HM Treasury’s role with MiFID is in negotiations with the EU over legislation and changes to UK legislation. MiFID is a key EU directive affecting the buying and selling of financial instruments and began with the Financial Services Action Plan in 98/99 with a view to achieving a long established aim of a single market in investment services throughout Europe. The ISD had failed to remove barriers as member states could put up their own restrictions and the UK very much championed the cause rather than MiFID being something imposed by Europe.

With all things European there were negotiations and compromises. The UK had significant influence but other member states were only content to dismantle barriers and harmonise in exchange for imposing mandatory pre trade transparency before relaxing exchange restrictions.

There are very few changes to the UK scope of regulation as we already have a regulator just a slight change in the financial instruments affected. The main changes are in derivatives but not a huge change to chapters of the FSA source book.

There is a move towards copy-out of EU directives so some familiar terms will disappear and be replaced with European terms. The rules are based on much of the FSA rulebook but are not the same. Insurance companies and IFAs are out of scope unless they trade cross-border. However it does not mean out of scope firms will not be affected as FSA have to think about the impact on competition and the how different rules should apply, which will form the basis for their consultation paper in October. The Treasury were particularly keen to exempt IFAs from the scope of MiFID as the capital requirements of £50,000 was felt to be too much for many small firms.

Client classification is similar to the UK but more restrictive for professional clients. There is less scope for opt outs and waivers from MiFID and dealing with professional clients will become more onerous. The sales process is also similar but now firms will need to assess the level of education, an area other member states were keen on. The appropriateness test is new but you can still sell an inappropriate financial instrument provided a warning is given. Execution-only sales are permitted but only for less complex instruments e.g. derivatives would be excluded but not derivatives forming part of a unit trust. Marketing will be restrictive and probably become more generic.

Best execution means all reasonable steps have been taken to achieve the best result and will need to be process driven. Client consent is also needed to agree your execution policy though it is not expected clients will have to sign this off. There is also the requirement to monitor and review your policy on a regular, at least annual basis. The venue will also need to comply and be reviewed either annually or when information becomes available.

With conflicts of interest there is currently a reliance on written policies whereas under MiFID these conflicts will need to be effectively managed. You begin by avoiding the conflict and only declare it if it cannot be avoided rather than the other way around. The conflict happens as the end of the process rather than the beginning. Firms are also responsible for outsourcing and will need to demonstrate how they control their outsourcers.

There are two key dates; 31 January 2007 when the rules need to be fully transposed and 1 November 2007 when firms need to fully implement the Directive. Firms will need to demonstrate they have made best endeavours to comply or face enforcement action from the FSA. The Conduct of Business rules consultation is only one month but there are currently informal discussions going on with MiFID Connect so the new rules should not be a surprise. There is a client classification paper from the FSA this month to consider.

Hector Sants referred to the costs being clear but the benefits less tangible. Charlie McCreevy admitted there had been no cost benefit analysis of MiFID but somewhere in the region of 15 consultations had taken place.

Much will depend on implementation in the UK and elsewhere. In many firms directive implementation has been led by compliance rather than the business. With the Market Abuse Directive some firms had implemented in a very strange way with some thinking they needed to declare fluctuations in price whereas the Directive required disclosure of transactions. Firms who trade cross border will win with MiFID but otherwise there will be costs with no benefit. There are also few benefits to clients.

There will be less flexibility for the FSA to change its rules once MiFID is implemented and in many cases waivers will not be possible. The aim for a level playing field means it would be unlikely there would be two sets of ISA rules for example.

Much is said about first mover advantage and for MiFID this would mean a firm would:

•have their gap analysis largely completed
•have plans ready to implement against the final detail
•be ready to implement against final rules
•be MiFID compliant by January 07

There is also a brand new investment sourcebook to be issued and MiFID should be seen in the wider context of a move towards more principle-based rules. A gap analysis will need to include conflicts of interest, outsourcing, systems and controls and record keeping. This is as well as wholesale firms having to consider best execution, transparency, transaction reporting, systematic internalisers and MTFs. Client classification will also have a significant impact with a review of terms of business and repapering of clients in many cases. A detailed gap analysis will be essential to full compliance.

Suitability will apply to all clients not just retail. Appropriateness tests will apply to investment services other than advice. A review of the financial promotion rules is also underway with many similar themes that will be driven by MiFID. Whether promotions are caught by the appropriateness test will require some detailed analysis by FSA and the degree of personalisation of a direct offer will matter e.g. targeting new parents about Child Trust Funds.

There is a lot to do and firms may wonder where to begin. A healthy project culture is essential that encourages ‘kill often kill early’ to avoid projects taking a life of their own. Focus on achievability and attractiveness with accountability and measurement of benefits planned and delivered.

There are some rules engines and planning tools that can considerably reduce the amount of time spent analysing regulatory change, which is coming like a tidal wave towards firms right now. The rules can be pre-populated in a database and automatically compared to existing systems and controls rather than struggling with spreadsheets. Best execution is only likely to be solved with effective business process management and these tools can ensure administration processes remain compliant and can be updated and sustained without dependence on key staff who move on leaving things to go back to a redundant process.

Keep the end goal in mind when aiming for a solution rather than focus on the technology or the gadget. Deliver against the objective and ditch projects and tools that get in the way. Regulatory change can be used to drive out efficiencies. There are opportunities for firms to review and improve what they do.

There are 73 articles in MiFID twice as many as ISD. Best execution causes some concern but in what areas? Outsourcers will also need to be managed to ensure they meet the challenges of MiFID and using the right retail service providers will be vital. Client agreements also need to be reviewed to ensure they incorporate treating customers fairly objectives as well as suitability requirements. Everyone will need to be repapered and most professional clients will have similar rights to private clients. It is an opportunity to improve client relationships.

Conflicts of interest relates mainly to investment research. Trying to assess conflicts and Chinese Walls is best achieved with location of offices and complete separation of data and email. A risk assessment of the whole organisation is required. IIMIA will also make greater use of their website publishing Chinese Walls procedures, client agreements and standards. It is best not to deal with clients who refuse to provide information, as it always leads to problems.

There is a real opportunity for organisations interested in joining or selling out to a firm who takes these problems away from them. Many firms will move out of familiar territory and most of the costs will affect the bigger players who will stumble with old-fashioned systems.

Treating customer fairly fits very well with requirements for transparency. TCF and MiFID are difficult to differentiate and to have good relationships with your clients you must treat them fairly or they will go elsewhere. Some small stock exchanges are so under resourced it is a risk to put client’s money through them and MiFID will force firms to re-examine how they use them.

MiFID language is opaque and the level of education alone is not sufficient as it depends on circumstances and products. There is an interaction with FOS who may use this as a proxy for determining cases. It is better left to the judgement of a firm’s as many teachers may be very well qualified for example but not necessarily financially aware. It appears FOS has already begun to identify an occupation as a measure of customer understanding. You need to demonstrate the customer’s understanding in your fact finding or it may come across as no more than an intelligence test. The increasing threshold could be frustrating for firms and their clients and may especially affect multi ties.

Firms will need to inform all clients of their right to opt up or down in their agreements. All clients who change status under MiFID will also need to be informed of their new status. Firms should also look out for whether they are caught by CRD as handling client money is likely to greatly increase the regulatory burden.

Anthony Smith