Markets in Financial Instruments Directive 2014
Markets in Financial Instruments Directive 2014, is a directive of the European Union. Together with Regulation No 600/2014 it provides a legal framework for securities markets, investment intermediaries, in addition to trading venues. The directive provides harmonised regulation for investment services of the member states of the European Economic Area — the EU member states plus Iceland, Norway and Liechtenstein. Its main objectives are to increase competition and investor protection, as well as level the playing field for market participants in investment services. It repeals Directive 2004/39/EC.
MiFID 1 was a cornerstone of the European Commission's Financial Services Action Plan, whose measures changed how EU financial service markets operate. It is the most significant piece of legislation introduced in the Lamfalussy process designed to accelerate the adoption of legislation based on a four-level approach recommended by the Committee of Wise Men chaired by Baron Alexandre Lamfalussy. There are three other "Lamfalussy Directives": Directive 2003/71/EC, replaced with Regulation 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, the market abuse directive, and Directive 2004/109/EC on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market.
MiFID 1 retained the principles of the EU "passport" introduced by Directive 93/22/EEC but introduced the concept of "maximum harmonization", which places more emphasis on home state supervision. This is a change from the prior EU financial service legislation, which featured a "minimum harmonization and mutual recognition" concept. "Maximum harmonization" does not permit states to be "super equivalent" or to "gold-plate" EU requirements detrimental to a "level playing field". Another change was the abolition of the "concentration rule" in which member states could require investment firms to route client orders through regulated markets.
MiFID 1, implemented through the standard co-decision procedure of the Council of the European Union and the European Parliament, set out a detailed framework for the legislation. Twenty articles of this directive specified technical implementation measures. These measures were adopted by the European Commission based on technical advice from the Committee of European Securities Regulators and negotiations in the European Securities Committee, with oversight by the European Parliament. Implementation measures in the form of a Commission Directive and Commission Regulation were officially published on 2 September 2006.
After its initial implementation, MiFID 1 was intended to be reviewed. After extensive discussion and debate, in April 2014, the European Parliament approved both MiFID 2, an updated version of MiFID 1, and its accompanying Regulation No 600/2014. The directive and regulation include fewer exemptions and expand the scope of MiFID 1 to cover a larger group of companies and financial products. Both MiFID 2 and Regulation No 600/2014 have been effective from 3 January 2018.
Background and history
MiFID 1 was intended to replace Directive 93/22/EEC, which was adopted in 1993. The law creates a single market for investment services and activities, which improves the competitiveness in EU markets. While the original law did succeed in lowering prices and expanding choices for investors, weaknesses in ISD's structure became apparent during the 2008 financial crisis.MiFID 1 was also intended to make changes to share trading, and it set guidelines for the use of related financial instruments. The law was introduced in order to reduce systemic risk and strengthen existing investor protections.
During the approval process for MiFID 1, a proposal from the European Commission was read by the European Parliament in March 2004. In April 2006, the Commission published consultation responses it received in 2005. In June 2006, the Commission published a new draft. The EC and EP discussed any suggested amendments to approve Level One texts. A second reading of the legislature, by both EP and EC, followed.
MiFID 1 was introduced under the Lamfalussy procedure, which was designed to accelerate the adoption of legislation based on a four-level approach recommended by the Committee of Wise Men. The Committee was chaired by Baron Alexandre Lamfalussy. There are three other "Lamfalussy Directives": the Prospectus Directive, the Market Abuse Directive, and the Transparency Directive.
Level 1
MiFID 1, implemented through the standard co-decision procedure of the Council of the European Union and the European Parliament, sets out a detailed framework for the legislation. It also amends Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC and repeals Council Directive 93/22/EEC, Investment Services Directive originally adopted in 1993.Level 2
Twenty articles of this directive specified technical implementation measures. These measures were adopted by the European Commission, based on technical advice from the Committee of European Securities Regulators and negotiations in the European Securities Committee with oversight by the European Parliament. Implementation measures in the form of a Commission Directive and Commission Regulation were officially published on 2 September 2006.Level 3
Level 3 texts are explanatory material issued by regulators and national bodies that set out regulators' approaches to interpretation of level I and II material.They usually do not carry the force of law, but regulators often require explanations for departures from their interpretation. Level 3 texts are sometimes referred to as "soft law". ESMA has issued a large number of level 3 texts on MiFiD II in the form of documents and questions and answers.Contents
Scope
To determine which firms are affected by MiFID 1 and which are not the directive distinguishes between "investment services and activities" and "ancillary services". More detail on the services in each category can be found in Annex 1 Sections A and B of MiFID 1.If a firm performs investment services and activities, it is subject to MiFID 1 in respect to both of these and also of ancillary services. However, if a firm only performs ancillary services, it is not subject to MiFID 1 but also can not benefit from the MiFID 1 passport.
MiFID 1 covers almost all tradable financial products except for certain foreign exchange trades. This includes commodity and other derivatives such as freight, climate and carbon derivatives, which were not covered by ISD.
That part of a firm's business that is not covered by the above is not subject to MiFID 1.
Celent, a financial services consultancy, estimated in 2007 that under MiFID 1, the three largest EU jurisdictions—France, and the UK—would require publication of over 100 million additional trades annually, with spending increasing as well but at a slower rate, from €38 million yearly to close to €50 million.
Substance
;Authorisation, regulation and passporting: Firms covered by MiFID 1 will be authorised and regulated in their "home state". Once a firm has been authorised, it will be able to use the MiFID 1 passport to provide services to customers in other EU member states. These services will be regulated by the member state in their "home state".;Client categorisation: MiFID 1 requires firms to categorise clients as "eligible counterparties", professional clients, or retail clients. Clear procedures must be in place to categorise clients and assess their suitability for each type of investment product. That said, the appropriateness of any investment advice or suggested financial transaction must still be verified before being given.
;Client order handling: MiFID 1 has requirements relating to the information that needs to be captured when accepting client orders, ensuring that a firm is acting in a client's best interests and as to how orders from different clients may be aggregated.
;Pre-trade transparency: MiFID 1 requires that operators of continuous order-matching systems must make aggregated order information on "liquid shares" available at the five best price levels on the buy and sell-side; for quote-driven markets, the best bids and offers of market makers must be made available.
;Post-trade transparency: MiFID 1 requires firms to publish the price, volume, and time of all trades in listed shares, even if executed outside of a regulated market, unless certain requirements are met to allow for deferred publication..
;Inducements and investment research: One of the most controversial aspects of MiFID 2 is that it severely restricts asset managers' ability to obtain investment research with client commissions.
;Best execution: Directive 2014/65/EU requires that firms take all sufficient steps to obtain the best possible result in the execution of an order for a client. The best possible result is not limited to execution price but also includes cost, speed, the likelihood of execution and likelihood of settlement and any other factors deemed relevant. MiFID 2's "all sufficient steps" test sets a somewhat higher standard than the previous "all reasonable steps" standard in MiFID 1.
;Systematic Internaliser: A Systematic Internaliser is a firm that executes orders from its clients against its own book or against orders from other clients. MiFID 2 will treat Systematic Internalisers as mini-exchanges, hence, for example, they will be subject to pre-trade and post-trade transparency requirements.
Market fragmentation
Although MiFID 2 was intended to increase transparency for prices, the fragmentation of trading venues has had an unanticipated effect. Where once a financial institution was able to see information from just one or two exchanges, they now have the possibility to collect information from a multitude of multilateral trading facilities, Systematic Internalisers and other exchanges from around the European Economic Area. This results in an additional amount of work to benefit from the transparency that MiFID 2 has introduced.The number of additional pricing sources introduced by MiFID 2 means that financial institutions have had to seek additional data sources to ensure that they capture as many quotes/trades as possible. Numerous financial data vendors have worked with the MiFID 2 Joint Working Group and Regulators to make sure that they are able to help financial institutions to deal with the fragmentation and benefit from the increased transparency while helping them to fulfill their new reporting liabilities.