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| Financial Law Update | Back to article summary. |
| MiFID - level 2 measures agreed (almost) |
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| Joe Beashel of Matheson Ormsby Prentice scrutinises the details of MIFID level 2 and examines the key features of the directive. |
The Markets in Financial Instruments Directive ('MiFID' Directive 2004/39/EC) is due to replace the Investment Services Directive (93/22/EC) with effect from 1 November 2007. Implementing legislation is required to be in place by 31 January 2007, therefore it is time for anyone involved in financial services to consider the impact of MiFID on their business and to start to develop an appropriate implementation plan. In short MiFID will:
Which firms will be affected? In general, MiFID will cover firms which are currently subject to the original Investment Services Directive plus some that currently are not. The Directive will cover stockbrokers and broker dealers, portfolio managers, investment banks, corporate finance firms, investment advisors, retail banks and building societies to the extent that they deal in securities and investment products which contain securities. 'Level 2' Measures The Directive is implemented on the basis of the 'Lamfalussy' process in which a main Directive is agreed and certain elements of that Directive are subject to detailed consultation, the results of which are set out in so called 'Level 2' measures: 1.for MiFID, although it will still be several weeks before the finalised official texts are available, this Level 2 consultation process is all but complete and consists of two measures, a Regulation, which cannot be amended and will have a direct legal effect in all Member States 2.a Directive, which requires implementation in each Member State and may be subject to some local interpretation The split of matters covered in the Level 2 Regulation and Directive respectively are: Regulation Record Keeping Transaction Reporting Market Transparency Admission of Financial Instruments to Trading Financial Derivative Instruments Directive Organisational Requirements Outsourcing Safeguarding of Client Assets Conflicts of Interest Information to Clients Assessment of Suitability Definitions of Non-Complex Instruments Best Execution Client Order Handling Why is this important? The finalisation of the Level 2 measures helps clarify some of the requirements of MiFID. Given the broad scope of the Directive, it is inevitable that further clarifications will be required across a range of issues, some of which may be clarified by the Financial Regulator but others that will require clarification by the Committee of European Securities Regulators (CESR pronounced �caesar�) as part of the so - called �Level 3� process. CESR has just started its work, therefore it will be a number of months before any clarifications are made. What is clear is that the finalisation of the Level 2 measures will provide a basis for affected firms to plan for implementation. How will MiFID be implemented in Ireland? The process of implementation is being run by the Department of Finance and it is their intention to, as far as possible, publish one statutory instrument which would include all of the MiFID requirements, i.e. those contained in the main Directive and in the Level 2 implementing measures. We certainly support the approach of seeking, so far as possible, to consolidate all requirements into a single text. The original Investment Services Directive was implemented in Ireland by two pieces of primary legislation, the Investment Intermediaries Act, 1995 and the Stock Exchange Act, 1995. At this point, we understand that neither piece of legislation will be completely repealed but a MiFID Implementation Act will be brought forward which will provide for such matters as criminal offences on indictment, the appointment of the Financial Regulator as the relevant competent authority for the purposes of the Directive and other matters. At present, draft Regulations prepared by the Department of Finance are available on its website, although it does not yet include the Level 2 measures and as such are incomplete. Neither is a copy of the proposed implementing legislation currently available. Working very closely with the Department of Finance has been the Financial Regulator which will very shortly launch a formal consultation in respect certain aspects of the Directive. Some Key Features of the Level 2 Directive MiFID sets out some basic organisational requirements and conduct of business rules which are expanded upon in the Level 2 Directive. The Directive repeatedly uses the phrase 'establish, implement and maintain' for all processes and procedures to be put in place. There is also a specific requirement on senior management to 'assess and periodically to review the effectiveness of the policies, arrangement and procedures' put in place to comply with MiFID and to receive a written report (at least annually) in respect of compliance, risk management and internal audit obligations. MiFID will therefore continue the trend for more documentation of processes and procedures and for active review by senior management of compliance/risk/governance matters. Compliance MiFID will impose a statutory requirement for investment firms to have a compliance function. One requirement contained in the 'Level 2' Directive is that the 'method of determining the remuneration of the [compliance officer/team] must not compromise their objectivity and must not be likely to do so�. It will be interesting to tease this issue out with the Financial Regulator, does this mean that compliance officers should be excluded from a general bonus pool operated by an investment firm? Risk Management In addition, and depending on the nature, scale and complexity of the business, a separate risk management function is required. Even where a separate function is not justified, the firm must be able to demonstrate that it has 'established, implemented and maintained' adequate risk management policies. These will identify the risks relating to the firm's activities, processes and systems and, where appropriate, set the level of risk tolerated by the firm. While all regulated firms will currently have a compliance officer/team, MiFID will require a more rigorous approach to general risk management. Outsourcing MiFID will for the first time introduce statutory rules around the outsourcing of functions by investment firms. Outsourcing will be permitted but important operational functions may not be outsourced in such a way as to 'impair materially' the quality of a firm's control and its ability to supervise and monitor its compliance with all its obligations. The Level 2 Directive sets out, in some detail, a list of requirements including, inter alia: 1.that the outsourcing must not result in the delegation by senior management of its responsibility 2.outsourcing must be carried out on the basis of a written contract with appropriate due diligence and ongoing supervision of the outsourcer. In addition, the firm must retain the necessary expertise to supervise the outsourced function 'effectively and manage the risk associated with outsourcing' and must supervise those functions and manage those risks. There are particular restrictions on the outsourcing of portfolio management to retail clients to a service provider outside the EEA Conflicts of Interest Firms will need to provide for a conflicts of interest policy. This policy must set out the circumstances which constitute or may give rise to a conflict of interest entailing a material risk of damage to the interests of one or more clients and it must specify the procedures to be followed and measures to be adopted in order to manage such conflicts. Where conflicts of interest cannot be adequately managed, this fact must be disclosed to clients. Investment Research Where firms produce investment research for their clients or to the public, they must have arrangements in place to ensure that the firm does not trade on the recommendation until the recipients have had a 'reasonable opportunity to act on it'. Except in exceptional circumstances and with the prior consent of the relevant firm's legal or compliance function, the financial analyst or other persons involved in the production of the research may not undertake personal transactions which are contrary to the current relevant recommendations. Information concerning client classification New clients and existing clients must be notified that they have been newly categorised as required by the Directive as either a 'retail client', 'professional client' or an 'eligible counterparty'. This does not mean that all clients must be 'repapered', although it does mean that all clients will have to be contacted in writing. Assessment of Suitability and Appropriateness Like the current regime, for retail clients it will be necessary to establish the suitability of a product or service for a client before a recommendation can be made. MiFID provides that if the investment firm does not obtain the information required it must not make a recommendation. Best Execution Investment Firms must prepare an execution policy and provide retail clients with certain details of that policy. In designing a policy, a firm must consider and document its view of the importance of criteria such as the characteristics of the client, the client order, the instruments being traded and the execution venues to which the order can be directed. For retail clients the best possible result must include the total consideration, i.e. the costs of execution and all expenses incurred by the client which are directly related to the execution of the order. Summary The so called 'Level 2' measures contain a very significant level of detail which amplify the requirements of the main directive. Although many uncertainties exist, the finalisation of these Level 2 measures will allow firms to plan for implementation of the broad ranging and complex Markets in Financial Instruments Directive. |
Joe Beashel is a partner in the Banking and Financial Services Department at Matheson Ormsby Prentice and is Head of the firm's Regulatory Risk Management and Compliance Group. He can be contacted by phone: +353 1 619 9000 or by email: joe.beashel@mop.ie Further information on the firm is available at www.mop.ie |