MiFID II – the second iteration of the EU’s Markets in Financial Instruments Directive – takes effect on January 3. Touted as the most extensive shake-up of the financial markets landscape in a generation, MiFID II is high on the agenda for EU financial institutions of all kinds.
MiFID II’s extensive changes – to the execution landscape and to practitioners’ obligations with respect to investor protection and market transparency – will be felt most on its home turf: Europe. But in today’s globalized markets, many non-EU financial institutions will be impacted. These players need to take time to understand which of their activities are MiFID II-liable and how best to deal with their new obligations.
Non-EU firms need to consider whether they will be affected by MiFID II under either a ‘beneficial’ or an ‘exposed’ paradigm. Non-EU firms are ‘beneficial’ if they are owners of Europe-based companies or beneficiaries of funds or portfolios of European investments. They are ‘exposed’ if they invest or trade in MiFID II-mandated instruments that are traded on European Regulated Markets or other trading platforms.
Either situation can mean significant obligations under MiFID II. The regulation introduces complexity for transactions between EU and non-EU institutions, whether orders originating from non-EU institutions for execution on EU trading venues or vice versa. For non-EU financial institutions and execution venues, working with EU investments and orders may require adherence to MiFID II’s reporting obligations.
For example, non-EU venues executing instruments listed both on EU and non-EU markets need to comply with MiFID II transaction reporting rules, which among other things requires they ensure the entities they are dealing with have been assigned legal entity identifiers (LEIs) and that they are compatible with MiFID II reporting systems, including Approved Publication Arrangements (APAs) for pre-trade and Approved Reporting Mechanisms (ARMs) for post-trade. Meanwhile, orders originating from non-EU jurisdictions but executed in the EU will need all parties to have LEIs for transaction reporting.
MiFID II’s best execution rules expand those of its predecessor to include non-equity securities and introduce more granular data reporting requirements. In order to demonstrate best execution should the regulator require it, trading firms need to collect and store transaction details including order/quote, trade price, volume and transaction counterparty, as well as time-stamps throughout the trade order flow.
Any EU orders handled by non-EU firms will be subject to MiFID II outsourcing provisions. These require EU entities to attest to the suitability of US affiliates, so that a client order originated outside the EU for execution on an EU Regulated Market (exchange) or other trading platform (multilateral trading facility [MTF], organised trading facility [OTF] or systematic internaliser[SI]), can be subject to MiFID II outsourcing or client classification provisions.
A non-EU firm providing advisory services to a European client, meanwhile, may have a relationship with a European executing broker that is governed by MiFID II. This means the non-EU advisor needs to be aware of best execution and reporting obligations, as well as client classification provisions, which assess a customer’s qualifications for investing in any given security.
Non-EU firms operating with clients or execution venues in the EU must ensure their data processes and data quality metrics are in line with MiFID II rules. This entails the use of International Securities Identification Numbers (ISINs) for instruments, LEIs for entities, Market Identifier Codes (MICs) for venues and multiple other identifiers used within other aspects of the regulation.
Non-EU US firms working with European counterparts also need to be aware that many of MiFID II’s requirements are subject to its record retention provisions, which are required for trade surveillance and fraud prevention. Finally, non-EU firms planning to unbundle research and broker execution services in keeping with MiFID II need to consider using commission sharing arrangements (CSAs).
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