Mifid II switches on new transparency and governance rules

Stockmarkets remained stable as Mifid II, the EU-wide rules introduced to strengthen the financial markets in response to the 2008 crisis, took effect today.

The massive overhaul of the investment market, which took effect today, introduces new rules around transparency, governance and the payment for research.

Fund managers will from now on be required to pay investment banks and brokers directly for analyst research, rather than bundling it in with trading commission. Fund managers will now either pay for research from their own account or through a ring-fenced client research-payment account.

Some brokers say an unintended consequence of the directive could be reduced coverage of smaller quoted companies as asset managers will source significantly less research from banks and brokers.

Local government schemes will need to ‘opt-up’ to be classified as professional clients if they wish to continue investing in infrastructure. Under MiFID II local authorities will automatically be categorised as ‘retail’ instead of ‘professional’ clients, barring them from infrastructure investments unless they opt-up.

MiFID II also means more organisations will need to obtain a Legal Entity Identifier (LEI). This is a unique 20-character code assigned to each legally distinct entity that engages in financial transactions. From today, firms subject to MiFID II transaction reporting obligations will not be able to execute trades on behalf of clients which are required to have a LEI if they do not have one. Whether a scheme needs a LEI will depend on whether it uses the services of a financial institution which has to fulfil reporting obligations under MiFID II.

Investment firms now have a strengthened duty to take all sufficient steps to obtain the best result when executing client orders under MiFID II. Firms also have to report on a more stringent basis to clients about the quality of their execution.

On costs disclosure, MiFID II places new duties upon fund managers including full point-of-sale (ex ante) disclosure and annual post-sale (ex post) disclosure. Costs must be aggregated and expressed both as a percentage amount and a monetary value. Schemes should use this opportunity to conduct due diligence on their managers, using this new information, as well as to consider further steps to achieve greater value for money.

PLSA investment and defined benefit policy lead Caroline Escott says: “Under MiFID II, schemes will have to deal with a vast range of changes affecting everything from the way in which research is paid for, to the disclosure of cost and best execution information. Although this poses challenges to pension schemes and trustees, who need to get to grips with what the new rules mean for them, it also offers an opportunity for in-depth consideration of the value of schemes’ fund management services. For instance, schemes could take advantage of the improved research cost transparency to assess where investment research adds value, or use the cost disclosures to improve their due diligence on managers and think about how to achieve better value for money.

“With the new automatic categorisation of LGPS funds as ‘retail’ instead of ‘professional’ clients, it is particularly important that this sector takes all the necessary steps to be ‘opted-up’ to professional status by their managers. Retail clients do not have access to some asset classes like infrastructure and schemes will need to opt-up as quickly as possible to ensure that their investment strategy is not adversely affected.”

Matt Smith, CEO of regulatory compliance firm SteelEye says: “Most firms will have prepared adequately ahead of today’s implementation date. However, for those who have not, it is important for them to remember that regulators are prepared to show leniency for non-compliance only if firms can show they have started to take relevant steps and are making good progress in their efforts to comply with the new MiFID II rules.

“Firms should remember that, while MiFID II certainly presents some challenges, it also presents opportunities and it should be viewed as not just being a burden but as potentially providing benefits too. The task of becoming compliant with MiFID II can bring significant advantages to firms, including risk reduction, enhanced communications and greater data transparency. Firms can leverage the information they generate for MiFID II compliance to gain business insights, develop more relevant content through better sales and marketing and optimise their business.”