This checklist describes the European Commission’s Markets in Financial Instruments Directive (MiFID) and its aims and purpose.
The European Commission’s Markets in Financial Instruments Directive (MiFID, EU Directive 2004/39/EC), was implemented on November 1, 2007, replacing the Investment Services Directive, and applies to all 27 EU member states plus Iceland, Norway, and Liechtenstein. Each country must incorporate MiFID either into local law or into the rules of the local regulatory handbook, depending on how financial regulation is applied in that state.
The objective of MiFID, apart from increased harmonization, is to boost innovation and competition across the financial markets within the European Union and adjoining states, improve liquidity in the markets, and reduce costs for issuers and investors.
As the key plank of the European Commission’s Financial Services Action Plan, MiFID’s 42 measures bring significant changes to how EU financial service markets operate. Whereas previous EU financial service legislation focused on “minimum harmonization and mutual recognition,” MiFID’s “maximum harmonization” principle places emphasis on home state supervision within a level playing field. The EU “passport” approach has been retained, but the old “concentration rule,” which let member states require investment firms to route client orders through regulated markets, has been abolished.
MiFID’s various articles cover almost all tradable financial products, with the exception of certain foreign exchange trades. This includes commodity and other derivatives such as freight, climate, and carbon derivatives, which were not covered by the Investment Services Directive. Any investment firm operating in Europe’s financial markets is affected.
MiFID distinguishes between “investment services and activities” (core services) and “ancillary services” (non-core services). Details of these can be found in Annex 1 Sections A and B of the MiFID Level 1 Directive. A company providing core services is subject to MiFID in respect of both these and also ancillary services and can use the MiFID passport to provide them to other member states. However, a company engaged only in ancillary services is not subject to MiFID and cannot benefit from the MiFID passport.
MiFID sets out various elements of good practice, such as how an investment firm should protect its customers or retain records. These apply to whatever is being traded. The following areas form the key aspects of the directive.
Authorization, Regulation, and Passporting
Companies are authorized and regulated in their “home state,” typically the country in which they are registered. They can use the passport to provide services to customers in other member states.
Client Categorization and Order Handling
Companies must categorize clients as “eligible counterparties,” professional clients, or retail clients (these have increasing levels of protection). Clear procedures must be in place to categorize clients and assess their suitability for each type of investment product. There are stringent requirements on the information to be collected when accepting client orders, to ensure that the company is acting in its clients’ best interests, and on how orders from different clients may be aggregated. Appropriate investment advice or suggested financial transactions must be verified before being given.
Pre- and Post-Trade Transparency
Before trading, operators of continuous order-matching systems must aggregate their order information on liquid shares available at the five best price levels on the buy and sell side. The best bids and offers of market-makers must be made available for quote-driven markets. Post-trade, companies must publish the price, volume, and time of all trades in listed shares, even where conducted outside of a regulated market, unless certain requirements are met to allow for deferred publication.
Companies must take all reasonable steps to obtain the best possible result in the execution of a client order. This includes not just the execution price but also cost, speed, likelihood of execution, likelihood of settlement, and any other relevant factors.
A systematic internalizer is a company that executes orders from its clients against its own book or against orders from other clients. Under MiFID, systematic internalizers are treated as mini-exchanges and are thus subject to pre-trade and post-trade transparency requirements.