MIFID, Forex and regulation

/MIFID, Forex and regulation

What is MiFID?

MiFID stands for Markets in Financial Instruments Directive. It isRegulation 300x198 a European Union law that provides harmonized regulation across the 31 states of the European Economic Area (EEA) for investment products, services and activities. Adopted in 2004 and implemented in 2007, it was the cornerstone of the European Commission’s Financial Services Plan.

MiFID consists of 2 levels:- Level 1, contains the detailed framework of the entity and Level 2, contains the technical aspects built around Level 1.
The MiFID that is currently in place in the EU is known as MiFID I, the first directive passed. It will be in place until 2018, when MiFID II will come into effect.

What are the key aspects of MiFID?
MiFID has several key aspects:

      • It provides authorization to firms, allowing them to provide services in the other member states.
      • It requires firms to categorize clients by capability in order to assess their suitability for each type of investment.
      • It requires that the firm captures information in order to ensure that client order handling is maintained appropriately.
      • It requires firms to provide high levels of price transparency both pre and post execution of a trade.
      • It has processes established in order to ensure that the client receives the best possible execution result for an order.

MIFID general knowledge

MiFID replaced the Investment Services Directive (ISD) that was in place since 1993. This previous directive introduced the concept of the European Union “Passport”, and had a focus on “minimum harmonization and mutual recognition”. MiFID retained the passport aspect but reversed the minimum harmonization to maximum harmonization in order to create a more leveled playing field.
As per the European commission website, “Its aim is to improve the competitiveness of EU financial markets by creating a single market for investment services and activities, and ensuring a high degree of harmonized protection for investors in financial instruments, such as shares, bonds, derivatives and various structured products.” As a result, it sets guidelines for share trading and financial instruments, improving transparency on prices and “regulating” service providers. This move was primarily designed to provide a high standard of investor protection, particularly by improving systemic risk.
In April 2014, updated legislation known as MiFID II was approved by the European Union. It expanded the scope of the original legislation and included MiFIR, the regulation arm. This legislation is due to take effect in 2018. The global financial crisis of 2008 exposed weaknesses in the structure of MiFID, necessitating a review to improve those elements. After a thorough consultation process, MiFID II was tabled and ratified in April 2014.

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The European commision website explains that “MiFID establishes a regulatory framework for the provision of investment services in financial instruments (such as brokerage, advice, dealing, portfolio management, underwriting etc.), for the operation of regulated markets by market operators and also establishes the powers and duties of national competent authorities in relation to these activities.” Thus MiFID is not a regulator itself, but provides the rules by which regulators acting within the EEA must abide. As a result, regulatory bodies that are active within the EU jurisdiction will only provide a license to brokerages which are in compliance with the MiFID statutes. So, whilst technically the brokerages may not be regulated directly by MiFID, they will be following the requirements indirectly.
A company which is authorized under MiFID can generally undertake the offering of financial services throughout the 31 states of the European Economic area. This is through the use of the passport aspect of MiFID, which allows activity throughout Europe. For those countries that continue to have their own national bodies for this purpose, the MiFID requirements were generally passed into those authorities, making its activities practicable throughout the EEA. It is worth noting that MiFID requirements actually extend slightly beyond the EU (which is only 28 states) to the area known as the European Economic Area, containing 31 states. The EEA includes all EU member states as well as Iceland, Norway and Liechtenstein.
When a Forex company operates under MiFID, it generally means that the company trading or incorporated in Europe is considered a financial service provider, thereby directly falling under the jurisdiction of MiFID requirements. Alternatively, it may have regulations within the EU, which are governed by the principles of MiFID. Depending on the scope of the forex brokerage, its core activities may not fall under the current MiFID definition of Financial instruments. As an example, under the current rules of MiFID I, Spot Foreign exchange transactions are not considered financial instruments under MiFID. Conversely, rolling spot FX contracts are considered a type of derivative contract, and as such are considered financial instruments contracts under MiFID.

Amongst traders and clients in the Forex market, MiFID has long been regarded as a symbol of high quality regulations. This is because much of the focus is directed to ensuring that the offerings covered by MiFID adhere to the highest standards of transparency and fairness. Whilst everyone welcomes good standard of fairness and transparency, maintaining this does confer a significant burden on the brokerage, which is tasked with ensuring that it keeps up to the requirements of data capture, regulatory maintenance, fund segregation, risk levels, etc. Whilst this can limit the offerings available compared with other jurisdictions and regulators, the lucrative EU market and the stamp of quality that MiFID represents amongst potential clients, make it a valuable asset for a brokerage.