Introduction to MiFID - Key information to understand
Story by Mila Klimkowicz
6 min read
As an investor, one of the terms worthy of knowing is MiFID - an EU regulatory framework that implemented a higher level of transparency in the financial market. Put into effect in 2007, the first iteration was regarded as incomplete and underwent revision, ultimately evolving into MiFID II in 2018. In this post, we will explain what MiFID stands for, who is impacted by this directive, and the key requirements to be aware of.
What Is the Markets in Financial Instruments Directive (MiFID)? 📜
The Markets in Financial Instruments Directive (commonly referred to as MiFID) was formulated by the European Union to standardize regulations governing all investment services within the EU's financial market. Its goal is to enhance investor protection and promote fair competition by establishing a set of standards and rules for investment firms.
What is MiFID II/MiFIR? 📋
Following its implementation, it became noticeable that the initial framework of MiFID lacked adequate regulations in the investment sector. Due to this, the European Commission, the European Parliament, and the Council of the European Union collaboratively agreed to address all gaps and enhance the existing arrangement.
This resulted in the introduction of a revised directive known as MiFID II in 2018. While MiFID was originally limited to equity stocks, MiFID II/MiFIR significantly broadened its scope to include a wider range of firms and instruments.
Another difference is that prior to MiFID II regulations, investment companies were limited to gathering information from just one or two public exchanges. With the implementation of MiFID II, they are now permitted to collect information from all sales points, provided they publicly disclose their prices and details.
Who is affected by MiFID? 📈
Simply put - it affects all investment services. The directive doesn’t regulate private investors or individuals but firms that operate on their behalf, including banks and non-banks. MiFID II/MiFIR applies to investment firms, market operators, and third-country firms providing investment services or performing investment activities through the establishment of a branch in the Union.
What are the requirements of MiFID? ✅
MiFID regulations are designed to enhance transparency in financial markets, promote competition by bringing together merchants and service providers, and improve investor protection.
One of the most crucial parts of MiFID is adhering to AML regulations which include customer classification (explained in detail later in this blog post). Investment firms are also required to maintain records of all the services, activities, and transactions they undertake. Additionally, they must keep recordings of all telephone conversations and other electronic communications.
Below is an overview of the elements that form MiFID.
The elements that make up MiFID 🧩
Transparency in the equity market has increased significantly and transparency for non-equity instruments, which were previously outside the scope of MiFID, such as bonds and derivatives has been introduced (including pre-trade and post-trade regulations). Additionally, this data must be publicly disclosed and made commercially available.
A new market structure has been designed to close the regulation gaps, which resulted in trading taking place on regulated platforms. Investment firms, when executing client orders through their internal systems, are required to register as a Multilateral Trade Facility (MTF). Apart from that, The OTF (Organised Trading Facility) has been introduced as a multilateral trading platform to synchronize MTFs with Regulated Markets.
Organizational requirements related to protecting client assets and product monitoring have been established. The marketing and distribution of certain financial instruments can be prohibited or restricted by ESMA (European Securities and Markets Authority) or EBA (European Banking Authority). Another change is that the Insurance Mediation Directive (IMD) has been amended to provide new regulations governing insurance-based investment products.
Investment firms are obliged to report complete and accurate details of transactions in financial instruments. Firms also have to continuously check their reporting framework by using an established test mechanism.
Client categorization 🧑💼
MiFID categorizes clients into three different categories: professional clients, retail clients, and eligible counterparties. The reason behind this is that different clients have varying levels of financial knowledge and require different levels of protection for their account types and investments.
Retail (or Private) clients are those who do not meet the criteria to fall within the Professional or Eligible categories and are granted the highest level of protection.
A Professional client is considered to have enough knowledge, experience, and skill to make their own investment decisions and properly assess the risks involved. Some examples of clients that might belong to this category are credit institutions, investment firms, insurance companies, or other institutional investors.
Eligible Counterparties are those considered to be the most sophisticated investors operating in the financial sector and are subject to a lower level of regulatory protection due to their comprehensive knowledge of investment matters. These are typically national governments and their departments, investment companies, Central banks, and Supranational organizations.
What is the appropriateness assessment?
One of the MiFID requirements is that financial institutions must only recommend investment-based services and products that are suitable for the client (considering the client’s nature and risk tolerance). In order to obtain this information about the client's suitability and appropriateness checks are carried out by these institutions. For a deeper understanding of MiFID II appropriateness requirements, you can refer to the guidelines provided by ESMA.
It is important to categorize clients correctly at the initial stage, but this information must be regularly reviewed and updated if necessary. This is part of the KYC process which you can read more about in one of our previous blog posts.
During the Customer Due Diligence stage, the user is asked to fill in a MiFID questionnaire. It consists of questions that help in assessing whether the investor possesses the necessary level of experience and knowledge to comprehend the risks associated with the investment proposal. Thanks to this firms know which products or services are in line with the needs and expectations of the client. Below is an example of the appropriateness questionnaire from Oanda (a project in which we are actively engaged):
The primary objective of the MiFID regulations was to enhance transparency and regulate equity markets within the EU for the protection of European investors. While this goal was achieved it also added to the workload which companies must deal with in order to remain compliant with the updated rules. At Direkpoint, we have been a part of projects that involve the integration of MiFID into company processes for firms within the investment sector. If you need assistance in implementing these regulations into your company's products, feel free to contact us and let us know how we can help!