adopts the position that senior management of firms, not regulators, are best placed to assess risks and design controls to manage those risks; the trade-off for less prescriptive, principle-based rules on organisation, governance and controls is that senior management are held responsible for the governance structure and control environment in their firm. It sets out certain requirements in areas such as risk management, compliance, internal audit, managing conflicts of interest, outsourcing, investment research, inducements, client money and custody. Such requirements are largely familiar to UK firms, in principle, though the devil is in the detailed differences.
In the UK, the FSA is taking this opportunity to move to its stated intention of greater principles-based regulation (with less detailed prescriptive rules) in line with their focus on ‘better regulation’ and rule simplification. The EU legislation is tightly framed to try to ensure consistency of rules across Europe and avoid so-called ‘gold-plating’ of the rules in certain member states, for which the UK has been famous.
So the FSA has a challenge for 2006/7: to implement MiFID in a straightforward and compliant manner; to apply a logically consistent regime to products inside and outside (such as life products); to retain requirements which go beyond MiFID (such as commission unbundling) without falling foul of the gold plating prohibition; and to simplify, rationalise and reduce its rulebook. All at the same time.
KPMG recently conducted a Europe-wide survey in co-operation with the Economist Intelligence Unit to explore the challenges and opportunities that MiFID brings. This involved almost 200 executives in a range of financial services companies and revealed that nearly 50% of board members and senior managers are unaware of the implications of MiFID. The full findings are included in our ‘Capturing Value from MiFID’ report.*
Asset managers appear to be the most optimistic financial service segment surveyed, with 62% ranking themselves as clear winners in terms of the potential benefits available. With pension planning becoming an increasingly important topic in Europe, this perhaps reflects the hope that MiFID will help asset managers respond on a cross-border basis to the growing demand for savings products and investment management services.
Many asset managers felt that the common regulatory standards introduced by MiFID should make it easier to do business across Europe (51%) and increase investment product sales to European clients outside their home market (31%). The survey found that nearly 60% of respondents are optimistic that MiFID will deliver a greater choice of investment products, more competitive pricing (47%) and more accessible objective advice (45%) if implemented effectively. However, there seems to be a real concern within the industry that MiFID will not result in common rules that will be consistently applied across Europe.
Only one in five respondents to the survey expects this consistency to occur. This is perhaps borne out of historic experience that where states legislate consistently, they interpret differently; and even where they interpret consistently, they enforce differently. EU commissioner Charlie McCreevy is determined that MiFID will be different.
While firms recognise the importance of integrating MiFID with other compliance initiatives such as Basel/ CRD, over half of asset managers surveyed identified the sheer volume of compliance changes as being a major threat to MiFID success.
For firms to gain the full benefits of MiFID it is imperative that they treat it as a business issue and prepare now: it is not just about internal compliance. Unlike much regulation that has gone before, it is likely to have a significant impact on the whole business value-chain as well as the European financial landscape.
Andrew North is principal adviser, investment management at KPMG
*The KPMG-EIU ‘Capturing Value from MiFID’ report is available from www.kpmg.com