MiFID II is European Union legislation enacted in 2018 to make Europe’s financial markets more transparent, robust, and reliable. Considered one of the most important laws in the global financial system, it standardized financial practices in the European Union, increasing investor protection.
Its acronym stands for Markets in Financial Instruments Directive II. One of the main objectives for developing MiFID II was to restore shareholder confidence after the 2008 financial crisis.
In this article, we will discuss the main differences between MiFID I and MiFID II, explain which companies are affected by the legislation, and explain MiFIR.
What is the difference between MiFID I and MiFID II
MiFID I (Markets in Financial Instruments Directive) was drafted in 2004, with the final version being adopted throughout the European Union in 2007. The legislation remained in force until 2018 when it was replaced by MiFID II 11 years later.
The weaknesses of the first version became relatively clear quickly, as it was tested in 2008 by a global financial market crisis. The previous legislation was criticized for focusing too much on the stock market, without paying attention to fixed income sources, derivatives, cash, and other assets.
To correct these and other problems, the Markets in Financial Instruments Directive II was created, bringing innovations such as:
- Greater transparency. The second version of the directive imposes more reporting and testing requirements to prevent the use of dark pools — private stock exchanges where investors trade without revealing their identity.
- Fraud protection. MiFID II includes rules that prohibit practices such as quote stuffing. This fraudulent method involves placing a large volume of buy orders followed by their immediate cancellation, to manipulate and confuse the market.
- Emphasis on transparency. The second edition of the legislation determined that banks and brokers can no longer charge for transactions in a single package, making the price of each transaction clear to customers. It is also necessary to separate which amounts are being charged for the transaction itself and which are subsidizing research initiatives.
- Investor security. The law restricts the possibility of third parties paying investment firms or financial advisors to access their clients’ data. This aims to reduce conflicts of interest in situations where banks and brokers offer consulting or services to users.
- Non-EU companies. MiFID I did not address negotiations with companies outside the European Union. The second version corrects this by having jurisdiction over firms from anywhere in the world, as long as they are working with products or services within the EU.
- High-Frequency Trading (HFT). High-frequency trading and algorithmic trading have come under stricter scrutiny. The goal was to prevent market manipulation and abuse, as well as to ensure fairer investment practices.
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Which companies are affected by MiFID II
The Markets in Financial Instruments Directive II affects a large number of financial institutions both inside and outside the European Union. For example, this includes investment firms such as banks, brokers, and asset management firms.
Trading platforms, such as regulated markets, organized trading facilities (OTFs), and multilateral trading facilities (MTFs), also need to adhere to these rules.
The third category that needs to pay attention to the legislation is financial advisors and intermediaries. These agents offer investment advice and portfolio management services to investors.
In principle, all companies headquartered in at least one of the European Union countries are the main ones affected by MiFID II. However, companies outside the EU may also be subject to this law. Some examples include:
- Investment firms. Investment companies that offer services to clients within the European Union need to comply with MiFID II requirements. This includes companies that invest in assets within the EU, which will need to have transparency before and after their investments.
- Trading platforms. Regulated markets, OTFs, and MTFs that have participants from within the EU or that trade financial instruments of the European political and economic union.
- Financial advisors. Companies that offer investment advice or portfolio management services to clients in the European Union also need to adhere to the Markets in Financial Instruments Directive II.
What is MiFIR
While MiFID is the directive, MiFIR is the regulation itself. In other words, the directive sets objectives that EU members must strive to achieve. The regulation imposes rules that all countries must follow.
The acronym MiFIR stands for Markets in Financial Instruments Regulation. This is binding legislation and applies directly to all EU member states. Its main requirements involve the transparency of services provided by financial market institutions.
An example of this is the MiFIR Transaction Report, which requires the submission of all trading data from an authorized financial services provider to an Approved Reporting Mechanism (ARM). This information must reach the ARM within a T+1 interval, or the first business day after the transaction is completed.
The regulation has been in force since 2018, being enacted on the same day as MiFID II. The institutions affected by the directive and MiFIR are exactly the same.
The latest changes to MiFID II
In November 2022, a new version of MiFID II came into force, highlighting the final sustainability rules of the guidelines. Since then, investment service providers have been required to consider their clients’ environmental, social, and governance (ESG) preferences when advising on investments.
The aim of this change was to allow investors to make more objective and sustainable decisions when investing their clients’ money. From then on, ESG information became another data point in MiFID questionnaires — which already included things like financial goals, risk profile, and client experience.
In February 2024, the European Commission adopted new rules to strengthen the transparency of the EU financial services market. The text was updated to increase the scope of transaction reporting, making alternative investment fund managers (AIFMs) also subject to MiFID II rules.
These more recent changes also seek to protect retail investors through practices such as banning Payment for Order Flow (PFOF), a practice where brokers receive payments to direct clients to specific platforms. Additionally, the centralization of data from stock exchanges and investment banks aims to facilitate access for small investors to the most up-to-date information.
How to Prepare for MiFID III
Just two years after the creation of the Markets in Financial Instruments Directive II, the European Commission began preparing reports to assess its effectiveness. Since then, the expectation for the creation of a MiFID III has only been increasing.
According to the Financial Times, companies have complained about the high costs they need to invest to comply with the guidelines. This includes investments in new technologies, increased reporting requirements, and hiring new employees to handle compliance.
Another common complaint from affected companies is the lack of clarity about the benefits of MiFID II. Although legislators aim for increased transparency and greater investor protection, representatives of the interviewed firms claim that these advantages have not been evident in practice.
With these demands for improvement, it may only be a matter of time before a MiFID III is developed. So, let’s check out everything your company needs to do to be prepared for a possible update of the guidelines:
1. Implement Automated Compliance Management
Automated compliance management systems can help your team be more efficient and accurate. After all, such software can facilitate the process of data monitoring, report creation, and risk analysis.
An example of this is the AI-powered risk management feature of SoftExpert Suite, which, in addition to helping structure risk policies, providing visibility and monitoring to the team, offers quick and structured suggestions automatically. This allows you to focus on activities that offer greater added value, such as strategic management.
2. Mitigate Your Financial Risks
Establish a clear and easily accessible vision for those involved to ensure the monitoring, identification, and mitigation of risks. With the ability to understand action plans from detection, decision-making and execution become much more agile.
It is worth remembering that MiFID II already requires financial services firms to implement robust data and document management services to ensure the accuracy and integrity of information. Therefore, it is important to have the right governance tools and easy identification of necessary information, preventing your company from having problems with regulatory entities.
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3. Invest in Advanced Analytics and Traceability
Predictive analysis tools can help your organization find potential risks and non-compliances before they become serious problems. By analyzing large volumes of data, companies can detect patterns and anomalies that alert to regulatory violations.
With the right system, your company can create real-time customized reports and reduce the risk of human errors. These documents can be stored and displayed to regulatory agencies in the future, ensuring greater transparency in case of audits.
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4. Promote Training and Internal Audits
Regular training programs ensure that your employees are up-to-date on the latest regulatory requirements and best practices. This will help your company stay compliant and reduce the risk of regulatory violations.
It is also important to promote internal audits to identify gaps and weaknesses in your current compliance framework. This will allow you to address these issues before the arrival of MiFID III.
These inspections are key pieces to promote continuous improvement within the organization. Take advantage of valuable feedback from your employees and auditors to refine training programs and ensure maximum compliance with current legislation.
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Conclusion
MiFID II represents a milestone in financial market regulation, promoting greater transparency, investor protection, and fair trading practices within and outside the European Union.
However, like any far-reaching legislation, MiFID II brings significant challenges for companies, including the need for high investments in technology, compliance, and training.
With the recent updates of 2022 and 2024 and the possible arrival of a MiFID III, companies must maintain a proactive stance towards compliance. Investing in advanced technology, training, and internal audits not only ensures adherence to current guidelines but also prepares organizations for future regulatory changes.
By implementing modern strategies for internal controls, governance, data analysis, and risk management, your company can turn the challenges of MiFID II into opportunities for growth and innovation, establishing itself as a leader in an increasingly regulated and competitive market.
Looking for more efficiency and compliance in your operations? Our experts can help identify the best strategies for your company with SoftExpert solutions. Contact us today!
