Europe Moves Toward a Single Financial Market
While U.S.-based investment firms scramble to cope with the national market system created by Reg NMS, their European counterparts have their own regulatory headache, which is equally taxing and farther reaching. If MiFID - the Markets in Financial Instruments Directive - works out as planned, the entire European Union (EU) - which comprises 25 countries and 450 million people - will be turned into a single market for wholesale and retail financial transactions.
"What MiFID is supposed to do is level the playing field for individual investors," explains Tom Price, a senior analyst with Needham, Mass.-based TowerGroup. "The U.S. is a lot more advanced than the EU markets both in terms of technology and structure," he notes. MiFID, he says, will play catch up and "drive the EU market into a much more pure electronic model."
According to Paul Edmonson, a financial services lawyer with CMS Cameron McKenna LLP in London, MiFID's objective is to "harmonize regulation across Europe for investment services," which includes advising on things like securities, derivatives and mutual funds. MiFID replaces the existing Investment Services Directive (ISD), which was the EU's first attempt at harmonization about 10 years ago says Edmonson.
But harmonizing the market practices of 25 countries is no easy task. A massive undertaking, MiFID has implications for both sell-side and buy-side firms, though most observers agree that the sell side faces greater hurdles.
It also is a project whose deadlines are moving like a balloon in the wind - all over the place. Originally scheduled for implementation in April 2006, the deadline for compliance with the regulation has been extended to Nov. 1, 2007, and even that time frame has its skeptics, given the enormity of MiFID's scope.
Interestingly, MiFID is creating many of the same concerns that the investment industry in the U.S. faces - things like data fragmentation, debates over what constitutes best execution, and the impact the changes will have on both clients and the industry.
And it's not a cheap initiative, either. TowerGroup estimates that a medium-size European broker will spend $22 million to become compliant. Some analysts predict that the industrywide spending figure for European securities firms will ring in at more than $1.3 billion. But the devil is in the details, and the actual compliance requirements still are being ironed out, so it is difficult to ascertain accurate spending estimates.
Partially as a result of that uncertainty, firms are grappling with the change. A survey of 35 London-based investment firms conducted by Riversix for the MiFID Joint Working Group last fall found that 80 percent did not have a MiFID compliance framework in place or, if they did, they did not know about it. However, 44 percent budgeted for MiFID compliance initiatives in 2006, and 60 percent had assigned staff to work on developing a compliance plan.
Further, a Capco survey last fall of North American banks with operations in the EU found that 80 percent were not on schedule to meet MiFID's then deadline of April 2007 and that it would take 10 months to 14 months to get there. Additionally, the survey revealed that it would cost the banks $25 million each to achieve compliance.
Readiness, however, seems to be changing. A January Datamonitor survey of senior executives responsible for compliance at the U.K.'s top 20 financial services firms found that 53 percent claim they are now fully compliant with MiFID, and 33 percent believe they are close to complying. That's despite the fact that a number of details remain to be worked out, such as how best execution actually will work.
Easing Cross-Border Trading
The MiFID changes will make it easier for EU-member firms to offer cross-border trading in these services and financial instruments. It does that by enhancing the existing ISD passport system, allowing a firm that is licensed in its country, known as the "home state," to conduct similar business in another country where it has subsidiaries, known as a "host state," within the European Economic Area (EEA).
Under MiFID, the home state will be responsible for licensing organizations and business conduct of the firm if it has no subsidiaries in the EEA. If it has a subsidiary in a host state, then the home state regulates organizational issues and the host will regulate local business conduct issues.
What about the impact on U.S.-based buy-side firms? Dermot Turing, a financial services lawyer at Clifford Chance LLP in London, says that, "Unfortunately, MiFID does not solve the problem of non-EEA firms being unable to do investment business in Europe without obtaining a local license from each relevant EEA country. This does not make things any worse than now, but it does not particularly help."
CMS Cameron McKenna's Edmonson confirms this position. "If they don't have a presence in Europe and they don't have clients in Europe, there will be very little direct effect," he says.
However, Edmonson warns, firms that don't have a presence in the EU but are servicing their own clients who are in the EU might run into problems and find they need to be licensed in those EU countries. That's because the overseas person exclusion, which some non-EU firms rely on to service clients in places like the U.K., may not survive. "It's not clear yet," he says, noting that such a change would impact the offshore banks in particular.
Client Classifications Revamped
MiFID also impacts the treatment of clients and imposes new information obligations on investment management firms. Clients fall into one of three categories: retail; professional; and eligible counterparties, which applies to a limited number of clients.
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