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mifid II and esma intervention

MiFID II and ESMA intervention – summary

The MiFID II and the ESMA product intervention activated trader environments, thus, motivating them to take a stand in the case of changes regarding the European Forex/CFD market. How does the new law, which directly influences retail traders, look like in the end? We will try to clearly and explicitly summarise all changes.

What is the MiFID II?

The EU Markets in Financial Instruments Directive II (MiFID II) issued by the European Securities and Markets Authority (ESMA) updates European legal frameworks for financial markets. The first version of the MiFID was drawn up in 2004.  Two principal objectives thereof consist in increasing and regulating the market competition and protecting customers in the European investment markets. It regulates all entities in the capital market and all (apart from cryptocurrency) financial instruments. It is accompanied by the MiFIR (Markets in Financial Instruments Regulation), which supports functioning of the directive implemented in the legal systems of the Member States. In its original form the regulation (MiFID I) covered with its scope mainly the equity market.

Very fast development of the industry, dissemination of electronic platforms so-called dark pools (OTC market) in place of stock exchanges and an increase in the popularity of derivative instruments and bonds required updating binding regulatory frameworks.

New principles for brokerage houses

Prices of instruments considered by the ESMA as liquid must be published pre and post transaction. Prices of less liquid instruments must be published as well, however, in this case a delay is allowed. Furthermore, the most liquid derivative instruments as e.g. interest rate swaps must become an object of trading on public platforms (as e.g. GPW).

As of introduction of the MiFID II brokerage houses and brokers are also required to report any data regarding transactions directly to regulatory authorities. Furthermore, upon the customer’s request they have to share full details regarding each transaction (e.g. spread, bid/ask, market depth). Both of these activities are aimed at avoiding market abuse. It is also required to present so-called best execution policies in order to prove that the institution trades assets at the best possible price.

Pursuant to the new regulations all brokers and investment firms must register all concluded transactions, whole correspondence with the customer and all recordings of conversations on the phone for a period of at least 5 years, depending on the national authority (yet, not shorter).

Moreover, each firm from the sector will have to employ a separate employee with regard to the so-called compliance, who will be monitoring fulfilment of new legal requirements.

In other words, the MIFID II “supports” honest and full transparency, in particular, in the CFD industry, which often has not been regulated sufficiently. By definition, all that could have been hidden or kept in secret by the broker, will be finally disclosed.

Thus, what are the possibilities gained by traders pursuant to the new law?

New rights of traders

  • Customers can request a transaction report with indication of the place of conducting the transaction – thus, you can easily find out, if your item was conducted in A-Booked system (the broker released it further) or in B-Booked system (the broker conducted it in the internal market [MM]).
  • Upon request, customers can now also receive access to the report on the specific transaction, which has to be forwarded within 24 hours as of enforcing a given movement.  Such a report includes accurate information on factors comprising the transaction price, that is, e.g. the amount of commission, costs, possible amount of discount or price mark-up, or price supplements.
  • If your order was executed in several batches, you can ask for a detailed explanation of VWAP (volume weighted average price) of your transaction.

Changes regarding other financial firms

Another important change includes the one regarding costs related to drawing up analyses by financial firms – so far they were included in brokerage fees and commissions. New regulations require collecting fees due to such analyses separately. It is intended to result in a situation, when market mechanism automatically develops reports’ pricing. Thus, both, assets managers and institutional customers will be able to purchase high quality research and analyses appropriate to their needs.

A new term OTF, that is, organised trading facilities, is also introduced to the market structure. It is to govern derivative instruments, such as e.g. CFD.

One of the very important changes is the sellers’ remuneration regulation. The previous version of the directive introduced the customers’ obligation to fill in special surveys, which were to describe their investment profile and risk propensity (popular KYC), in order to protect them against an unsuitable investment product. Obviously such a survey was usually a fiction. However, what is worse, in practice financial advisors often earn on commissions from sold products. It leads to the situation, when they induce customers to invest in products from which they receive the largest profits, that is, the most often those of the highest risk rate.

Due to the new directive, brokers cannot share with distributors so-called management fees, that is, the percentage collected for handling customer’s money. This type of rates vary between 1% and 4% of the balance value, whereas, distributors received even 70% of such an amount. Moreover, now regulations guarantee customers’ access to all details regarding fees, commissions and incentives for advisers, intermediaries and distributors of products.

ESMA product intervention

The above changes result directly from the MiFID II.  In order to maximise customers’ protection, by virtue of its rights the ESMA introduced additional product intervention. Therefore, another important fact comprises drastic restriction on the financial leverage in the area of the European jurisdiction with regard to CFD contracts:

  • 30:1 in case of main currency pairs;
  • 20:1 in case of currency pairs other than main pairs, gold and main indexes;
  • 10:1 in case of goods other than gold and stock indexes other than main indexes;
  • 5:1 in case of individual shares and other reference values;
  • 2:1 in case of cryptocurrencies.

It is worth supplementing this information with the fact that higher leverage is still available for professional customers (more information). Moreover, the supreme European regulator introduced a complete ban on selling and distributing binary options to retail customers in the territory of Europe. Another important, from the retail investor’s point of view, issues include restrictions in the scope of incentives to investments and general advertisement of financial instruments – with regard to various types of commissions and other financial and non-financial benefits. New regulations significantly limit marketing possibilities of brokerage houses. It results from the fact that too aggressive activities can incline customers to invest in complex instruments and lead to losing capital as a result of a lack of relevant knowledge.

The MiFID II provisions will provide consequences for all entities engaged in investments in the EU. It also applies to firms outside the EU, which operate in the territory thereof. Nevertheless, many traders decide to use services of brokers outside the ESMA jurisdiction.

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