Monday, 6 May 2024
by Patrick Genazzi - Founding Partner, CEO BRP Bizzozero & Partners SA
and Andrea Briganti - Director, Head of e-Learning Indigita SA
The Markets in Financial Instruments Directive (MiFID II) is the principal text regulating investment services and financial markets activities in the EU. Its design is aimed at bolstering transparency, strengthening investor safeguards, and promoting competition within financial markets.
For Swiss banks, the impact of MiFID II is significant, despite Switzerland's non-membership in the EU. In fact, MiFID II defines the limits applicable to the promotion and provision of investment services to clients resident in the EU by financial intermediaries established in a third country.
1. Scope and Application
MiFID II has been in force since January 2018. It applies to investment firms, market operators, and third-country firms providing investment services or performing investment activities through the establishment of a branch in the European Union.
Investment services and activities within scope of MiFID II include inter alia dealing, underwriting, placing, portfolio management, investment advice and ancillary services such as investment research.
Concerned Financial Products include transferrable securities (e.g. bonds and shares negotiable on the capital market), derivatives (including commodity derivatives), and units in collective investment schemes.
MiFID II reinforces the role and powers of regulators, who, in coordination with the European Securities and Markets Authority (ESMA), can ban specific products, services or practices that threaten investor protection, financial stability or the orderly functioning of markets.
2. Third-country Regime
Swiss banks traditionally manage a large number of clients domiciled in the EU. While Switzerland has its own set of financial regulations, complying with third-country rules defined by MiFID II is a compulsory prerequisite for managing the cross-border risk.
2.1. MiFID II framework – license requirement
The MiFID II framework has re-regulated the market access possibilities for third-country investment services providers into the EU. This change has transitioned the system from one governed by national rules to a partially harmonised framework. As per Article 39 of MiFID II, which pertains to the servicing of private clients (including those who are elective professionals), it is within the rights of Member States to mandate the establishment of a branch. This article also enumerates the conditions that Member States may stipulate for such an establishment.
2.2. The definition of reverse solicitation
MiFID II sets forth an exception to the previously mentioned requirement for a branch and acknowledges a valid entitlement for a firm from a third country to offer investment services to an EU citizen, provided it is in response to their spontaneous request. This introduces the concept of reverse solicitation, as outlined in Recital 111 and Recital 42 of MiFID II. According to these recitals, if a third-country firm provides services exclusively at the initiative of a person established in the EU, such services should not be considered as being provided within the EU’s territory.
The significant implication of this is that the activity is deemed to be located outside the EU territory. Consequently, EU regulations are not fully applicable, and the third-country firm is not obligated, in particular, to establish a presence in the EU Member State where the client resides or to secure a cross-border license.
3. MiFID II - Key Points
3.1. Investor Protection
MiFID II foresees stronger organisational requirements around conflicts of interest, client asset protection and product governance. It also strengthens conduct requirements.
The investor protection framework set out in MiFID II aims at ensuring that financial intermediaries act in the best interest of clients through a number of requirements, including but not limited to product design and governance, suitability and appropriateness, inducements and disclosure on costs/charges requirements.
3.2. Product Governance
Under MiFID II, financial intermediaries need to make specific arrangements for product governance and establish effective policies and arrangements to identify the category of clients to whom products and services are provided.
Financial intermediaries that manufacture financial instruments need to identify the target market of end clients, ensuring that these are distributed to the identified target market and periodically review such identification and the performance of the products they offer.
Financial intermediaries that offer or recommend financial instruments not manufactured by them will also need to obtain and understand the relevant information concerning the product approval process, including the identified target market and the characteristics of the product.
3.3. Transparency
Pre/post-trade transparency requirements are extended under MiFID II to non-equity instruments as bonds, structured products and derivatives and equity like instruments as depositary receipts, ETFs and certificates).
As a result of these extended transparency requirements, more information is available to the public on trading in financial instruments.
Financial intermediaries are required to public annually, for each class of financial instruments, the top five execution venues in terms of trading volumes where they executed client orders in the preceding year and information on the quality of execution obtained. In addition, they are required to publish on a quarterly basis execution quality data in relation to the execution venues which they use.
Costs and charges disclosure requirements are expanded to cover all client types.
3.4. Suitability
The assessment of suitability is one of the most essential elements for investment protection in the MiFID II framework. It applies to the provision of any type of investment advice (whether independent or not) and portfolio management.
Financial intermediaries providing investment advice or portfolio management have to provide suitable personal recommendations to their clients or have to make suitable investment decisions on behalf of their clients.
The suitability evaluates a client’s knowledge and experience, financial situation (incl. ability to bear financial losses) and investment objectives (incl. risk tolerance). To this end, financial intermediaries have to obtain the necessary information from the client or prospect.
4. Challenges and Opportunities in Compliance
Compliance with MiFID II presents both challenges and opportunities for Swiss Banks and Investment firms. The formulation of a strategy that is oriented towards delivering services in compliance with MiFID II necessitates substantial organisational endeavours. This includes the eventual integration of technological solutions that facilitate adherence to crucial reporting, transparency, and business conduct requirements.
Nonetheless, this investment can be viewed as a strategic opportunity to refine operations and augment the overall organisational efficiency of entities operating within the financial sector. Moreover, by embracing stringent standards, Swiss Banks and Financial intermediaries can set themselves apart as premier institutions that are deeply committed to transparency and the protection of investors. This could potentially appeal to discerning clients who place a high value on these attributes.
Conclusion
The importance of MiFID II for Swiss banks and Investment firms cannot be underestimated. If compliance presents important challenges, it also offers opportunities to affirm their commitment to transparency and investor protection.
By adopting a strategy that complies with the requirements set by the third-country regime as defined by MiFID II, financial intermediaries can contribute to strengthening Switzerland’s position as a global financial leader, capable of balancing regulatory requirements with innovative financial solutions.
Within the dynamic realm of international finance, the strategic approach adopted by Swiss financial intermediaries towards MiFID II compliance serves as a testament to their unwavering determination to uphold resilience. Moreover, it underscores their steadfast commitment to the pursuit of excellence in the provision of financial services.
What do we do at Indigita
At Indigita, we are committed to supporting professionals in understanding and navigating the complexities of the product placement from a regulatory and cross-border perspectives. We offer a comprehensive course on MiFID II designed for banking executives, relationship managers, and compliance officers. This course covers the main concepts and definitions of the EU regulation and its applicability for Swiss banks. It provides an overview on the regulatory framework and concrete practice cases. Additionally, through our inApp solution, we provide product placement compliance answers on the go, including MiFID II appropriateness scores, empowering professionals to make informed decisions in the rapidly evolving landscape of cross-border product placement.