MiFID II – The implications for the investing public

Financial Article 521 by Edward Rizzo - Jan 18, 2018

As was widely reported in various parts of the local and international media, on 3 January 2018, the EU Markets in Financial Instruments Directive and Regulation (MiFID II and MiFIR) came into effect across all EU member states, including Malta.

EU member states were required to implement the regulations into national legislation by 3 July 2017, i.e. 6 months before the ‘live’ date. Unfortunately, the Malta Financial Services Authority (MFSA) only issued its new Conduct of Business Rules (transposing all MiFID II requirements into local rules) on 20 December 2017, thus leaving very little time for local investment services practitioners to understand the entire requirements of the new rules imposed by the local regulator prior to the implementation date of 3 January 2018.

MiFID II, MiFIR and the Conduct of Business Rules bring about numerous changes to the services provided by investment firms to their clients and it is therefore important for investors to be made aware of the more significant changes and how their dealings with financial services practitioners may be impacted.

In the case of non-advisory (i.e. execution-only) services, few changes are required as from 3 January 2018. With respect to trading in complex financial instruments (including callable bonds, subordinated bonds, bonds subject to BRRD and leveraged financial products), investment firms must conduct an appropriateness test to assess the knowledge and experience of the investor. On the basis of the result of the appropriateness test, investment firms must consider whether the client possesses the necessary knowledge and experience to trade in the complex financial instrument requested by the client. Assuming that the client has sufficient knowledge and experience, the transaction can be executed but the appropriateness test needs to be signed by the investor and the investment firm is required to declare that no recommendation was provided.

In the case of non-complex financial instruments (equities and plain-vanilla bullet bonds – whether secured or unsecured), there have been no major changes and an investor must be aware that investment firms are not required to perform an appropriateness test.

On the other hand, in the case of advisory services,  more significant changes are required with more formal procedures being implemented. Investment firms are now required to provide a Suitability Report to their client detailing how the advice given is suitable to their specific personal circumstances and investment objectives. The information required to assess the suitability of a client involves the collection of information such as a person’s investment knowledge and experience as well as a detailed overview of a client’s financial situation including the person’s ability to bear financial losses.

The Suitability Report needs to be provided to the investor prior to the execution of a trade or, if specifically consented to by the client, as soon as possible thereafter. More importantly, investors should be aware that the Suitability Report requirement applies to any investment advice provided (buy/sell/hold/switch) and must be drawn up and provided to the client irrespective of whether the client chooses to act on the advice given, or otherwise. The advice may be either of a one-time nature or may be subject to a periodic review (at least annually). This would need to be agreed between the investment firm and the investor at the time of the drawing up of the Suitability Report.

In the case of portfolio management (discretionary), the valuations and statements now need to be provided to clients on a quarterly basis and also need to contain more detailed information. Additionally, investment firms must also inform the client immediately in the event that the value of the portfolio declines by 10%, and thereafter at multiples of 10%, since the beginning of each reporting period.

Unfortunately, the MFSA’s Conduct of Business Rules differ from the MiFID II requirements in respect of the requirements to provide Suitability Reports to advisory as well as portfolio management clients. While MiFID II requires that the Suitability Report is provided to clients solely in the case of advisory services, and it does not make reference to clients being provided with discretionary portfolio management services, the MFSA’s Conduct of Business Rules have added the exact same requirement, namely that of providing a Suitability Report to clients before a transaction is undertaken, even for discretionary portfolio management services.

This goes against the whole concept of a discretionary service. Many investors opt for a discretionary mandate precisely since they do not have the time or do not wish to get involved in the management of their investment portfolio and therefore require the professional assistance of licence holders to carry this out in line with the investor’s profile and objectives that would have been discussed at the time of the fact-find process. The requirement for the portfolio manager to send the client a Suitability Report for each investment decision before the actual trade is executed is unreasonable and would be very detrimental to such investors if this approach would need to be adopted, as the prices of securities may change significantly in a short period of time especially when dealing across international financial markets. This would surely not be acting in the client’s best interests.

Another important requirement under the new rules and applicable as from 3 January 2018 is that minutes of all relevant face to face meetings, whether under an execution-only or an advisory service, held between a representative of an investment firm and an investor, must be drawn up and kept on record by the investment firm. Operators within the investment services industry may therefore likely request that such minutes are signed by both parties and that a copy of the minutes is provided to the client.

Additionally, under the new rules, any investor who is not an individual (i.e. companies, partnerships, trusts, charities, associations, and others) is required to have a valid Legal Entity Identifier (“LEI”) to trade securities (shares, corporate bonds, government bonds, etc.) listed on the local or any international stock exchange.

This LEI is needed since MiFIR requires trading venues (such as the Malta Stock Exchange) and all investment firms to report the details to the MFSA of all the trades it executes on behalf of clients. In this respect, both when trading in the direct name of a client or when trading in securities held under nominee, investment firms are required to share personal details of a client including the trade order details with the MFSA. The personal details for an individual include the name and date of birth, while for non-individuals, the name of the entity and the LEI number is required to be sent to the MFSA. In the case of trades registered in the name of the client directly at the Central Securities Depository of the MSE, investment firms (who are members of the MSE) are required to provide these client details to the MSE (unless the MSE is already in possession of these details) to ensure compliance with this new MiFIR requirement.

The items mentioned above are not an exhaustive list of all the additional requirements under the new rules. The intention here is to provide readers with an overview of the main changes since investment firms will be amending their procedures with many clients and it is important for investors to understand the background behind the changes being made. A high degree of co-operation on the part of the investor is important to ensure a smooth process in this respect.

As one may appreciate, the wide-ranging impact of these new rules entails investment services companies to devise additional documented procedures to assist investors especially those requiring advisory or discretionary portfolio management services. The detailed new procedures will require additional IT as well as increased human resources support, so investors need to be well aware that investment services providers will be incurring additional regulatory induced costs, thereby necessitating increased charges and fees to their clients going forward.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.