Investment Services

Better regulated and transparent financial markets

SUMMARY OF:

Directive 2014/65/EU on markets in financial instruments

It aims at making financial markets in the European Union (EU) more robust and transparent.
It creates a new legal framework that better regulates trading activities on financial markets and enhances investor protection. The new rules, called ‘MiFID 2’, revise the legislation currently in place and will apply from January 2018.

KEY POINTS

Ensuring financial products are traded on regulated venues

The aim is to close loopholes in the structure of financial markets. A new regulated trading platform is established to capture a maximum of unregulated trades. This is the so-called Organised Trading Facility (OTF), which will exist alongside existing trading platforms such as regulated markets.

Increased transparency

The rules strengthen the transparency requirements that apply before and after financial instruments are traded, for instance when market participants have to publish information regarding the prices of financial instruments. These requirements are calibrated differently depending on the type of financial instrument.

Limiting speculation on commodities

Speculation on commodities — a financial practice that can lead to the prices of basic products (such as agricultural products) soaring — is restricted by introducing a harmonised EU system setting limits on the positions held in commodity derivatives. National authorities may limit the size of a position that market participants can hold in commodity derivatives.

Adapting rules to new technologies

Under the new rules, controls must be established for trading activities which are performed electronically at a very high speed, such as ‘high-frequency trading’ (a type of trading which uses computer programs to perform trades at high speed using rapidly updating financial data). Potential risks from increased use of technology are mitigated by a combination of rules aiming to ensure these trading techniques do not create disorderly markets.

Reinforcing investor protection

Investment firms should act in accordance with the best interests of their clients when providing them with investment services. These firms should safeguard their clients’ assets or ensure the products they intend to launch are designed to meet the needs of final clients. Investors will also be provided with increased information on products and services offered or sold to them. Moreover, firms must ensure that staff remuneration and performance assessments are not organised in a way that goes against clients’ interests. For instance, this may happen when remuneration or performance targets provide an incentive for staff to recommend a particular financial product instead of another that would better meet clients’ needs.

Delegated acts

In April 2016, the European Commission adopted a delegated directive which deals with aspects of investor protection:
safeguarding clients’ funds and financial instruments;
product governance (this ensures that firms which manufacture and distribute financial instruments and structured deposits act in their clients’ best interests); and
monetary and non-monetary compensation.
It also adopted a delegated regulation on organisational requirements and operating conditions for investment firms.

Implementing Regulation (EU) 2016/824 lays down technical standards for the description of the functioning of multilateral trading facilities and organised trading facilities and the notification to the European Securities and Markets Authority (ESMA).

DOCUMENTS

Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (recast) (OJ L 173, 12.6.2014, pp. 349-496)

It applies from 3 January 2018 (i.e. postponed by one year by Directive (EU) 2016/1034). EU countries have to incorporate it into national law by 3 July 2017.

Successive amendments to Directive 2014/65/EU have been incorporated in the original text. This consolidated version is of documentary value only.

Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits (OJ L 87, 31.3.2017, pp. 500–517)

Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive (OJ L 87, 31.3.2017, pp. 1–83)

Commission Implementing Regulation (EU) 2016/824 of 25 May 2016 laying down implementing technical standards with regard to the content and format of the description of the functioning of multilateral trading facilities and organised trading facilities and the notification to the European Securities and Markets Authority according to Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments (OJ L 137, 26.5.2016, pp. 10-16)

Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (OJ L 173, 12.6.2014, pp. 84-148)

Markets in financial instruments regulation

Regulation (EU) No 600/2014 on markets in financial instruments

It updates earlier legislation on markets in financial instruments* to ensure that these:

are more transparent;
work more efficiently; and
provide investors with more protection.

It covers:

disclosure of trade data to the public;
reporting of transactions to the relevant authorities;
trading of derivatives* on organised venues;
non-discriminatory access to clearing* and trading in benchmarks*;
powers for national authorities, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA);
investment services and activities by non-EU firms.

KEY POINTS

The legislation applies to:

investment firms and credit institutions such as banks;
insurance, assurance and reinsurance companies or alternative investment funds (known as ‘financial counterparties’);
non-EU firms with the necessary authorisation from the European Commission.

Transparency rules:

aim to ensure trading takes place on organised and appropriately regulated trading venues*;
require market operators and investment firms to make public, both before and after trading (the latter in as close to real time as technically possible), information such as bid and offer prices and the volumes involved;
allow for limited exemptions from the above requirement;
state the information be available to the public on a reasonable commercial basis, in a non-discriminatory way and free 15 minutes after publication;
set out specific requirements for systematic internalisers* and investment firms which trade over the counter (OTC) without the supervision of an exchange.

Transaction rules require:

investment firms:
to keep all relevant data on orders and transactions carried out for themselves or for a client for 5 years
to report complete and accurate details of all transactions to the relevant national authority as quickly as possible and no later than close of the following working day;
trading venues:
to keep all data on financial instruments advertised through their systems for 5 years.

Trading in derivatives must:

take place in:
regulated markets
a multilateral trading facility
an organised trading facility
a non-EU trading facility that the Commission has authorised;
be cleared by a central counterparty* as quickly as technologically possible.

Central counterparties must clear financial transactions in a non-discriminatory and transparent manner.

ESMA:

drafts certain technical standards, notably for derivatives and central counterparties;
monitors the financial instruments marketed, distributed or sold in the EU.
ESMA, the EBA and national authorities work closely together and have the power to temporarily ban or restrict the use of financial instruments considered a threat to investors or the financial system.

The Commission:

has adopted more than 20 implementing and delegated acts;
must, after consulting ESMA, submit reports to the European Parliament and the Council on various aspects of the legislation between March 2020 and July 2022.
Coordinated by ESMA, national authorities monitor investment firms to ensure they act honestly, fairly and professionally.

BACKGROUND

The 2008 financial crisis exposed weaknesses in EU rules for financial instruments other than shares, which are mainly traded among professional investors.
It amends Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories.

Alongside Directive 2014/65/EU on markets in financial instruments (MiFID II), this regulation sets up a new framework establishing uniform requirements for various financial instruments.

KEY TERMS

Financial instrument: asset, or evidence of ownership of an asset, or a contractual agreement between 2 parties to receive or deliver another financial instrument.

Derivative: a financial instrument whose value is based on the change in value of an underlying asset.
Clearing: the process used to manage the risk of open positions by checking that securities, cash or both are available.

Benchmarks: any publicly available rate, index or figure determined by a formula or value of underlying assets.
Trading venue: an official venue, such as multilateral trading facilities, organised trading facilities or regulated markets, where securities are exchanged.

Systematic internaliser: an investment firm that on an organised, frequent, systematic and substantial basis deals on its own account outside a regulated market.
Central counterparty: an entity acting as intermediary between trading counterparties and absorbing some of the settlement risk.

DOCUMENTS

Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (OJ L 173, 12.6.2014, pp. 84-148)

Successive amendments to Regulation (EU) No 600/2014 have been incorporated into the original text. This consolidated version is of documentary value only.

Key information about investment products

Regulation (EU) No 1286/2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)

It obliges those who produce or sell investment products to provide retail investors with ‘key information documents’ (KIDs) about the products.

The aim is to help investors to understand and compare the key features and risks of these products.It has applied since 1 January 2018.

Key information for retail investors

The producer of an investment product intended to be sold to retail investors has to provide a KID concerning the product. Those selling or advising on these investment products have to provide the KID to an investor before any agreement is made.

KIDs should be a maximum of 3 pages and provide clear information on a product allowing the investor to take an informed investment decision.

KIDs should include the following information:

the name of the product and the identity of the producer;
the types of investors to whom it is intended to market the financial product;
the risk and reward profile of the financial product, which includes a summary risk indicator, the possible maximum loss of invested capital and appropriate performance scenarios of the product;
the costs associated with the investment in the financial product to be borne by the investor;
information about how and to whom an investor can make a complaint where there is a problem with the product or the person producing, advising on or selling the product.

‘Comprehension alert’ for investment products that are difficult to understand

When an investment product is very difficult to understand, the provider has to ensure the KID contains the following warning: ‘You are about to purchase a product that is not simple and may be difficult to understand’.

Investment products covered

The rules apply to packaged retail and insurance-based investment products (also known as ‘PRIIPs’). These are a standard range of investment products typically offered by a bank to consumers, for example, in order to save for a specific objective such as a house purchase or for a child’s education.

They include investment funds, insurance-based investment products, retail-structured securities and structured-term deposits (structured products are investments with a pre-set formula for calculating returns and a pre-set formula for calculating risk).

Delegated Regulation (EU) 2017/653 supplements Regulation (EU) No 1286/2014. Its Annex I establishes a common template for the KID describing the purpose of the investment product to help investors understand the nature, risks, costs, potential gains and losses of the product and help them compare it with other products.

For example, the KID must provide the following.

Standardised information on the type of the PRIIP, its investment objectives, how these will be achieved and the key features of aspects of the product such as the insurance cover.

Information on the risks of a PRIIP in an aggregated form (as far as possible) and present it numerically as a single summary risk indicator with sufficient narrative explanations.

Information on potential consequences of a PRIIP manufacturer not being able to pay out. The degree of protection of the retail investor in such cases under schemes (investment, insurance or deposit-guarantee) must be clearly set out.
Clear information on recommended holding periods and required-minimum holding periods, and the possibility of partial or complete early exit in the event that the investor needs to disinvest.

DOCUMENTS

Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs) (OJ L 352, 9.12.2014, pp. 1-23)

Successive amendments to Regulation (EU) No 1286/2014 have been incorporated into the original document. This consolidated version is of documentary value only.

Commission Delegated Regulation (EU) 2017/653 of 8 March 2017 supplementing Regulation (EU) No 1286/2014 of the European Parliament and of the Council on key information documents for packaged retail and insurance-based investment products (PRIIPs) by laying down regulatory technical standards with regard to the presentation, content, review and revision of key information documents and the conditions for fulfilling the requirement to provide such documents (OJ L 100, 12.4.2017, pp. 1-52)