By James Hamilton, J.D., LL.M.
A sweeping reform of financial services regulation in the European Union is represented by MiFID, the Markets in Financial Instruments Directive, 2004/39/EC, which takes effect on November 1, 2007. It replaces the Investment Services Directive which was adopted in 1993. MiFID is a central element of the European Commission's Financial Services Action Plan, which is intended to create a single market for financial services across the EU.
MiFID is a far-reaching piece of legislation that sets out a comprehensive regulatory regime covering investment services and financial markets in the European Union. It contains measures which will change and improve the organization and functioning of investment firms, facilitate cross-border trading and thereby encourage the integration of EU capital markets. At the same time, it will ensure strong investor protection with a comprehensive set of rules governing the relationship that investment firms have with their clients.
The Commission's overriding objective is to provide a single, predictable set of rules for firms operating throughout the EU and greater security for consumers buying investment services. In an effort to avoid gold plating, MiFID establishes a highly harmonized regime under which it should not be necessary for Member States to add supplementary rules over and above what is in the Directive. Indeed, they are only allowed to do so in exceptional and strictly defined circumstances to address national or emerging issues which affect investor protection or the stability of their markets.
MiFID abolishes the concentration rule, which means that Member States can no longer require investment firms to route orders only to stock exchanges. Thus, exchanges will be exposed to competition from multilateral trading facilities (MTFs), which broadly are non-exchange trading platforms and systematic internalizers, such as banks or investment firms who systematically execute client orders internally on their own account rather than sending them to exchanges.
MiFID is also good news for consumers. They will have a bigger choice of investment service providers, who will be required to conform to high standards of behavior to their clients. This should allow them to seek out services of the best quality at the cheapest price.
MiFID envisages two types of investor protection mechanisms. On the one hand, firms will have to provide their clients with information about the investment firm, the services it provides and the financial instruments that are the object of these services. This is important. If clients receive sufficient information, they should be able to detect and reject inefficiency and unprincipled conduct by firms. However, this mechanism cannot be relied on entirely. It is no good swamping clients with large amounts of complex information and hoping that they will be able to analyze and evaluate it all and then draw the appropriate conclusions.
MiFID therefore also places considerable emphasis on the fiduciary duties of firms towards their clients. It imposes a number of specific obligations on firms, including best execution and the obligation, when providing investment services, to collect sufficient information to ensure that the products and services which they provide are suitable or appropriate for their clients. It also imposes strict limits on the inducements which banks or financial advisers can receive in respect of the services which they provide to their clients.