The Markets in Financial Instruments Directive (MiFID) came into force during 2007 to facilitate cross-border financial services throughout Europe and foster competition between trading venues via a level playing field. Following the financial crisis in 2008 and during 2011, proposals were set out to revise MiFID. Since the political agreement on the adoption of MiFID II in 2014, there has been lengthy consultation on the ‘level 2’ provisions which contain the finer details and technical standards of MiFID II. Due to the enormity and complexity of this reform, the original timeframe for transposition and implementation within the EU member states has been delayed by 12 months to January 2018.
While U.S. managers offering discretionary or segregated account portfolio management are not directly in scope for MiFID II, there are a number of considerations they should be aware of–much the same as when the Alternative Investment Fund Managers Directive (AIFMD) came into force. Processes, conflicts with U.S. rules, distribution and relationships should be reviewed by the U.S. manager.
Here are four areas for consideration:
1. Trading with Europe
The reforms mainly affect the sell side as they consist of significant structural changes in order to improve transparency, but they will indirectly impact the managers who deal with them. In particular, MiFID II seeks to address the trading of fixed-income and derivative instruments on an Over-The-Counter (OTC) basis, and restricts the ability of regulators to grant transparency waivers to reduce trading on ‘dark pools’. These provisions could potentially lead to higher costs and less liquidity when trading European securities. U.S. commodity pool operators may also be affected by the proposed introduction of position limits on commodity derivatives by European national competent authorities, which impacts the composition of the underlying investment vehicle or portfolio.
2. Contractual Services
Delegation and outsourcing arrangements between a U.S. manager and a European-based manager in scope for MiFID II will need to be carefully considered. In particular, where a U.S. manager is providing services to a European-based manager they may be required to assist with the transparency and reporting obligations.
3. EU Subsidiaries
It goes without saying that a U.S. manager with an EU-based subsidiary that conducts investment services will most likely be subject to the MiFID II provisions and will already be fully versed in complying with MiFID I. However, MiFID II does extend the range of regulated activity considerably and introduces a new form of product governance not seen before. The new provisions will impact any firm that ‘manufactures’ investment products. They place a prescriptive obligation for the EU manager to identify information and the target market, provide appropriate disclosure and regular assessment of the risk profile of the client compared to the risk profile of the manufacturer’s product. Because this ongoing obligation includes platforms, U.S. manufacturers’ with EU-based distribution subsidiaries or relationships with EU distributors may experience the need for increased information flow on any changes to risk profile, strategy or composition in relation to any product being distributed in Europe.
The marketing provisions set out in MiFID II are easily comparable with AIFMD. The concept of ‘Third Country’ applies and ESMA is in the process of finalizing its assessment of the U.S. as a jurisdiction of equivalent standing. Post positive assessment, MiFID II will introduce the ability for an EU member state to allow a Third Country manager to establish a presence and then utilize the cross-border passport for marketing products and services within the EU from that member state.
Even though (as mentioned above) the time frame for MiFID II has been extended to January 2018, U.S. managers should ensure they allocate adequate time to evaluate how MiFID II affects them and their ability to conduct business with and from within Europe.