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A Market Turned Upside Down

The European Union's Markets in Financial Instruments Directive (MiFID) is scheduled to go into effect in November 2007. Even U.S.-based firms will need to have a thorough strategic plan for compliance in order to stay competitive in the global markets.

Why It's Important: MiFID ushers in a major restructuring of European capital markets that will alter the competitive landscape. Widely recognized as broader in scope than the SEC's Reg NMS, MiFID makes fundamental changes to rules governing client interaction and the suitability of investment strategies, best execution, and the definition of an execution venue. New business models will crop up to capture revenue from systematic internalization and market-data distribution, and firms that cannot adapt will inevitably fade away.

Although MiFID will be enforced by the European Commission and individual member state regulators, its impact will extend far beyond the European Union. Even U.S.-based firms will need to comply with MiFID's requirements in order to deal with European clients, counterparties or business partners.

Where the Industry Is Now: At the end of 2006, firms were in discussions with business analysts and consultants in an attempt to determine their strategies for achieving MiFID compliance. Toward the end of the year and into early 2007, front- and back-office leaders will collaborate to make hard decisions about how to prioritize MiFID compliance.

Many firms will elect to minimize the impact of MiFID and simply integrate compliance initiatives into their normal mode of business. Others will choose to exploit the regulation and the opportunities it opens for new business by opening systematic internalizers as trading venues and selling market data.

Focus in 2007: Early 2007 will see firms defining their policies surrounding MiFID, including policies on best execution, customer classification and investment-strategy disclosures. The beginning of the year also should see clarification from European regulators on outstanding uncertainties, which should expedite the process. These definitions should be complete by April, according to consultants, in order to meet the November implementation schedule.

By spring firms will engage in customer education efforts so that clients understand the changes to policy and procedure, and how MiFID's client-classification rules will affect their investment activity. Throughout the summer, the buy side will be shopping across the sell side for the best deals under the new guidelines, which will affect everything from product offerings to the pricing of execution and market data.

The heavy lifting of system rollout and testing should begin in late summer or early fall.

Industry Leaders: Although several global investment banks have invested in launching new pan-European execution venues to participate in the new competitive environment created by MiFID, no firm has yet to take a significant lead in their offerings to clients. However, financial firms operating in the U.K. stand to benefit from the aggressive approach to market preparation taken by the Financial Services Authority, which has released copious amounts of market guidance since MiFID's inception. Those U.S.-based firms that can dovetail their MiFID compliance efforts with similar Reg NMS activities also stand to gain through improved efficiency.

Technology Providers: MiFID, like Reg NMS, is a very large pie, and virtually every solution provider has a finger in it. While some vendors position themselves as MiFID specialists, the regulation will affect the entire transaction life cycle, from customer data to post-trade reporting.

The Price Tag: Estimates on the overall cost of MiFID vary widely, but it is sure to be expensive. A survey by the FSA, the U.K. regulator, puts industry costs at anywhere from US$2.3 billion to US$12.6 billion by 2010, with ongoing annual costs in the hundreds of millions industrywide.

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