MiFID II Explained: The Operational Impact on US Investment Managers

Huge, complex and far-reaching. The updated Markets in Financial Instruments Directive (MiFID II) and accompanying regulation (MiFIR) – which eventually came into effect this January – are reshaping the investment landscape in the European Union.

But it’s not just EU investment management firms being impacted. As PwC points out, non-European Economic Area (EEA) institutions also fall under the rules:

  • Directly, if they have a licensed branch in the EEA, and/or
  • Indirectly, any time they deal with EEA parties, products or trading venues.

As a result, an estimated two-thirds of US buy-side firms, for instance, are likely to be impacted by the new regime.

Operational Considerations of MiFID II

MiFID II covers a range of issues, but its primary aims are to create a more harmonized and robust European rulebook that improves how financial markets function, while strengthening investor protection. Enhanced transparency, disclosure and reporting feature prominently.

The new rules affect investment managers throughout the trade lifecycle, but among the major operational considerations are:

Suitability and Appropriateness

  • Firms providing investment advice will need to collect and maintain detailed data on clients’ financial goals and risk tolerance to assess their suitability for different services and products, and to show they are meeting their clients’ investment objectives.

Client Disclosures

At least once a year, each client must receive a full breakdown of the total costs and charges impacting their investments, including management and advisory fees, broker commissions, transaction taxes and FX costs. Investment managers need to ensure they have access to the relevant data, and can collate and report on it.

Client Reporting

Firms now need to provide clients with portfolio reports – including details on performance and asset valuations – at least quarterly, rather than every six months.

Depreciation Reporting

If the value of a client’s portfolio drops more than 10% in a single reporting period, the investment firm has to report it to the client no later than the end of the business day on which it happened.

Further notifications are required for every additional 10% fall. Similarly, retail clients invested in leveraged financial instruments must be informed whenever an individual instrument depreciates by 10%. This requires daily tracking of asset and portfolio valuations, and automated notification capabilities across the entire client base.

Transaction Reporting

Firms have to report the details of any transactions to their National Competent Authority (NCA) no later than the end of day on T+1. This is a priority area for regulators, with inaccurate or incomplete reporting set to incur significant fines.

Completing the reports involves a significant increase in data, as they now comprise 65 reporting fields – compared to 24 under MiFID I. The reporting obligation has also been extended to new types of financial instruments, including FX and commodities.

Legal Entity Identifiers (LEIs)

All legal entities need an LEI, which must be included in the transaction reports. US investment firms trading on behalf of clients will need to record and validate the LEIs in advance of trading, and where appropriate provide it to their EEA counter-party so they can carry out their regulatory reporting.

Research Unbundling

The unbundling of research from trading commissions means investment managers must either:

  • Pay for research themselves, or
  • Charge it to clients through a defined research payment account (RPA).

Many asset managers so far have indicated they will shoulder the research costs. Those using RPAs though have to provide clients with an annual statement that sets out the research charges and how much they paid – requiring firms to track all their research expenses, book the expenses and payments to the relevant client accounts, and generate the reports.

Bear in mind too that many of these rules have been introduced in the form of a directive, giving EU member states some scope to adopt varying approaches when implementing them into their national laws. Investment firms therefore need to be aware of, and able to adapt to, any national differences where they exist.

MifID II Creates Added Importance for Data Management and Reporting

Investment managers’ ability to collect, manage and report on a huge variety of data points is crucial to meeting their extensive MiFID II obligations. This brings sizable costs and operational challenges.

But forward-thinking firms also have an opportunity to leverage the flood of new market and client data to improve their execution quality, and better understand their clients’ and target prospects’ needs so they can elevate their services.

US Investment Managers: When Are You in Scope?

  • Trading or servicing EU clients
  • Trades booked on EEA entity directly, or back to back, or remote
  • Trading on EEA venues/EEA underlyings on non-EEA venues
  • Distribute products in the EEA
  • Distribute EEA-manufactured products in other countries
  • Provide execution and research to EEA managers
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