What is the concept and objectives of MiFID?
It is the acronym for "Market in Financial Instruments Directive". This Directive entered into force on 1 November 2007 and establishes a homogeneous regulatory framework in the financial markets of different countries of the European Union, which favors among other things investment in the products covered by this Directive, providing a degree of information to investors, and protecting investments across the states of Europe.
MiFID essentially has two objectives:
- Increase protection for clients that opt for financial or investment services.
- Increase the level of competition in the markets.
From the point of view of financial institutions, among which its activities logically provide such services to its customers, the Directive has brought about various changes that have resulted in better information to them.
What financial products does the MiFID does and does not cover?
There is an explicit characterization of covered and not covered products in the Directive. This can be illustrated as follows:
The first issue to consider is that MiFID does not affect all products offered by financial institutions, but only a few that could be defined in simple words as being more complicated than average and involving considerably more risk to investors who don’t particular understand their mechanisms.
In this sense, we distinguish between:
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Products that don’t have the MiFID cover
They are not affected by the regulation established by the Directive; for example current accounts, savings deposits for traditional term, pension plans, etc. -
Products that have the MiFID cover
These are products whose degree of complexity is higher than the ones not covered by the Directive. These products are further divided into two groups, with the high complexity ones being given preferential treatment in the Directive.
- Low complexity: These include stocks, mutual funds, promissory notes and government debt.
- High complexity: These include debts, derivatives, hedges, currency options, etc.
What is the classification of clients in the MiFID?
The provisions of MiFID are only be applicable to customers, who are legal or naturalized residents of the European Union, and have financial contracts covered by that directive or are involved in investment services mentioned above. There are variations in the design of the level of product protection MiFID offers based on the knowledge and experience of these customers.
Specifically, customers are classified in the Directive as:
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Retail:
They are the majority and are customers with lower levels of knowledge and experience in the products covered by the Directive and therefore in need of greater protection.
MIFID also defines retail customers by exclusion, that is, someone who is deemed a customer but isn’t covered by the criteria outlined under paragraph b) and c) below. -
Professionals:
Have a greater level of knowledge than retail customers. In fact, they are those who have the experience, knowledge and skill to make their own investment decisions and understand the risks arising from their endeavors. -
Counterparty eligible:
They are those with the highest level of knowledge, experience and qualifications (fund managers, etc.).
What are the adaptation guidelines issued by MiFID?
MIFID classifies customers in the above categories in order to offer a different level of protection for each one of them. Also, it helps in assessing the suitability of a given financial product for a given customers.
To Directive provides with two solutions in assessing and adapting services for a given customer:
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Test of adequacy:
It is a test to be performed by the retail customer who wants to utilize a complex product. With the test results, the financial institution can tell you whether the product you want to opt for is suitable for your level of expertise or not.
The test of adequacy is not usually applied by some financial institutions if the customer wants to opt for a non-complex MiFID product or a part thereof. -
Suitability test:
This is usually a longer and more intricate version of the adequacy test and usually involves individuals who are involved in advisory services in financial matters or in the management of investment portfolios.
What is the requirement of information provision under MiFID?
MiFID distinguishes between two types of information that, in any case, must meet certain requirements: clarity, fairness, etc.
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Pre-contractual:
It pre-contractual information that is delivered to a client or potential client before the imparting of financial services. -
Post-contractual:
It will be sent to customers after the service has been opted for. It can be of two types:
- Spot: It informs the customer of the concrete implementation of one of their orders (eg, bond trading, stock unloading).
- Periodic: The customers must also be informed about the status of their portfolio after frequent, periodic intervals. Usually, this period is quarterly.
It is pertinent to mention that MiFID II is slated to supersede MiFID in the latter half of 2016. While the MIFID centered on the concept of breaking down trade barriers and curtailment of financial instrument monopolies in the European Union, MiFID II is far more exhaustive and regulatory in nature with its primary focus being to reduce the recurrence of a scenario like the 2008 economic crisis. We will look at it in more detail in a later article.