ESMA Spells out Revised Regulation, Vows Retail Investor Protection

The European Securities and Markets Authority has released a guide to MiFID II for retail investors highlighting important changes to

ESMAThe European Securities and Markets Authority (ESMA), has published highlights for retail investors about the most important changes and updates taking place with the Markets in Financial Instruments Directive (MiFID) regulations.

ESMA, the financial regulatory institution of the European Union, wants investors to know it is strengthening the regulatory framework in the union in various important areas and the updated framework will be known as MiFID II, which will take a number of years to develop. Anyone dealing with futures and structured deposits in Europe will be affected by the change to MiFID II and therefore needs to understand it.

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Analysing the changes ESMA writes about, it seems there will be a move to harmonize what are now tailored products. The most important changes is that firms claiming to offer independent advice to investors will have to explain if they really are independent or somehow benefiting from the advice they get. For example, an advisor will not be able to refer an investor to a firm and receive a fee from the firm if he has not disclosed that to the investor.

Some of the changes will surely be welcomed by traders and investors as they will result in greater market strength, transparency and honesty. No one will complain that investment firms will have to disclose the total cost of trading or will have to spread the funds around a number of banks in case of a crash. However, other changes seem paternalistic and will only limit the availability of certain investment products to retail investors by requiring that only professionals have access to them or by outright banning them.

Additionally, ESMA’s emphasis on ‘product governance’ is likely to create more work for compliance and legal departments of investment firms rather than protect anyone from trading on products deemed too complex to understand by mere retail investors. Regulators in the EU will from now on have even more power to limit the choices of retail traders and the work of investment firms, deciding if it is a good development or not generally depending on the assessment of the investors’ ability to know what is right for them.

MiFID II Highlights:

The first highlighted change is that MiFID II will limit the receipt of commissions. It does this by strengthening the current MiFID protection concerning the types of payments a firm can receive or pay when they provide investment services. In some circumstances, MiFID II will introduce a complete ban on some firms receiving a payment benefit from third parties. In the future, any portfolio manager or firm which says they provide independent financial advice will no longer be able to accept payments.

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Under the existing MiFID legislation, firms providing investment advice are not required to explain the exact nature of their advice services. In the future, the changes to MiFID will mean that firms will have to be very clear about whether or not the advice they offer is given on an independent basis, and whether the advice they provide is based on a broad or more restricted analysis of which financial products are available on the market.

MIFID II will require firms to have stricter internal and/or organizational requirements  with explicit arrangements around their product design and distribution. In other words, in the future, firms must have better ‘product governance’ as referred to it by ESMA. Firms will be required to identify the target market for each product and ensure that all relevant risks are assessed and understood before a product is distributed. They must also ensure that the product is only distributed to those investors for whom it was actually designed.

The changes introduced to the MiFID II protocols are for safeguarding client assets, meaning that firms must take into consideration how client funds are spread across different banks, so that if one firm in a financial group gets into financial difficulty, the risk to client assets is contained.

MiFID II will enable financial regulators in each member state to ban certain products permanently, if they consider these products not in the interests of investors and provided a number of legal conditions are fulfilled. Regulators will also be able to limit the marketing of these products to certain investor types only. Regulators will monitor the kinds of products firms market to certain investors and, where appropriate, will also ban (but on a temporary basis) the marketing and distribution of products that raise cause for concern.

MiFID II  is strengthening requirements for investment firms to provide clear guidance and warnings of the risks associated with their financial instruments and whether the financial instrument is intended for the everyday retail market or for the more sophisticated, ‘professional’ clients.

MiFID II will introduce additional disclosures about a firm’s costs: All costs and related charges must now include information relating to both investment and/or other ‘ancillary’ services, including the cost of advice. The firm should make it clear as to how these services/products are to be paid for. The total figure of all costs and charges must be provided and an itemized breakdown of costs should be provided by the investment firm upon request.

The requirement to ensure prices are clear before and after trading on an exchange or other type of trading platform, will now apply to a wider set of financial instruments than just shares. For instance, firms will have to be clear about prices offered to buy or sell bonds, depositary receipts, exchange traded funds, structured finance products and they must also be clear at what price these products were actually bought and sold.

MiFID II will  limit the types of non-complex instruments that can be sold without the firm needing to ask about, or to assess the investor’s knowledge and experience. In addition, MiFID II will cover structured deposits – a category of financial products which was previously unregulated at EU level, but which satisfies similar investor needs and raises comparable investor protection challenges to the types of financial instruments already within the scope of MiFID.

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