Implementing MiFID

Implementing MiFID

Oliver Lodge, Kinetic Partners

The long drawn out saga of the implementation of MiFID has spawned another epic, FSA’s Implementing MiFID for Firms and Markets (CP0614), adding 517 pages to this great series. Will there be more pages to MiFID than to Gibbon’s Decline and Fall?

Aside from its appealing title, so well reflecting the clamour from the industry for swift and rigorous implementation of the directive, this latest offering from FSA perfectly illustrates the flaws in the process, as well as the concept, of euro regulation.

As implementation time runs out – it has to be finished by the end of January – the sense of piling uncertainty on indecision grows. It is already more than two years since the directive was formally adopted, so why the continued debate? Quite simply because the Lamfalussy process of ‘streamlined’ directive production is still far from complete. While ordering national regulators to be ready and waiting by the end of January, the European tanker is still many miles from harbour. Level 2 will not be signed off until September; Level 3 is barely begun. The odds on a false start for implementation must be well worth a flutter.

MiFID is probably the most significant step to date in the process of removing the policy-making function from FSA and other national regulators across Europe in order to centralise that authority with the EC. It will not be many years before the FSA is no more than an agent of Brussels, carrying out supervision and enforcement of regulations written into international legislation. It remains unclear whether this is the intention of the government or merely the result of its previous lack of foresight.

Interestingly, some supporters of euro regulation are among the most sceptical of the EU generally. This support is, however, based on the firm expectation that the European version will retain the bark but compromise the bite.

In this paper, the FSA is again as good as its word on super-equivalence. Its manful struggle to avoid burdening the industry with more dead-weight regulation than is already ordained by the directive may spare some firms from the imposition of some requirements, but undoubtedly at the cost of super-complication. The policy of copy-out (use of the directive’s phraseology in preference to FSA-speak), designed to avoid the unintended consequences that so easily creep in, makes, by happy chance, for simple drafting – it does not make for simple interpretation. Fortunately, the FSA’s guidance goes some way to making up the intelligibility deficit.

It would be misleading though to suggest that this was entirely a policy of self-denial. Super-equivalence is all but prohibited by the infamous Article 4 of the Implementing Measures, which obliges national regulators to go cap in hand to Brussels to seek leave to apply an extra rule or two. The fate of many existing rules remains unknown until we see October’s offering on the re-write of the Conduct of Business requirements. But what we do know is that FSA is even now proposing to compromise its Principles.

It is perhaps the most striking individual feature of these proposals that the high-minded, uncontroversial and universal sentiment set out in Principle No 1, that a firm must conduct its business with integrity, should, in certain circumstances, be disapplied. And the same fate awaits Principle No 2, that a firm must conduct its business with due skill, care and diligence. Both are, it seems, incompatible with pan-European business.

“The long drawn out saga of the implementation of MiFID has spawned another epic”

Somewhat less striking and perhaps not even surprising is the extent of the collateral damage. FSA’s own estimate of the number of small UK firms caught by MiFID is 2,600. How many of them will benefit from access to the Single Market? It must be doubtful that more than a tiny number have ever seen fit to apply for an ISD passport; somehow the lure of MiFID seems unlikely to convert them now. When FSA represents this country – easily the biggest in Europe in terms of financial services – in directive negotiations, how does it evaluate the benefits and costs of the euro proposals? It already publishes its cost-benefit analysis where it exercises discretion in rule-making; as European regulation diminishes that discretion, the FSA should publish an objective evaluation of the impact of each directive.

Fortunately, for those who do intend to use the passport, there is a ray of hope in this tome. The basic concept is that business done from a branch in a ‘host state’ (an EEA country other than the one in which the firm is authorised) should be regulated by the host state regulator. For those clients based in the host nation, anyway; for clients based elsewhere, only home state regulation is good enough. The ray of hope is that this amazing arrangement is under review.

Now for the bad news. The proposals in this paper, most of which are anchored in the directive and will not therefore change in substance, set out for firms what they need to do. Most fundamentally, those who are not currently authorised but know themselves to be operating on the margin, need to look again at their exemption. Some will no longer be fancy-free.

Also fundamental for any firm is the question of whether it can or should apply to trim its FSA permission to escape from the new measures. For some this may have real appeal, but there is a cautionary note to be sounded: the FSA has yet to determine how it will treat ‘non-scope’ firms. There is the prospect of a range of MiFID measures being applied to all. But there may also be non-discretionary reasons for seeking revised permission. As most will now know, MiFID introduces revised client classifications, similar, but not identical, to those in current use. Additionally, the scope to treat a client as falling into a different category due to their considerable sophistication is to be curtailed, although not abolished altogether. This will oblige some firms to seek permission to deal with retail clients for the first time.

Even where those classification changes have no impact, the disapplication of rules to business done for non-retail clients is also curtailed. Key among these is the removal of the current scope for intermediate customers to opt out of the client money protections. So firms previously reliant on that provision will need to adopt the client money procedures or make substantial re-arrangements to their modus operandi.

Next come the cherished waivers. Many of these will perish alongside the FSA’s authority to grant them. The European Commission fears waivers, seeing them as a Trojan horse capable of attacking the system from within. This loss of flexibility in the system will be bound to produce some remarkable absurdities. Finally, no one should overlook the scope, thoughtfully provided by the Treasury, for firms that are exempt from MiFID to opt-in. No doubt, many will be tempted.