MiFID stands for Markets in Financial Instruments Directive (Directive 2004/39/EC). Approved by the European Parliament in April 2004, the MiFID replaces and repeals the previous Investment Services Directive (Directive 93/22/EEC or ISD), radically changing the community legislative framework on the offer of investment services. Together with the Market Abuse Directive (MAD), the Prospectus Directive, and the Directive on Transparency Requirements for listed companies, the MiFID is an integral part of the Financial Services Action Plan adopted by the European Commission in May 1999.
Pursuant to the approach proposed by the Lamfalussy Commission, MiFID regulations consist of three levels:
- the first level, represented by the cited Directive 2004/39/EC, defines the regulation's general principles;
- the second level, represented by Regulation 1287/2006/EC (on market discipline and pre and post-trade transparency issues in particular) and Directive 2006/73/EC (on the conduct and organisation of intermediaries providing investment services);
- the third level, corresponding to the Committee of European Securities Regulators (CESR) guidelines, designed to ensure uniform reception and application at the national level of all regulations at the first two levels.

From ISD to MiFID

The first MiFID Consideranda clearly outline the difference in approach as compared to the ISD Directive. While the ISD aimed at harmonising only “[] initial authorisation and operating requirements for investment firms, including conduct of business rules, [...]” and “[...] some conditions governing the operation of regulated markets […]”, the MiFID is designed to ensure “[…] the degree of harmonisation needed to offer investors a high level of protection and to allow investment firms to provide services throughout the Community [...] on the basis of home country supervision […]” (Directive 2004/39/EC, Consideranda 1 and 2).
Compared to the ISD - where “minimum harmonisation” principles prevailed - the MiFID and related execution measures represent a switch to a “very wide harmonisation” approach, identified as the tool for developing an effectively integrated and single financial market. Even when it assumes the form of a Directive, the European legislation looks very detailed: this tightly limits the possibility for Member States to introduce additional rules, when EU standards are transposed into national law.

MiFID’s objectives

Despite the complexity and variety of the issues addressed, the objectives of the MiFID and the related implementation provisions are clear:
- to stimulate competition, by repealing regulated market trading concentration obligations and by facilitating the offer of cross-border investment services (free provision of services in EU member countries, otherwise known as the “single passport”);
- to strengthen market integrity, efficiency, and transparency by setting out detailed rules on trade execution;
- to ensure investor protection and to set uniform rules of conduct in relations between investment firms and their clients;
- to introduce minimum organisational requirements for investment firms.

Market organisation

As far back as 2002, with the first draft of the new Directive, the European Commission noted that: “[...] since the ISD was adopted, the EU financial market has become more complex and the line between markets and intermediaries has become more blurred [...]”: alternative trading systems (ATS) have developed alongside regulated markets - known in the Italian law as Sistemi Scambi Organizzati (SSO).
The MiFID addresses this blurred line between intermediaries and markets in an ambitious and highly innovative way. Considerandum 5 of Directive 2004/39/EC reads: "It is necessary to establish a comprehensive regime governing the execution of transactions in financial instruments irrespective of the trading methods used to conclude those transactions so as to ensure a high quality of execution […] and to uphold the integrity and overall efficiency of the financial system […]. It is necessary to recognise the emergence of a new generation of organised trading systems alongside regulated markets which should be subjected to obligations designed to preserve the efficient and orderly functioning of financial markets”.
To achieve these objectives, the EU legislation has developed along several lines:
- elimination of the faculty previously attributed to Member States to impose that negotiations of listed securities concentrate on regulated markets;
- recognition of “systemic internalisers” - i.e.: investment firms which, on an organised, frequent and systematic basis, deal on their own account by executing client orders;
- inclusion of the “operation of multilateral trading facilities-MTF” among investment services;
- obligation that systematic internalisers, multilateral trading facilities and regulated markets abide by pre- and post-trade transparency rules, in order to avoid the negative effects deriving from the fragmentation of execution venues.
The repeal of trading concentration obligations means that buy and sell orders for financial instruments may currently be executed using three different trading venues in competition between themselves: regulated markets, multilateral trading facilities, and systematic internalisers. Readers can view an updated list of authorised trading venues on the CESR website.

Client relations

The MiFID regulates relations between intermediaries and their clients through:
- a more complex set of know-your-customer rules, centred on the notions of suitability, appropriateness, and execution only;
- the introduction of a different client categorisation, consisting of two general levels … “retail” and “professional” clients - and the new category of “eligible counterparties”;
- the requirement that investment firms establish and implement procedures capable of channelling orders to the trading venue that offers the best execution conditions, “[...] taking into account price, costs, speed, likelihood of execution and settlement …” (i.e. best execution, article 21, paragraph 1 of Directive 2004/39/EC);
- tight discipline over the intermediary's duty to provide clients with information;
- prohibition for banks and investment companies from receiving fees, commissions or non-monetary benefits (inducements) in connection with providing an investment service, except under particular conditions;
- extension of the notion of investment services, to include investment advice.

Suitability, appropriateness, execution only

In the MiFID framework, the intermediary’s assistance to the client is categorised at different levels depending on the nature of the service provided (see article 19 of Directive 2004/39/EC and related application provisions).
In the case of more complex and value-added services … i.e. portfolio management and investment advice … investment firms are required to have in-depth knowledge of the clients and to assess that recommended services or investments are “suitable” for them (so-called “suitability assessment”). Investment firms must gather information regarding the clients’ knowledge and experience in the fields relevant to the specific type of product or service, their financial situation and their financial goals. Afterwards, they must ensure that the service or product effectively corresponds to the clients’ stated goals and that it does not expose them to risks that they are not able to understand or to bear. If the investment firm does not obtain the information necessary for the suitability assessment, it must refrain from offering investment advice and / or portfolio management services.
For financial services other than advice and portfolio management, investment firms must carry out an “appropriateness” assessment. In other words, they have to assess whether the clients have sufficient knowledge and skills to understand the risks involved with the specific type of product or service offered or demanded, by gathering information on financial instruments they have most knowledge of, the frequency of transactions in the past, their level of education and profession. In case the investment firm considers, on the basis of the information received from the clients, that the product or service is not appropriate to them, it shall warn the clients. Once notification is given, the investment firm may proceed with providing the product or service.
Finally, in the case of "execution only", the investment firm is not obliged to assess whether the transaction is appropriate for the client's profile; therefore, it does not have to gather any information. The “execution only” procedure may be applied only when the service offered refers to shares listed on a regulated market, money market instruments, bonds and other debt securities, harmonised funds, and other non-complex financial instruments.

Professional clients, retail clients, eligible counterparties

The MiFID offers different degrees of protection according to different client categories.
Pursuant to Directive 2004/39/EC, a professional client is defined as “[...] a client who possesses the experience, knowledge and expertise to make its own investment decisions and properly assess the risks that it incurs […]” (Annex II). This category includes credit institutions, investment firms, insurance companies, collective investment schemes and their management companies, pension funds, other institutional investors, national and regional governments, public bodies with mandates to manage public debt, entities dedicated to the securitisation of assets, central banks, international and supranational institutions (World Bank, IMF, ECB, EIB, etc.). The following may also be classified as professional clients: a) large companies, subject to certain conditions1); b) clients other than those mentioned above, provided that they file a specific application with the investment company (so-called "professional clients upon request”) and that they satisfy the cases, conditions, and procedures described in Annex II, Section II of Directive 2004/39/EC2.
According to the MiFID, “eligible counterparties” are a sub-set of professional clients3. The attribution of the status of eligible counterparty is relevant only with reference to specific investments and related ancillary services4: dealing on own account, execution of orders on behalf of clients, reception and transmission of orders.
Finally, all persons not included among professional clients and eligible counterparties are classified as “retail clients”. The “retail” category also includes clients applying to be treated as such: as a matter of fact, the categorisation as eligible counterparty or professional client does not prevent the client from enjoying a more protective treatment, in general or for individual transactions. Obtaining a different status is subject to the consent of the investment firm.
Retail clients enjoy the highest level of protection pursuant to the MiFID. Directive 2004/39/EC specifies that, within a reasonable time before the service is provided, the investment firm must spell out for the retail client all the terms of service, together with a set of information about the investment firm and its services, the nature and risks of its financial products, the instruments designed to protect the client’s instruments and funds, and all the costs and charges for the service.
On the contrary, professional clients have to be provided with information exclusively regarding the nature and risks of the products and services on offer, the protection of the client's financial instruments and funds, the existence and terms of any rights of guarantee or privilege that the investment company has or could have on its financial instruments or funds.
Before providing investment advice and portfolio management services, the investment firm must acquire from the retail client all information useful for a “suitability” assessment. If the service is other than investment advice or portfolio management, the investment firm will ask the clients for information only about their knowledge and experience of the specific product or service recommended or requested (“appropriateness” assessment).
When the counterparty is a professional client, the presumption pursuant to the MiFID is that they have the necessary knowledge and experience to understand the inherent risks of products, transactions, and services in relation to which they are categorised as a professional client. Applicable to such services, the investment firm may omit the appropriateness assessment. If the financial service in question consists of investment advice, the investment firm has the right to presume that the professional client is financially capable of sustaining any risk connected to it and compatible with its investment objectives. Hence the suitability assessment will be simpler than the one conducted for a retail client.
Some of the MiFID rules on retail and professional client protection do not apply to eligible counterparties. In detail, when providing to such counterparties the services of dealing on own account, execution of orders on behalf of clients, and reception and transmission of orders, investment firms are not required to comply with the obligations pursuant to articles 19, 21, and 22(1) of Directive 2004/39/EC … which deal respectively with the general rules of conduct to follow when providing services, the obligation of executing orders at the most favourable conditions, and the obligation of applying procedures that ensure rapid and efficient order execution.

Investment firms’ organisational requirements

As already mentioned, among the MiFID's objectives is to introduce minimum organisational requirements for investment firms.
The Directive features a principle-based framework, setting general objectives and minimum requirements, and leaving investment firms the freedom to autonomously structure their organisational models. Hence the organisational and control set-up must be proportional to the type, size, and complexity of the firm’s operations, as well as the type and range of services offered (so-called “proportionality principle”).
The provisions on organisational requirements are contained in article 13 of Directive 2004/39/EC and detailed in Title II, Chapter 1 of Directive 2007/69/EC.
In short, these provisions set out investment firms' obligations regarding general organisational requirements, compliance, risk management, internal audit, and the responsibility of senior management. They also define guidelines for establishing sound policies and procedures to ensure accurate and regular provision of services; to monitor compliance with regulation; to prevent conflict of interests; to regulate personal transactions. Finally, they define conditions for outsourcing essential / important functions and mitigating related risks.

The transposition of the MiFID into the Italian legislation

The passage of Law Decree17 September 2007, no. 164, started the process of transposing the MiFID into the Italian legislation, by adding a series of significant amendments to the Consolidated Law on Financial Intermediation (Testo Unico della Finanza, TUF). The Decree came into effect on 1 November 2007.
On 29 October 2007, after a market consultation, the Italian Securities and Exchange Commission (CONSOB) introduced pertinent amendments to Regulation no. 16190 (“Regolamento Intermediari”) and Regulation no. 16191 (“Regolamento Mercati”). At the same time, the CONSOB and the Bank of Italy jointly published the “Regulations on the organisation and procedures of investment firms” (so-called “Regolamento congiunto” or “Joint Regulation”).
In pursuit of the objective of reducing fragmentation risks to a minimum and to ensure effective parity of treatment between all investment companies operating in the European market, Italy's reception laws and regulations show very little deviations from the EU legislation.

Assessment and review process

Pursuant to EU legislation, the European Commission should periodically review the MiFID and its application provisions: see article 65, paragraphs 2, 3, and 4 of Directive 2004/39/EC; article 44, paragraph 5, and article 51, paragraph 5, of Directive 2006/73/EC; and article 40 of Regulation 1287/2006/EC.
Since 2008, the CESR started checking several aspects of the Directive’s effectiveness, publishing, together with the Committee of European Banking Supervisors (CEBS) a report “CESR/CEBS’s technical advice to the European Commission on the review of commodities business” (CESR/08-752 and CEBS 2008 152 rev., 15 October 2008). Then in June 2009, the CESR published an assessment report on the Directive's impact on the functioning of secondary markets (“CESR’s assessment on the impact of the Markets in Financial Instruments Directive - MiFID - on the functioning of equity secondary markets”, CESR/09-355), and another report on the transparency of corporate bond, structured finance products, and credit derivatives markets (“Transparency of corporate bond, structured finance product and credit derivatives markets”, CESR/09-348).
In the same year, the Commission began work on the review of other aspects of the Directive. In July 2010, the CESR published a first set of technical reports on equity markets (“CESR Technical Advice to the European Commission in the Context of the MiFID Review - Equity Markets”, CESR/10-802), the transparency of non-equity markets (“CESR Technical Advice to the European Commission in the Context of the MiFID Review: Non-equity Markets Transparency”, CESR/10-799), transaction reporting requirements (“CESR Technical Advice to the European Commission in the Context of the MiFID Review … Transaction Reporting”, CESR/10-808), and on investor protection (“CESR Technical Advice to the European Commission in the Context of the MiFID Review - Investor Protection and Intermediaries”, CESR/10-859). It also published responses to questions that the European Commission addressed to the Committee regarding the Directive review process (“CESR’s Responses to Questions 15-18 and 20-25 of the European Commission Request for Additional Information in Relation to the Review of MiFID” - CESR/10-860).
A second set of technical reports was released by the CESR on 13 October 2010, addressing issues of standardisation and organisation of over-the-counter derivatives trading (“CESR Technical Advice to the European Commission in the Context of the MiFID Review … Standardisation and Organised Platform Trading of OTC Derivatives” - CESR/10-1096), post-trade transparency standards for the equity market (“CESR Technical Advice to the European Commission in the Context of the MiFID Review … Equity Markets: Post Trade Transparency Standards” - CESR/10-882), and client categorisation (“CESR Technical Advice to the European Commission in the Context of the MiFID Review - Client Categorisation” - CESR/10-1040). It also published a second set of answers to questions posed by the European Commission (“CESR’s Responses to Questions 1-14 and 19 of the European Commission Request for Additional Information in Relation to the Review of MiFID” - CESR/10-1254).
In 2011, the European Commission should submit a draft revision of Directive 2004/39/EC, to be passed by year-end. Revision of Directive 2006/79/EC is scheduled for 2012.
1Large undertakings that meet two of the following size requirements on a company basis are considered professional clients: 1) total balance sheet, EUR 20M; 2) net turnover, EUR 40M; 3) own funds, EUR 2M.
2Recognition of professional client status “upon request” presupposes that the investment firm carries out “[…] an adequate assessment of the expertise, experience, and knowledge of the client […]” which reasonably allows it to deem “ […] in light of the nature of the transactions or services envisaged, that the client is capable of making its own investment decisions and understanding the risks involved [...]” (Directive 2004/39/EC, Annex II, Section II, paragraph II.1). In the assessment, at least two of the following criteria should be satisfied: 1) that the client has carried out transactions, in significant size, on the relevant market with an average frequency of 10 transactions per quarter over the previous four quarters; 2) that the size of the client’s financial portfolio exceeds EUR 500,000 - including cash deposits; 3) that the client works or has worked in the financial sector for at least one year in a professional position that presupposes knowledge of the transactions or services envisaged. The client must state in writing that they wish to be treated as a professional client, either generally or with regard to a particular investment service or transaction, or type of transaction or product.
3According to Article 58, paragraphs 1 and 3, of Regulation n°16190 (Regolamento Intermediari) the following are identified in Italy as “eligible counterparties”: 1) investment firms, banks, insurance companies, UCITSs and their management companies, pension funds, financial intermediaries enrolled in the list pursuant to articles 106, 107, and 113 of the Consolidated Law on Banking (Testo Unico Bancario, or TUB), companies pursuant to article 18 of the TUB, electronic money companies, bank foundations, national governments and their divisions, including government agencies with a mandate to manage public debt, central banks, and supranational government organisations; 2) companies whose main activity is trading on own account in commodities and derivative financial instruments on commodities; 3) companies whose exclusive business is trading on own account in the markets for derivative financial instruments and … for mere hedging purposes … on spot markets, provided that they are backed by members of settlement houses of such markets; 4) entities as listed above, resident in non-EU countries. Also professional clients pursuant to Annex 3 of Regulation n°16190, Section I, points (1) and (2), not included in the list above, may be treated as eligible counterparties: among them are stock brokers and large companies.
4According to Annex I of Directive 2004/39/EC, “investment services and activities” include: reception and transmission of orders in relation to one or more financial instruments; execution of orders on behalf of clients; dealing on own account; portfolio management; investment advice; underwriting of financial instruments and / or placing of financial instruments on a firm commitment basis; placing of financial instruments without a firm commitment basis; operation of Multilateral Trading Facilities (see Section A). “Ancillary services” include: safekeeping and administration of financial instruments for the account of clients, including custodianship and related services; granting credits or loans to an investor to allow him/her to carry out a transaction in one or more financial instruments; advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to mergers and the purchase of undertakings; foreign exchange services where these are connected to the provision of investment services; investment research and financial analysis; services related to underwriting (Section B).



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