The Markets in Financial Instruments Directive II / Markets in Financial Instruments Regulation ("MiFID II") came into force throughout the EU on 3 January 2018. With reports that there are several matters that firms have not yet managed to address, and some EU Member States still not having implemented their transposition measures, it seems an appropriate time to take stock of where we are, and focus on what firms should be doing now.
In September 2017, the FCA made the following statement:
"We are very much aware of how much work many firms have been engaged in for a very long time now in re-tooling and preparing for next year. This means we have no intention of taking enforcement action against firms for not meeting all requirements straight away where there is evidence they have taken sufficient steps to meet the obligations by the start-date, 3 January 2018."
Andrew Bailey, Chief Executive of the FCA, has clarified since that it is not their "intention to offer forbearance: we expect firms to comply with their obligations. But we thought it important to confirm that we would not use our enforcement powers in a disproportionate manner". Firms should therefore take some comfort that, where they have made reasonable progress with their MiFID II projects, they will be in a good position when the regulator comes knocking. However, September's statement from the FCA is in no way a carte blanche to delay on implementation.
The key areas firms should be continuing to focus on are:
Costs and charges
Costs and charges reporting still seems to be one of the most challenging aspects of compliance with MiFID II, with certain providers of underlying costs and charges information taking some time to provide the necessary figures.
There are also concerns within the industry that there is a lack of consistency with how costs and charges information is being calculated and communicated to investors. This is a concern that seems to be applying equally to the Regulation on Key Information Documents for Packaged Retail and Insurance-based Investment Products ("PRIIPS Regulation").
For both MiFID II and the PRIIPS Regulation, consensus appears to be that the European Commission and national regulators have not issued sufficient guidance on how firms can meet their disclosure obligations. Firms are advised to continue with their current approach to disclosure of costs and charges, keep a watching brief on the approach taken by other firms, and await further guidance from regulators.
- Firms should ensure that their product approval and oversight procedures are now fully implemented. Such procedures should include:A process for approving new products and making changes to existing products, which involves consideration of risks, regulatory issues, the target market and sign-off from the management body
- A process for carrying out an annual review of products, identifying whether such products satisfy the needs and requirements of target markets, and whether they are being sold to that target market
- A process for providing information to distributors, including target market assessments
- A process for obtaining data on sales from distributors
Firms are reminded that the MiFID II product governance requirements apply to both MiFID and non-MiFID firms.
Firms should also confirm that the composition, and prescribed duties, of management bodies are in line with MiFID II (and, ultimately, the principles of the Senior Managers and Certification Regime, as set out in FCA consultation paper 17/25 and FCA consultation paper 17/40. An effective approach to ensuring compliance with the MiFID II governance requirements may entail:
- Assessing directors' / officers' outside business interests on a rolling basis
- Introduce an induction training programme for new members of the management body
- Developing the management information provided to the management body, including data on product governance, client money and product governance
- Updating Terms of Reference to ensure they fully detail the oversight responsibilities of each member of the management body
Firms should also ensure they have implemented a process for monitoring and communicating to clients when there are 10% or more decreases in portfolio value.
Possibly the most cost- and labour-intensive aspect of MiFID II, transaction reporting has resulted in significant changes for firms, with many having to select outsourced reporting providers, running tests in UAT environments, and then going live, only to find there were teething issues on the first few days due to the volume of information passing through new systems and processes.
The main issue for firms will be to identify, as early as possible, any under-reporting or over-reporting. Whilst the FCA expected errors within the first few weeks of implementing MiFID II, firms should now ensure that they are confident they have in place appropriate systems and controls to recognise and manage reporting errors.
Firms should also be looking to confirm they have received all legal entity identifiers ("LEI") for clients. Although bear in mind that ESMA has issued a statement allowing for a temporary period of 6 months (until June 2018) for compliance with the LEI requirements, which gives firms some leeway where clients have not been forthcoming in obtaining LEIs.
Generally, firms have implemented the necessary changes to their best execution policies and procedures to take account of MiFID II. However, firms should also be working now to ensure that they are ready for the first RTS 28 reporting that is due by 30 April 2018.
RTS 28 reporting covers (i) a statement on the best execution policy that the firm adheres to; (ii) information on the distinction between orders executed directly on venue and orders executed through brokers; and (iii) an outline of the 'top five' execution venues and quality of execution obtained.
Firms should now be looking to ensure that they have appropriate procedures in place to provide this information for the RTS 28 report.
Now that firms have decided whether they will be paying for research from their own account (otherwise known as "P&L"), charging clients for research (through a research payment account, or an "RPA") or a mixture of both, the practicalities of each approach are being addressed.
For firms adopting the P&L approach, they must be confident that they are not paying too little for research, and could therefore be accused of receiving inducements. For firms taking the RPA approach, they must have in place a robust process to ensure proper budgeting, evaluation and communication with clients as to research costs incurred.
We anticipate that, for some time, receipt of unsolicited (usually free) research will continue to present a problem for firms. Firms are encouraged to continue to review their procedures and carry out refresher training for portfolio managers to re-emphasise the need to unsubscribe from unsolicited research received directly into inboxes.
Matters for investors
We have seen several investment management agreements ("IMAs") coming from MiFID managers which do not yet take account of the MiFID II changes. In general, investors are advised to require that their managers include the following key points in their IMAs (or another form of client communication):
- Trading outside a trading venue - MiFID II expands the definition of a "trading venue" to include multilateral trading facilities and organised trading facilities, as well as recognised exchanges. If your manager will be trading outside a trading venue, they will require your express consent to do so. This consent should ideally be located in your IMA.
- Client reporting - we would expect that the IMA, or some other form of client communication, will contain information on the enhanced reporting you will receive, as prescribed by MiFID II. In addition, MiFID II requires that all client reporting is provided in hard copy form, unless the client consents to receive that information electronically. For convenience, it would usually be preferable for investors to receive electronic reporting, and your consent to this should be included in the IMA.
- Conflicts of interest - firms are now required to "prevent" conflicts of interest, as well as identify and manage conflicts, and must take all "appropriate" steps (as opposed to all "reasonable" steps) to do so. Disclosure requirements are also now more prescriptive. These obligations should either be reflected in the IMA or the manager's conflicts of interest procedure.
- Research payments - managers should generally deal with the payment of research (whether by RPA or P&L) in the IMA, particularly in new IMAs being entered into following the date of implementation of MiFID II. We would expect that managers would have already communicated their approach to research to you, so this should not be unexpected.
- Best execution and risk warnings - MiFID firms should have communicated their updated policy on best execution and risk warnings document to you.
- Costs and charges - although this will not necessarily contained in the IMA, investors should now be receiving MiFID II compliant information on costs and charges (for some products this will be dealt with in the KID).
Managers are taking varying approaches to covering these points. It is not essential that older IMAs are opened up simply to incorporate these changes. In most instances, firms will have issued a client communication and will actively seek your consent to those matters that require it. For IMAs entered into going forward, it would be best practice to include these items within the agreement.
Some of the FCA's views on the market since MiFID II implementation are:
- New systems have generally stood up to the test of heavy trading (which was seen when markets were particularly volatile in February)
- OTC trading has been markedly down, which was expected
- There has been a delay in implementing the double volume cap mechanism, which limits trading in dark pools. Andrew Bailey expects data systems across the EU to get up to speed with these requirements shortly
UK firms seem to have made good progress with their MiFID II projects, and any particular areas causing concern appear to be faced generally throughout the industry. Indeed, at the end of February 2018, UK Finance issued a paper stating that their members have found MiFID II implementation to be considerably smoother than originally anticipated, and this is the feedback from the industry that the FCA has also received. While the FCA statement should provide some comfort, it is important that firms can prove that they have taken "sufficient steps" in order to avoid enforcement action.