MiFID II – Institutional topics

Hannah Meakin:

Welcome to our latest financial services video. In this video we are going to look at the MiFID II conduct obligations and how they are relevant to institutional clients.  By institutional clients we really mean professional clients and eligible counterparties (ECPs). 

So Imogen what are some of the themes that are coming up in this area?

Imogen Garner:

So there are a couple of key themes here that we can come on to talk about in a little bit more detail but the first of them I think I would describe as retailisation so there’s this sense that there is some standards, conduct and investor protection standards in particular that we have been familiar with for some time in the retail sphere and there’s been a sense that professional investors and ECPs can look after themselves. What’s really changing is that whole concept actually and there’s more of an extension of retail type protections to ECPs and to professional clients. 

On top of that I think there is another theme which is around the way in which the industry responded to MiFID I. There’s a general sense out there from regulators that the industry perhaps didn’t respond to it in quite the way the regulators would have hoped.  Perhaps didn’t take it seriously enough, so there’s that.  Linked to that is a theme around the way in which the regulator will supervise and really put pressure on firms in relation to their compliance.  We don’t see the regulators taking their foot off the pedal on this any time soon and there are some really key areas of focus that they are interested in.  Things like inducements and best execution. 

So when firms are dealing with ECPs you think that life would be quite a lot easier. What sorts of issues do you see there?

Hannah Meakin:

Well your right, you would think that given many of the obligations don’t actually apply to eligible counterparties that there should be less to think about but actually compared with MiFID I there are various additional requirements that are going to be applying to eligible counterparties. A lot of those relate to requirements to give counterparties and clients information about the services being provided and various details along those lines.  It is true to say that when you are dealing with eligible counterparties and even to some extent professional clients there will be a bit more flexibility in how that information is presented and to the extent that you can agree with your clients you may not need to provide all of that information but I think that firms will still need to be taking into account the obligations to act in a way which is honest, fair and professional and to communicate with clients in a way that is clear, fair and not misleading and of course those are two standards that haven’t applied to eligible counterparties at the MiFID II level previously and so I think there are some real questions that firms need to be asking themselves in the way that they go about their conduct with clients and the decisions they are making to make sure that they can show they are complying with those high level standards.

So Imogen you mentioned that one of the themes for institutional clients is this idea of retailisation and those retail standards starting to apply more relevantly to the institutional client base and I think perhaps one of the areas to talk about here is product governance. What should we be thinking about in that context?

Imogen Garner:

Ok so product governance is an area in which we in the UK have had a regime for in the retail sphere for quite some time. What MiFID II is doing is taking that, applying it on a Europe-wide basis and then of course it is not going to apply purely to retail and professional and it will not be the same as the UK regime but slightly different.  So what does that mean, well the way our rules sort of work is that they look at who in relation to a financial product for example, who is its manufacturer and who is its distributor and depending on which of those two buckets you are in, different obligations apply to you.

The way the rules work is that those definitions are really broad so manufacturers can capture anyone who is involved in creation of a product, its design, its issuance so you could potentially have more than one manufacturer. Questions arise how you split up and allocate responsibilities between them and then distributors on the other hand will have their own obligations.

What the rules are going to do is set out particular standards that will require manufacturers and distributors to interact with each other in a particular way to make sure there is information flowing between them so for instance there will have to be a specific target market for a particular product and manufacturers are going to have to pass sufficient information to their distributors about that. Make sure the distributors understand it and distributors will have to actually be passing on information back to manufacturers about how products are sold.  Now, so far so good in the retail context, the big question is how do you make all this work and apply in an institutional context and there are some real challenges there. 

One of the great benefits of this is that the rules say you can apply them in a proportionate way so I think firms are really thinking hard now about what a proportionate application of these standards means. There’s a lot of inspiration to be taken in the retail regime but ultimately we are dealing with professional clients and ECPs here so there’s going to be something of a difference. The important thing would be about thinking about what those differences are and why it’s justifiable and yet the investor protection aims of MiFID II can still be achieved. 

So one of the other topics we talked about was this whole idea that MiFID I perhaps wasn’t being taken seriously enough by the industry. Are you seeing that come out in particular areas of MiFID II?

Hannah Meakin:

Yes, that’s an interesting question. I would say that this is really showing itself perhaps in 3 different areas.  Primarily best execution, inducements and conflicts of interest.  Those are all areas where actually the framework under MiFID II is not radically different to what it was under MiFID I but where the regulators have been much more explicit about some of the requirements that they expect firms to be meeting in practice.  To give a couple of examples perhaps order execution policies, the regulators have been clear that they expect those to be a lot more tailored under MiFID II so it won’t be good enough any longer to just reflect in your order execution policy what the legislation says, you really need to be thinking about the particular products and services you are providing to clients and making sure that you tailor your order execution policy to reflect exactly how you are achieving the best possible results for the client in each of those different areas.  So we might find that order execution policies will develop so perhaps you as an organisation may have different policies for different types of business lines or for different types of clients or maybe you will have one order execution policy but different parts of it relating to different instruments.

The other example I would give is in relation to the conflicts of interest. There has always been an expression from the regulators even under MiFID I that conflicts should be managed by organisational means rather than just by relying on disclosure but the industry has really kept disclosure as a back-up option and actually I think the regulators feel in some senses perhaps the industry has relied too heavily on disclosure as a means of managing conflicts but this is something that they have emphasised in relation to MiFID II and which I think firms will really need to think about.  It’s a difficult area, especially for lawyers because actually disclosure of potential conflicts is an important legal mechanism but it’s certainly something that the regulators don’t think should only be the way in which conflicts are being managed.

Imogen Garner:

So that’s been a very quick run through of some of the key topics / themes that we have been seeing in relation to MiFID II on the institutional side.

Thank you very much for watching.