Markets in Financial Instruments Directive 2014

Markets in Financial Instruments Directive 2014 (2014/65/EU), commonly known as MiFID 2 (Markets in financial instruments directive 2), is a legal act of the European Union (EU). 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).

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 (EU) 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 (Level 2). 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 (EU) 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 (EU) 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 financial crisis in 2008.

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 (EC) was read by the European Parliament (EP) 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 (ISD) originally adopted in 1993.

Level 2
Twenty articles of this directive specified technical implementation measures (Level 2). 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.

Scope
To determine which firms are affected by MiFID 1 and which are not the directive distinguishes between "investment services and activities" ("core" services) and "ancillary services" ("non-core" 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 (and it can use the MiFID 1 passport to provide them to member states other than its home state). 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, (Germany), 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" (broadly, the country in which they have their registered office). 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" (whereas currently under ISD, a service is regulated by the member state in which the service takes place).


 * Client categorisation: MiFID 1 requires firms to categorise clients as "eligible counterparties", professional clients, or retail clients (these have increasing levels of protection). 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. (Note consideration is being given to extending these requirements to other financial instruments. Under Article 65(1) of MiFID 1, the European Commission is due to submit a report to the European Parliament and to the Council on extending pre and post-trade transparency requirements to transactions in financial instruments other than shares by October 2007.)


 * 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. (Note see comment above regarding extension of these requirements to other financial instruments).


 * 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 (see above).

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 (and in some cases the obligation) to collect information from a multitude of multilateral trading facilities, Systematic Internalisers and other exchanges from around the European Economic Area (EEA). 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.

Transposition
MiFID 2 and its accompanying implementing directive were transposed in full and on time, with minor exceptions. The European Commission has published a transposition table linking to lists of national provisions which transpose directives.

National courts play an especially important role in the enforcement of the directive. National courts are tasked with adjudicating cases involving breaches of MiFID 2 regulations and can impose sanctions, fines, and order corrective actions to ensure compliance. Courts also interpret how MiFID 2 should be applied in specific national contexts, hence shaping the practical impact of the directive across different jurisdictions. This judicial oversight ensures that financial institutions adhere to MiFID 2’s high standards.

Notable examples of how national courts have dealt with several MiFID 2-related cases include the UK Financial Conduct Authority (FCA)’s use of British courts to enforce financial regulations, and Germany’s BaFin v. Deutsche Bank which protected MiFD 2’s regulations for German financial companies.

United Kingdom
The Financial Services Authority (FSA), now the FCA, was the body responsible for the regulation of the securities industry in the United Kingdom during the period of implementation.

Prior to Brexit, the UK FCA was proactive in pursuing enforcement actions under MiFID 2, especially concerning the accurate and timely reporting of transactions. The FCA brought numerous cases involving serious infringements to MiFD 2 before British courts, which usually resulted in the imposition of fines on major financial institutions like UBS and Goldman Sachs. Such institutions were often found by the courts to have failed in reporting millions of transactions.

Post-Brexit, the UK is no longer bound by MiFD 2. However, to maintain market stability and ensure smooth cross-border financial services, the UK initially incorporated MiFID 2 into its domestic law under the European Union (Withdrawal) Act. Thus, the FCA continues to enforce MiFID-like rules domestically.

Germany
The German financial watchdog BaFin, and direct affiliate of the German Federal Court of Justice (GFCC) as a German national financial regulator, identified significant lapses in Deutsche Bank's transaction reporting system. BaFin imposed a fine of €170,000 on Deutsche Bank due to deficiencies in its anti-money laundering procedures and for not accurately representing its environmental, social, and governance (ESG) investment practices. Consequently, through the jurisdiction of the GFCC, BaFin played a key role in enforcing MiFD 2 by mandating Deutsche Bank to implement a comprehensive overhaul of its transaction reporting procedures to ensure future compliance with MiFID II regulations.

France
The French government has implemented MiFID 2 by modifying the French Monetary and Financial Code, in particular by ordinance number 2007-544 of 12 April 2007, and the decrees 2007-901 and 2007-904 of 15 May 2007. The Autorité des Marchés Financiers (AMF) has also applied MiFID 2 t o its General Regulations (Règlement Général).

Directive 2014/65/EU / Regulation (EU) No 600/2014
In April 2010, CESR issued consultation papers on MiFID 2 review. The consultation period was short and ended on 31 May 2010. There was one day of open hearings in Paris on 17 May 2010. Public responses to the consultations are now available although a number of institutions also submitted confidential responses.

On 8 December 2010, following a public hearing held in September 2010, the European Commission released a substantial public consultation relating to the review of MiFID 2, accompanied by a press release and frequently asked questions. The public consultation period was scheduled to close on 2 February 2011. On 26 May 2011, the Commission was reported to be working to present its proposals before the end of 2011.

On 20 October 2011, the European Commission adopted formal proposals for a "Directive on markets in financial instruments repealing MiFID 1 of the European Parliament and of the Council", and for a "Regulation on markets in financial instruments", which would also amend Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories.

In March 2012, MEP Markus Ferber suggested amendments to the European Commission's proposals, intended to strengthen restrictions on high-frequency trading and commodity price manipulation. The Association for Financial Markets in Europe (AFME)'s formal response to Ferber particularly cited concern with the requirement that all algorithms run continuously as this would preclude the use of broker algorithms to execute client orders. The creation of the Organized Trading Facility (OTF) rules have also caused concern because of their proposed ban on proprietary trading in broker crossing networks, which would prevent brokers from using their pools to unwind risk on behalf of a client or the bank itself.

Both MiFID 2 and Regulation (EU) No 600/2014 entered into force on 2 July 2014. MiFID 2 replaced MiFID 1, which in turn replaced Directive 93/22/EEC. MiFID 2 is complemented by Regulation (EU) No. 600/2014 on markets in financial instruments The initial date for implementation by the Member States was 3 January 2017, however, in February 2016 the European Commission delayed this until 3 January 2018 to allow for the building of IT systems to enable enforcement of the new package. Some banks and institutions advocated for a further delay to the implementations of MiFID 2, with smaller organisations not yet equipped for the additional demands. However, MiFID 2 came into force on the revised date of 3 January 2018.

Some analysts believe the impact of MiFID 2 will lead to global investment research expenditures falling by as much as $1.5 billion annually when the rules come into force.

Within days of coming into effect, Intercontinental Exchange announced plans to transfer trading in 245 energy futures contracts from London to the US, putting transactions under the oversight of US, rather than European, regulators.

By 3 March 2021, the European Commission will need to present a report to the European Parliament and Council on the functioning of the directive. This will cover a broad range of issues, including the impact of requirements regarding algorithmic trading and the development in prices for pre and post trade transparency data. The European Securities and Markets Authority is to support the Commission with this exercise.

General references

 * MiFID 2.0. Casting New Light on Europe's Capital Markets – Centre for European Policy Studies