5 Reasons why MiFID II provides Enhanced Investor Protection

The Markets in Financial Instruments Directive I (MiFID I) was introduced in all European Union (EU) Member States in 2007. Its objective was to create a single financial services market in the EU by promoting the market’s integration, competitiveness and efficiency.

What is MiFID?

The Markets in Financial Instruments Directive I (MiFID I) was introduced in all European Union (EU) Member States in 2007. Its objective was to create a single financial services market in the EU by promoting the market’s integration, competitiveness and efficiency. It enabled free completion between traditional exchanges and alternative trading venues within Europe and it removed barriers to trading within Europe. With MiFID European Banks and Investment Firms (IF) were enabled to provide Investment Services across Europe subject to compliance with specific organisational and reporting requirements which aimed to protect investors.

MiFID applies to entities such as banks, investment service companies and asset managers providing investment services in relation to shares, bonds, units in collective instrument schemes and derivatives. MiFID is at the side of the investor as it requests firms to act in the best interest of their clients.

Timeframe for implementation of MiFID II

MiFID I was applied in the UK from 1 November 2007. It is now being comprehensively revised to (a) improve the functioning of financial markets in light of the financial crisis of 2008 by enhancing transparency, (b) keep pace with the growing complexity of technology and financial innovation and (c) further strengthen investor protection. The enhanced Directive will be known as MiFID II which must be transposed into national law by EU Member States by 3rd July 2016 and subsequently applied by 3rd January 2017.

Why does MiFID II allow for better investor protection?

  • Enhanced disclosure of information to investors when receiving Investment Advice services

Upon the provision of Investment Advice services, MiFID II strictly requires investment firms to explicitly and clearly disclose the following information in good time to the client:

  1. whether or not the advice is provided on an independent basis;
  2. whether such advice is based on a wide or more restricted range of financial instruments; and
  3. whether this range is limited only to products that the firm or related parties to the firm offer which would indicate impairment of independence.

In addition to the above, the investment firm will have to report to the investor how the investment advice given to them matches their profile and needs.

The above enhanced requirements will ensure that the clients will be informed well in advance of the quality of the investment advice they will purchase and also they will have a clear picture of the level of independence of the potential investment advisors. Furthermore, investors will be notified well before they make any investment decisions as to whether or not the investment advice was made looking at a wide range of products available in the market or not and this will help them make the best investment decision suitable for their needs.

  • Enhanced restrictions on allowable commissions & inducements from third parties

MiFID II strictly prohibits IFs which have declared that they will be providing independent Investment Advice or Portfolio Management to their clients, from accepting or retaining any major fees, commissions or non-monetary benefits from third parties as these constitute a clear threat to independence. Minor non-monetary benefits that could enhance the quality of service may be permitted, provided they are clearly disclosed to the clients and do not impair compliance with the firm’s duty to act in its client’s best interest.

Furthermore, firms will only be able to accept payments or non-monetary benefits for services other than Portfolio Management or Independent Investment Advice if these are designed to improve the quality of the service to the client, do not impair the ability of the firm to act with integrity and at the best interest of the investor and only if these payments or non-monetary benefits are clearly disclosed to the investor.

The above new requirements will further increase investors’ confidence and trust in the market as they will be able to distinguish whether the investment advice they receive is in their best interest or the person offering this advice has an incentive to do so.

 

  • Increased transparency due to full disclosure of costs and inducements 

What is even more encouraging for investors is the fact that Investment Firms will be obliged to disclose all information linked to costs and associated charges with a breakdown of what is charged linked to the actual investment in the financial instrument and any ancillary services (e.g. cost of advice). In addition, upon the client’s request, Investment Firms will have to also be ready to provide an itemised further detailed analysis of such costs. This will allow investors to transparently calculate their real return on investment. The requirement of enhanced disclosure of costs will also oblige firms to disclose clearly to the clients any fees, commissions and non-monetary benefits from or to third parties.

This increased transparency and enhanced disclosures of costs will help the clients to fully understand the level, nature and rationale behind both a firm’s and a product’s charges. Therefore investors will be in a better position to evaluate their choices of investment firms to work with by comparing what each firm charges and how.

To add to the above, the new enhanced disclosure requirements will assist investors to have a wider cross boarder variety of investment firms and products to choose from when they will be making investment decisions. Investors will have a real choice of high quality products and providers spread across the whole EU.

  •  Enhanced information to the investor  on suitability and appropriateness

MiFID requires IFs to obtain all necessary information from their clients to evaluate their knowledge and experience in the investment field as well as their financial situation and risk appetite in order to be in the best position to recommend investment services and financial instruments that are suitable to them. In case the investor does not provide the necessary information to the IF to allow it to evaluate the client, then the client should be informed that the firm cannot determine whether the service or product is appropriate for them. 

MiFID II enhances the above requirement by including the need for IFs to further communicate to their clients appropriate guidance and warnings linked to the risks associated with the recommended financial instruments or investment strategies as well as the investor profile to which these recommended instruments are intended for (i.e. retail or professional investors). This will ensure that the clients will be sufficiently warned prior to making any investment decisions and thus they will be able to make better and informed decisions based on their risk appetite and financial profile.  The new requirement matched to the requirement to disclose the range (narrow or wide) on which the investment advice was made on, will further allow the investors to clearly connect the risks and the returns of any type of investment recommendation made by the IF.

This suitability and appropriateness regulation aims at better investor protection and will limit the ability of IFs to make profits by taking into advantage their clients’ limited knowledge and experiences in the field of financial products. This requirement ensures that in no circumstances, investors will be deceived by IFs to invest in financial instruments which they do not understand and which do not match their financial and risk profile.

  •  Better product governance

MiFID II requires firms to build up financial products based on the investors’ need and not based on the firm’s profitability potential. Firms will have to identify a target market for each of the products that they produce or sell. Those target markets will be distinguished by the specific investor profiles which will have to match the nature and the risks of the financial product. It is imperative for firms to first understand the nature and risks of those financial instruments before linking them to investor profiles.

In order to achieve all the above, MiFID II requires firms to have stricter internal requirements to govern design and distribution of financial instruments and products. The ultimate goal is to ensure that each product is only manufactured, recommended and ultimately sold to clients who match the investor profile for which the product was designed for in the first place.

The regulation of product design and distribution is a key improvement of MiFID II which aims at better investor protection and will ensure that low quality products aiming at higher profit margins for the firms will be less likely to be promoted to the investors.

 

Remaining positive for the future of the Financial Services Industry

To conclude, the EU market of financial services is at the right path to improve investors’ protection and therefore investors’ trust and confidence. Regulations and Directives like MiFID are continuously enhanced in the light of the financial crisis, the market changes and the continuous innovation linked to the available market places. We should remain positive that all changes are aiming towards better investor protection which will in turn grant a more stable and secure future for the wider financial services industry.

As Jonathan Hill (EU Commissioner for Financial Stability, Financial Services and Capital Markets Union) said,

“Bringing financial services back to the people they serve is the right way to think about things. It is why early on I said that I wanted to turn the telescope round and look at retail financial services from the point of view of the consumer. It is why I am keen to open up markets to deliver more choice and better service so that people can see more examples of how the EU benefits them. And it is why the retail investor has to be at the heart of the work I am doing to build a single market in capital.

Trust is the bedrock of the financial system. It needs to be won back after the financial crisis and some of the scandals we have seen.”[1]

 



[1] Jonathan Hill, “Bringing financial services back to the people they serve”, European Commission, Joint ESAs consumer protection day, SPEECH/15/5117, 2015.

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