The comprehensive revisions to the Markets in Financial Instruments Directive (MiFiD) in response to the financial crisis have had a troubled gestation.
Investment firms executing (or arranging for the execution of) trades on behalf of clients must take all reasonable steps to obtain the best possible result for their clients when executing orders (known as “best execution”). Firms will already have policies in place to ensure that they can meet this obligation. However, MiFID II (the Markets in Financial Instruments Directive, 2014/65/EU) will impose a number of new and enhanced obligations on firms when it comes into force in January 2018.
What are the changes?
MiFID II builds upon the existing requirements in MiFID I in a number of ways, including:
- Firms are expressly required to explain their execution policies in sufficient detail to allow clients easily to understand how orders will be executed;
- Requiring firms to disclose the top five execution venues used;
- Disclose on at least an annual basis the quality of execution;
- Prohibiting the use of payments for order flow; and
- Upgrading the obligation to achieve the best result from an obligation to use “all reasonable steps” to a requirement to take “all sufficient steps”.
As part of its consultation process in 2014 for the implementation of MiFID II, ESMA expressed frustration at the perceived failure of the best execution regime set out in MiFID I to help investors differentiate between services provided by investment firms. ESMA’s technical advice, published in December 2014, therefore included a number of provisions seeking to clarify, but also tighten up on, equivalent provisions in MiFID I and its implementing directive. This has been confirmed in the draft implementing regulations for MiFID II that were published by the European Commission in late April2016.
Will MiFID II significantly change existing regulation of best execution in the UK?
The best execution requirements in MiFID II represent a significant step-up from the obligations that firms were under when the original Directive took effect in 2007. Certainly UK firms will need to look carefully at their policies and procedures to ensure that they are updated to comply with these more stringent requirements.
However, it is worth remembering that the FSA (the predecessor conduct regulator to the FCA) had already made it clear to firms that it expected them to go above and beyond what was required by the letter of MiFID I. In January 2009, the FSA, published a report on wholesale firms’ implementation of MiFID I which was critical of their efforts on execution best execution, expressing concern that firms were doing little more than reciting the rules in policies that were high level and vague.
Furthermore, UK firms had already been warned not to engage in accepting payments for order flows in FSA guidance that was adopted in 2012.
Nonetheless, there are still a number of changes that will require even the most compliant of firms to look again at their policies and procedures. The obligation to publish details of the five top executionvenues may give rise to concerns amongst brokers that they are having to reveal trade secrets and give more information to clients than they would be comfortable doing. Similarly, the requirement for providing clear and detailed execution policies that can be “easily understood by clients” may result in longer and more specific documents being produced. Greater care will also need to be taken to consider whether policies need to be revisited following changes within the firm (whilst this obligation is not new, as with much in MiFID II, it is expected to be more rigorously applied).