MiFID: two years later

2 November 2009

Sonja Lohse of Nordea Bank, and Uta Wassmuth of the European Banking Federation look at what MiFID has achieved. They then examine what can be done to make it work better.

Two years into life with the Market in Financial Instruments Directive (MiFID), opinions about the legislation grow increasingly diverse.

When MiFID became a legal reality for investment companies in November 2007, there was a widespread expectation among policymakers and market practitioners that it would generate great benefits for the European financial market in terms of increased competition, greater investor choice and enhanced investor protection.

However, shortly after MiFID came into force there were already calls for legislative amendments and further regulation. Not surprisingly, this was also as a result of the financial crisis that led policymakers to question existing legislation and legislative paradigms to the core.

Positive signs from MiFID implementation

The evaluation of the impact of MiFID so far is blurred by the consequences of the financial crisis. The interest of the general media has turned to spectacular stories about apparent mis-selling, which leaves little room to consider the increased investor protection standards under MiFID. The significance of MiFID's price transparency regime is of far less public interest than discussions about the justification and necessity of over-the-counter business and dark pool trading.

There is wide praise at least about the fundamental changes that MiFID has brought about in the trading landscape. The abolition of the 'concentration rule' has led to the creation of a considerable number of additional trading venues, including multilateral trading facilities (MTFs) and companies that execute client orders against their own books (systematic internalisers). The incumbent exchanges have responded to this competition by lowering trading prices and improving services.

But MiFID has achieved more than this. In view of the many discussions about perceived gaps in investor protection, it is regrettable that the high standards it ensures in this respect are given little consideration. This includes provisions for client categorisation, requirements for suitability respectively appropriateness tests, requirements for the substance and way of providing clients with product information, standards on how to deal with potential conflicts of interest, rules forbidding inducements - except in certain circumstances where they must be fully disclosed to clients - and the best execution requirement.

In combination, these carefully crafted rules cover the entire value chain of providing investment services to clients. Much work has been done by investment companies to ensure that their internal processes fully comply with these standards, and everyone who has been involved in the necessary review and implementation processes is convinced that their benefits will become clear.

Remaining challenges

This is not to say that everything works perfectly. Several matters remain to be resolved, in terms of legal interpretation and practical responses. Many market participants have regretted the fragmentation of trading data that resulted from the increased number of trading venues. Such fragmentation is an inevitable result of competition, and data providers stand ready to propose technical solutions. The main difficulty lies not in the consolidation of data but rather in weaknesses in the provision of trading information to data vendors.

This leads to additional complications further down the value chain. Best execution systems can function well only if based on accurate and timely data.

Regulators have an important role to play in this respect, as in other aspects of MiFID implementation. The financial crisis has put pressure on the time and resources left to regulators to check comprehensive and effective implementation of MiFID within companies. Such checks are, however, essential to ensure consistency across companies and EU markets. More evidence of these checks, with necessary follow-up measures and confirmation of orderly systems, would also contribute to restoring investor confidence in troubled times.

Impact of the crisis

Although the banks' evaluation of MiFID is on balance positive, it naturally takes time before this conclusion can be confirmed with systematic evidence.

Unfortunately, time is a particularly scarce resource during crises and, in their search for fast and rigorous responses, policymakers have identified a number of areas where they believe MiFID is either not working or insufficient. As in many other areas of the financial markets, such concerns centre primarily on questions of investor protection on one hand and transparency on the other.

As regards investor protection, this summer the European Commission (EC) notably published a communication on 'Packaged Retail Investment Products', which includes all investment products designed with the retail investor in mind and constructed from several underlying products in order to offer a modified risk-profile. In the communication, the Commission recognises that the MiFID rules constitute a benchmark for selling practices. In contrast, the commission considers insufficient the MiFID rules on product disclosures and has announced additional legislative rules to require short and harmonised factsheets for all retail investment products.

Discussions about transparency are manifold but include the Committee of European Securities Supervisors (CESR) proposals for a post-trading transparency framework for fixed-income instruments, which are intended to complement the transparency rules that MiFID prescribes for equities. Although CESR acknowledges that the lack of post-trade transparency data has not been a contributing factor to the crisis, it believes that easier availability of such data could help to improve reduced liquidity and increased spreads in the corporate bond markets. The Committee also suggests that such a transparency framework could gradually be extended to standardised kinds of asset-backed securities.

Other efforts to enhance transparency on the financial markets include the EC's proposals for the OTC markets, which feature more product standardisation and the clearing of an increasing number of OTC traded derivatives through clearinghouses.

Discussions risk being rushed

Regulation is rarely perfect and there is always scope for improvement. In different circumstances, a proper assessment of MiFID and of the potential need for amendments in some areas would have taken place several years after its effective application. However, circumstances are far from ideal and proposals for further regulation are well advanced.

At this stage care must be taken to centre these newly initiated discussions on the real needs of financial markets and the practical circumstances of conducting business, as opposed to theoretical commitments in favour of more regulation, transparency and investor protection.

If post-trade transparency rules are to be extended to the fixed-income markets it must be clear who is expected to be the end-user and how the published data would be used. There is also a risk of reducing liquidity on the fixed-income markets, as a result of the increased pressure on market makers. Such potential consequences must be taken into account to design rules that are genuinely in the interest of investors.

Furthermore, transparency rules would make sense only for tradable instruments, whereas many contracts are negotiated bilaterally between buyer and the seller, with the buyer intending to hold the instrument until maturity.

Similarly, in reforming the OTC markets there is a risk of losing sight of the very rationale of these markets. Today's product diversity is not an end in itself but a means to allow customers to hedge risks in as targeted a way as possible. Standardisation would result in efficiency losses. Efforts to reduce counterparty risk should not result in significant impediments to the hedging of market risks.

As regards the retail markets, much emphasis is given in abstract discussions to the objective of making products more comparable for retail investors. In reality, many retail investors struggle to understand the basic nature of investment products and how this relates to their financial needs. Helping these investors would in the first place mean making the most pertinent information more accessible to them. Comparability is a second and considerably more difficult step, which is typically given much attention by those who are closely involved in the industry and all too familiar with financial products. This is not the case for most retail investors or those who are most in need of support in their investment choices.


MiFID implementation was a very costly and cumbersome exercise for financial companies. Nevertheless, banks supported MiFID because they were convinced of its benefits. MiFID still has great potential to further reveal these benefits and, although the discussion has moved on, these should not be neglected. The focus now should lie on further implementation and harmonisation work.

This does not mean that banks consider present discussions about possible additional rules to be irrelevant, but rather that many of them are premature.

While banks recognise regulators' concerns about restoring efficient market functioning, a proper recognition of the MiFID context could be contributive to such efforts.