A closer look at the Commission-proposed quick fix of MiFID II within the EU capital market recovery package

To support capital markets recovery from the Covid-19 crisis, the European Commission recently presented its markets recovery package, which includes proposed amendments to the Markets in Financial Instruments Directive (MiFID II), Prospectus Regulations, and securitization rules. Since CFA Institute has been focusing particularly on the impact of the MiFID II rules for the past two and half years (the directive entered into force on 3 January 2018), we will be looking only at the tweaks to this regulatory framework. We may, however, provide a further analysis on the rest of the Commission package in a future post.

Following the public consultation on the review of the MiFID II framework (to which CFA Institute responded last May), the European Commission put forward a quick fix of MiFID II rules. More significant changes are expected to be presented next year in the context of a broader review of the legislation.

The most relevant issue that the industry has raised in the past couple of years was about the unintended consequences of the new investment rules, which require sell-side firms to separate costs of research from those of execution, and prohibit asset managers from bundling into single, and more opaque, transaction fees. Following the implementation of the directive, many asset management firms and investment banks have chosen to pay for investment research themselves rather than charging clients. Direct payment of research seems to have accelerated the existing trend of declining research pricing. The latter practice also may be due to increasing competition in the research market as firms have been more cautious on the use of expenses out of their income statement account. Coverage also appears to have gone down, especially for small and midsize enterprises (SMEs), along with its market capitalization.

In an attempt to incentivize more research for small and medium caps, the Commission proposed the exemption of the current rules on unbundling if brokerage and research services are offered on the same segment of the market. This would be an optional exemption as joint payments still would be allowed if the investment firm and the research provider agree on the fee amounts attributed to the provision of research. In this case, clients must be informed by the investment firm. These new rules for SMEs are applicable when firms provide fixed-income research.

Important changes also cover the product governance section of MiFID II as the proposal introduces a lifting of the requirements for simple corporate bonds with make-whole clauses. With such an exemption, the Commission looks to facilitate access to a broader category of investment instruments for sophisticated investors and to provide more flexibility for the offering of noncomplex products. The creation of a possible new category of clients (i.e., semi-professional investors), who would be subject to lighter rules, has not been taken into consideration for now in this legislative package, but this may be included in the next year’s broader amendments to the directive.

Furthermore, an exemption from the provision on costs and charges information has been introduced for eligible counterparties (ECPs) and for professional clients for services other than investment advice and portfolio management. Stakeholders have claimed that clients of services other than investment advice and portfolio management are more familiar with both the market conditions and prices of the various service providers than retail investors. Professional clients also receive more control of the prices. The lifting of this requirement for the two investor groups could streamline investments and create a more proportional regime for professionals and ECPs.

MiFID II set out clear information rules on the disclosure of cost information when using distant communication channels. Stakeholders responding to the public consultation underlined that the current ex-ante reporting requirements seem to contribute to delays in the execution of transactions. The new proposed rules would allow all clients, under certain conditions, to receive costs and charges information just after the transaction.

To further alleviate reporting, professional clients and ECPs also would be exempt from receiving ex-post statements from investment firms. Professional investors, however, would be allowed to opt in if they prefer to receive such information.

Another proposal concerns the suspension of best execution reports for two years. The Commission found that such reports are seldom read by investors as the data are insufficient to make comparisons between firms. Furthermore, such information is already provided to many investors during brokerage meetings. Hence, the suspension of the requirements to produce these reports would not, according to the Commission, decrease the level of investor protection.

Softer rules on the production of a cost–benefit analysis as part of the suitability assessment that firms must perform when providing investment advice or portfolio management are also included in the package. Currently, firms need to collect data about their clients so they can conduct a thorough cost–benefit analysis in case clients switch between products over the course of the relationship. Industry stakeholders stressed that this requirement is too burdensome when providing services for professional clients. Given this feedback, the Commission proposed that the analysis would be performed only if this category of investors decides to opt in for this process.

Finally, a phase-out of the paper-based default method for all communications to clients is also envisaged. In light of the European Green Deal strategy and the Covid-19 crisis, the Commission intends to accelerate the switch to digital communications, which will be the norm. Nevertheless, retail investors would always have the possibility to get information by paper if they wish.

All in all, the markets recovery package goes in the direction of an overall relaxation of the current rules regarding markets conduct. The aim is to give the industry more time and resources to deal with the impact of the Covid-19 crisis. We feel, however, that the current MiFID II requirements should not be massively lightened or exempted, especially if this move would affect transparency of information that is now guaranteed to investors. Conduct of business rules does not need to be drastically changed in a bid to drive more liquidity in EU markets. The recent CFA Institute Covid-19 survey report shows that CFA members from around the world do not agree on a significant relaxation of investor protection requirements. In particular, the rebundling of investment research for SMEs, which is intended to increase research coverage for these firms, would lead to lower clarity and reduce investor understanding of research costs. Research for small and medium caps could be encouraged in other ways, such as subsidizing research for such firms in some manner or through the adoption of specific measures to stop dumping.

Image Credit @ Getty Images/Stefan Cristian Cioata