What is Markets in Financial Instruments Directive (MiFID)?

The Markets in Financial Instruments Directive, or MiFID, is a cornerstone regulatory framework aimed at enhancing the transparency, efficiency, and integrity of financial markets across the European Union (EU). 

Since its introduction in 2007 and subsequent update to MiFID II in 2018, it has been instrumental in promoting sustainable economic growth within the EU.

MiFID and MiFID II together establish a comprehensive set of rules designed to protect investors and ensure fair and transparent market operations. These directives are pivotal in creating a more competitive and accessible financial environment across the EU, setting the stage for a stronger, more effective market landscape.

What Does MiFID Stand For?

It is a European regulation that enhances transparency in financial markets and standardizes regulatory disclosures for companies operating in the European Union to achieve sustainable economic growth in Europe. MiFID regulation has taken new measures, such as businesses' transparency requirements when trading, and financial firms have set behavior standards to follow. The MiFID ii Directive was prepared in 2004 and came into force in 2007. It has generally revealed the following: execution of business and organization requirements for investment firms, authorization for regulated markets, regulatory reporting to prevent market misuse, rules on transparency for commercial shares, and the acceptance of financial instruments to trade. Investment companies, institutions providing stock exchange and banks are the businesses in the scope of their standards. Under its authority, its product provisions and operations of financial instruments are supervised.

When it came into force, it could not meet adequate regulations in the field of investment. As a result, a new arrangement called MiFID II, compatible with the latest technologies, emerged in 2018. It regulates the gaps in the arrangement. It aims to become a more powerful version of the previous law. It focuses on transaction reporting and requirements, enhancing the client's protection, properly managing portfolios, and making trading platforms more open. In addition, the Markets in Financial Instruments Regulation (MiFIR) works with the MiFID and MiFID 2 to extend the conduct rules to other types of assets.

Key Takeaway

Which financial instruments are added of late in MiFID II?

  • Structured deposits issued or sold by credit institutions
  • Certain packaged retail investment products (PRIPs)
  • All emissions allowances (such as carbon)
  • The sale of financial instruments issued by the investment firm.

Who Is Affected by MiFID II?

MiFID2 affects all investment services, including banks and non-banks. In other words, it briefly covers all kinds of financial services. This Directive does not directly regulate private investors or individuals but instead regulates firms that operate on their behalf. MiFID 2 promotes infrastructural improvement while helping them provide their customers with the most transparent and valuable service. In addition to these, fixed-income markets, derivative markets, treasury transactions, and accounting are also affected by the Directives.

Before MiFID ii regulations, investment companies could only collect information from one or two public exchanges. Together with MiFID 2, they can collect information from all sales points as long as they publicly disclose their prices and details. Thus, financial institutions can access as much information as possible.

What Are The MiFID Requirements?

Companies within the scope of MiFID can be established and organized in their own country. After a company is issued, it can use the MiFID passport to provide services to customers in other EU member states. They require companies to classify customers as professional customers or retail customers. Clear procedures should be available to categorize customers and they must be evaluated appropriate regulations for each investment product. It recommends a firm act in the customer's interests regarding the information received when accepting custom orders.

In MiFID II, asset managers' ability to conduct investment research with customer commissions is severely restricted, so this issue is often discussed. MiFID II requires firms to take all necessary steps to achieve the best possible result in fulfilling a customer's order. The best possible outcome is not limited to the execution price but includes cost, speed, probability of execution and resolution, and other relevant factors. Also, MiFID II treats Systematic Internalizers as mini-exchanges.

The European Commission states several rules under MiFID II, such as;

  • To provide transparency in financial markets, sharing data on trading activity and transactions to related entities according to the nature of data
  • Using regulated platforms for transactions and trading
  • To increase competition, bringing together merchants and service providers
  • Organizing algorithmic and frequent trading
  • Protection of investors in a competitive market

Client Classifications Under the MiFID

A crucial component of the MiFID regulations is the systematic categorization of clients into distinct groups to ensure appropriate regulatory protections are applied. These groups are:

  1. Professional Clients: These clients are considered to have the experience, knowledge, and expertise to make their own investment decisions and properly assess the risks that they incur.
  2. Retail Clients: This group is offered the highest level of protection, recognizing that they are likely to have less experience, knowledge, and expertise in financial matters.
  3. Eligible Counterparties: Representing the category with the least regulatory protection, these are typically other financial institutions or entities involved in professional trading environments.

The purpose behind this classification is to ensure that investors receive a level of protection that corresponds to their financial literacy and ability to bear risk. This approach allows for the provision of tailored information and detailed explanations relevant to the risks and specifics of transactions based on the client's categorization.

Elements Forming MiFID

  • Transparency: Transparency in the stock market has significantly increased. Commercial data and public disclosure of the market have become mandatory, and new regulations for non-equity products have entered into force, including pre and post-trade regulations. 
  • Market Structure: Improved market structure has been designed mainly to close the previous regulation gaps. As a result, trade has shifted to regulated platforms. With this arrangement, when Investment firms place customer orders over the systems, their transactions should be registered as a Multilateral Trade Facility (MTF). Also, an Organized Trade Facility (OTF) has been created as a multilateral trading platform to synchronize MTFs with Regulated Markets (RMs). 
  • Investor Protection: New requirements for protecting customer assets and monitoring products have occurred. The marketing and distribution of financial products have become prohibited by the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA). New and improved codes of conduct regarding customer information were developed with the regulation. Finally, the Insurance Mediation Directive (IMD) has been amended to provide new regulations for insurance-based investment products.
  • Reporting Requirement: Reporting of all transactions has now become mandatory. The degree of required details in the report is also more extensive. Firms must regularly check their reporting framework using a test system to ensure that reporting is done correctly. Reporting requirements have become essential for regulators and risk managers.

MiFID Review

After the enactment of MiFID II, MiFIR conducted the first examination of the directives to analyze how to improve the market in light of it. MiFIR reviewed the data collected from companies across the EU to inspect different regulation implementations. It aimed to plan a pathway to provide improvements in pricing and liquidity in a competitive market. The review states that;

  • After Mifid II, competition in the market increased in a positive way
  • Plan to create the most transparent and advantageous market in terms of price in the EU
  • Advancing financial assets, stock markets, and bonds in this territory

Key Takeaway

How did the UK handle directives after Brexit?

  • HM Treasury, FCA, and Prudential Regulation Authority (PRA) were commissioned as responsible bodies.
  • FCA and PRA prepared handbooks to explain directives according to UK legislation
  • The directives were revised in line with exit regulations for adaptation.

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