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MiFID I to MiFID II

From MiFID I to MiFID II/MiFIR

MiFID II is the generic term referring to the revision of the Markets in Financial Instruments Directive (2004/39/EC) which was orginally introduced in 2007, more commonly known as MiFID I. Upon its application on 3 January 2018, the new directive (2014/65/EU) will be accompanied by the Markets in Financial Instruments Regulation (MiFIR, Reg. EU No. 600/2014). To avoid misunderstandings, Deutsche Börse consistently refers to either MiFID II/MiFIR, or to MiFID I where the old directive is concerned.

MiFID I was designed to set out:

  • conducts of business and organisational requirements for investment firms,
  • authorisation requirements for regulated markets,
  • regulatory reporting to avoid market abuse,
  • trade transparency obligation for shares, and
  • rules on the admission of financial instruments to trading.

In 2014, the European Commission, the European Parliament and the Council of the European Union agreed on a revision of MiFID designed to enhance the efficiency, resilience and integrity of financial markets and to level the playing field within.

Constituting a comprehensive overhaul of the existing directive, MiFID II/MiFIR significantly widen the scope of application to include a broader group of firms and instruments than were affected under MiFID I.

In particular, MiFID II/MiFIR aim at:

  • achieving greater transparency through the introduction of a pre- and post-trade transparency regime for non-equities as well as through a strengthening and broadening of the existing equities trade transparency regime,
  • moving more trading to regulated venues supported by the creation of a new trading platform category (Organised Trading Facilities, OTFs) for derivatives and bonds and by imposing a trading obligation for shares on regulated venues,
  • implementing the European Union’s G20 commitments on derivatives: mandatory trading of derivatives on regulated venues, introduction of position limits and reporting requirements for commodity derivatives, broadening the definition of investment firm to capture firms trading commodity derivatives as a financial activity,
  • facilitating access to capital for small and medium-sized enterprises (SMEs) via the introduction of the SME Growth Market label,
  • enhancing investor protection by e.g. banning the receipt of inducements, safeguarding independent advice, or introducing new product governance rules,
  • adapting to technological progress with the regulation of high-frequency trading (HFT) by introducing requirements on trading venues and on firms using HFT,
  • providing non-discriminatory access to trading and post-trading services, and
  • strengthening pan-European regulatory supervision and cooperation between national competent authorities (NCAs).

The (moving) scope of MiFID II/MiFIR

While the impacts of MiFID II/MiFIR vary depending on the nature and the volume of investment services and activities a company is performing, no one single type of enterprise can be understood to be as such exempt from the regulation. By definition MiFID II/MiFIR apply to investment firms, credit institutions, certain non-financial counterparties, central counterparties (CCPs) and third-country firms providing investment services or activities within the European Union. By derogation from or, at least, amending these definitions, NCAs may reserve the right to make the final decision on whom they consider to qualify as an investment firm under MiFID II/MiFIR and what to consider as investment services and activities.

Their scope, degree of detail, interconnectedness and cross-referencing of regulatory provisions and their enforcement regimes make MiFID II/MiFIR very complex and difficult to understand in their entirety. Adding to this complexity, the set-up of the regulation is designed to evolve with certain provisions being phased in and parts of the so-called Level 2 legislation being subject to potential continuous changes.

A suitable approach to understanding the regulatory reforms under MiFID II/MiFIR may be to largely follow the categorisation by the European Commission, Parliament and Council and to map it to the various segments as outlined below.

Procedure for the legal implementation of MiFID II/MiFIR

Going back to the so-called Lamfalussy Process, there are four levels of implementation of a financial services regulation. Whilst the implementation procedure has changed slightly since, the four-level framework remains.

RTS and ITS

Regulatory technical standards (RTS) and implementing technical standards (ITS) shall be drafted by the European Supervisory Authority and adopted by the European Commission. Read more on how they are developed and how they become effective.

Market structure

The new market structure introduced by MiFID II/MiFIR is designed to close legislative/regulatory gaps. It shall ensure that trading, where appropriate, takes place on regulated platforms. For that purpose a share trading obligation has been established. Investment firms executing client orders in equity and equity-like instruments via an internal matching system on a multilateral basis will have to be authorised as a Multilateral Trading Facility (MTF).

To create a level playing field with Regulated Markets (RMs) and MTFs, the so-called Organised Trading Facility (OTF) has been introduced for non-equity instruments (to be traded on an organised multilateral trading platform). OTF operators may execute trades at their discretion however not against own capital, including matched principal trading. Besides the trading obligation for shares, a trading obligation for derivatives which are eligible for clearing under the European Markets Infrastructure Regulation (EMIR) and which are sufficiently liquid has also been established. > More

Investor protection

MiFID II/MiFIR introduce a number of organisational requirements associated with the protection of client assets or product governance including the establishment of a compliance function monitoring the development and periodic review of product governance. The new regime also provides for strengthened conduct rules such as an extended scope for  appropriateness tests and reinforced information to clients.

Independent advice is clearly distinguished from non-independent advice and limitations are imposed on the receipt of commissions (inducements). MiFID II/MiFIR also introduce harmonised powers and conditions for ESMA to prohibit or restrict the marketing and distribution of certain financial instruments in well-defined circumstances and similar powers for the European Banking Authority (EBA) in the case of structured deposits. Concerning Packaged Retail Investment Products (PRIPs), the new framework also covers structured deposits and amends the Insurance Mediation Directive (IMD) to introduce some rules for insurance-based investment products.

A harmonised regime for granting access to EU markets for firms from third countries is based on an equivalence assessment of third country jurisdictions by the Commission. The regime applies only to the cross-border provision of investment services and activities provided to professional and eligible counterparties. For a transitional period of three years and then pending equivalence decisions by the Commission, national third-country regimes continue to apply. > More

Transparency

MiFID II/MiFIR increase equity market transparency and introduce a transparency regime for non-equity instruments such as bonds and derivatives. For equities, a double volume cap mechanism limits the use of reference price waivers and negotiated price waivers (4 per cent per venue cap and 8 per cent global cap) together with a requirement for price improvement at the mid-point for the former. Large-in-scale waivers and order management waivers remain the same as under MiFID I.

MiFID II/MiFIR also broaden the pre- and post-trade transparency regime to include non-equity instruments, while pre-trade transparency waivers will be available for large orders, requests for quotes and voice trading. Post-trade transparency is provided for all financial instruments with the possibility of deferred publication or volume masking as appropriate.

Trading venues have been obliged to make pre- and post-trade data available on a reasonable commercial basis. Systematic Internalisers and investment firms will have to provide post-trade disclosure via an authorised publication arrangement (APA). > More

Reporting

Measured by the operational challenges it implies, the obligation to report transactions according to Art. 26 of MiFIR clearly belongs to the most far-reaching provisions under MiFID II/MiFIR. In addition to the expansion in scope regarding reportable instruments and transactions or firms concerned, the degree and the kind of detail required constitute a paradigm change.

Investment firms obliged to report will be apprehensive of both the fact that they do not obtain some of the reportable data required and the fact that some of the data is sensitive third-party data the dissemination of which may potentially violate privacy rules. It may also unintentionally uncover trade secrets to a third party if an investment firm chooses to delegate its reporting to an appropriate provider.

Firms will also need to continuously assess their reporting framework by establishing a testing mechanism. > More