FORUM: MiFID II – the impact on investment managers


Financier Worldwide Magazine

December 2016 Issue

December 2016 Issue

FW moderates a discussion on the impact of MiFID II on investment managers between Matthew Baker at Berwin Leighton Paisner LLP, John Adams at Shearman & Sterling LLP and Etienne Deniau at Societe Generale Securities Services.

FW: Could you explain the key drivers behind the introduction of the EU’s MiFID II framework, and the range of entities that fall within its scope?

Baker: The Markets in Financial Instruments Directive 2004/39/EC (MiFID I) was implemented in November 2007 at a time when the markets were already beginning to look very different from how they did when it was first passed into EU legislation. A review had always been scheduled for 2010, by which time the fallout from the global financial crisis was in full swing. The hope of many in the industry was that the MiFID review would focus on areas of technological change such as algorithmic traders and leave investment managers well alone. However, it soon became clear that the EU had much more ambitious plans. In the face of such colourful phrases as dark pools and flash crashes, there was a desire to shine a greater light onto the markets. At its base, MiFID II does not hugely change the scope of regulation, but what it does do is bring in much more regulation to non-equity markets, expand the range of firms that are likely to constitute systematic internalisers (SIs) or multilateral trading facilities (MTFs), and create a whole new concept of organised trading facilities (OTFs).

Adams: MiFID II was originally intended as a response to the global financial crisis, to reflect the lessons learned and the weaknesses identified in some of MiFID’s underlying principles. However, it has in fact led to a far more wide-ranging proposal than necessarily required to achieve these goals. Increased investor protection has been a particular focal point, particularly in light of new technologies, such as an increase in high-frequency and algorithmic trading. MiFID II also revamps the regulation of trading venues, and introduces a third-country equivalence regime, which provides for the provision of financial services within the EU. MiFID II will apply to investment firms, market operators, data reporting services providers and third-country firms providing investment services or performing investment activities through an EU branch. MiFID II will continue to apply directly to EU discretionary portfolio managers, but also extend to UCITS management companies and EU AIFMs that manage separate discretionary accounts.

Deniau: On 20 October 2011, the European Commission published a new regulatory package introducing both a new directive and a new regulation. The first reason for this new regulatory package stems from the negative assessment of MIFID I’s implementation and its failure to achieve its initial objectives, in particular market efficiency and transparency. For instance, new market practices and the development of solutions based on new technologies such as high frequency trading (HFT), have led to liquidity fragmentation, with an increased difficulty regarding following orders on different trading venues creating a potentially less effective process for price discovery. They also induced a lack of transparency with the development of dark pools that are handling half of the OTC trades on equities. These new solutions hampered the implementation of ‘best execution’ due to a non level playing field between regulated markets and other platforms, resulting from a difference in regulatory rules. The second reason is the 2008 financial crisis that has emphasised previous excesses and achieved a context of strong political challenges conducive to strengthening the overall framework. The Directive amends the requirements for providers of investment services regarding authorisation, conduct of business and organisational requirements.

FW: To what extent is MiFID II likely to harmonise the EU’s regulatory approach to non-EU investment managers?

Adams: MiFID II will increase access to the EU market for non-EU investment managers, but provides a ‘patchwork’ solution rather than full harmonisation. Non-EU investment managers will be able to provide portfolio management investment services to professional clients on a third-country equivalence basis, provided that the investment manager is ESMA-registered and the other conditions for such equivalence are satisfied. However, absent such equivalence, EU market access may be impacted by the licensing requirements of individual member states, which take differing views at national levels as to what constitutes a ‘cross-border’ provision of services. To access retail clients, provided the relevant EU member state has chosen not to continue to apply its own national rules, a non-EU firm will need to establish an EU branch that is authorised pursuant to the harmonised procedure set out in MiFID II and will be subject to the MiFID II requirements.

Deniau: It is important to note that investment managers have their own dedicated regulatory framework with AIFMD and UCITS V, particularly since this new version of the directive came into force in 2016, and accordingly they are exempted from MIFID II MIFIR. The third-country regime that applies to non EU asset managers regarding asset management and fund distribution passporting is defined by AIFMD and UCITS V. They are, with some rare and special exemptions, mainly for investment managers that exclusively provide portfolio management services, only concerned with providing investment services – portfolio management, investment advice and RTO – and only by the relevant measures. MIFID II MIFIR defines a harmonised framework that applies to third-party investment companies that intend to provide investment services as defined in the appendices of the directive. It states that a Member State could require these investment companies to set up a local branch in order to provide services to retail clients and possibly professional clients. It may be inferred that these harmonised rules apply to non EU asset managers willing to provide investment services in European Member States. Furthermore, third country firms established in one or several countries in the EU would not benefit from the EU passport.

Baker: MiFID I was already quite a rare beast within EU financial services regulation in that it was a maximum harmonisation measure. This means that Member States have to apply for special dispensation to impose additional rules. Unsurprisingly, perhaps, the UK has the most of these. In theory, therefore, unlike the changes brought about by MAR compared to MAD for example, MiFID II should not change this much. However, MiFID II sees a phenomenal number of Level 2 measures, most of which take the form of regulations rather than directives. This means that MiFID II will be much more prescriptive in how it is applied and measured by different regulators. As with MiFID I, though, the real test is in how different regulators seek to enforce its provisions.

MiFID II will increase access to the EU market for non-EU investment managers, but provides a ‘patchwork’ solution rather than full harmonisation.
— John Adams

FW: Could you outline the main regulatory challenges that investment managers need to plan for under MiFID II? What immediate impact do you expect it to have as fund managers adapt to its obligations?

Baker: Perhaps more than any other sector subject to MiFID, the types of challenges that investment managers face under MiFID II will be very different depending on the nature of the firm in question. Is it also a UCITS manager or AIFM? Do they have retail clients or professionals and ECPs only? Do they undertake their own trading? And do they make use of soft commissions? Some firms will face huge challenges in designing and building IT infrastructure, while for others the main challenge will be in re-papering and recording updated policies and procedures.

Deniau: European asset managers managing AIFs and UCITS benefit from an exemption regarding MIFID II measures except when they provide investment services. It can easily be concluded that the impact of MiFID II will be more moderate. In reality, it is not as simple as it may seem as asset managers will have to cope with indirect impacts, the main issue being derived from the measures regulating product governance, inducements – especially concerning research – and information on costs and charges, which is to be articulated with PRIIPS rules.

Adams: The main regulatory challenges will vary, depending on the focus of the manager’s business. The changes relating to dealing commission and research – which the FCA currently plans to extend to all UCITS management companies and AIFMs – are a particular challenge. MiFID II has built on the previous best execution requirements by imposing further transparency obligations on investment managers. It requires managers to publish the execution venues, and the factors used to choose them, for financial instruments they trade for managed portfolios. This information is currently treated as confidential, as it outlines the commercial relationship with execution brokers, conflicts of interest and fee arrangements with the execution venue. Fund managers will also need to plan for compliance with post-trade transparency requirements and increased transaction reporting obligations given the significant increase in the scope of transactions subject to reporting obligations. Managers will need to determine the best way to report in order to be comfortable that correct and sufficiently detailed information is reported.

FW: In your opinion, what steps should investment managers take in the run-up to the MiFID II implementation deadline? What are the potential consequences of non-compliance?

Deniau: There are business and operational impacts. The investment manager’s business model may be impacted by the inducement ban. A decision is yet to be made over whether the investment manager will provide independent advice. As a manufacturer of products, investment managers should define and maintain for each product the target market and their distribution strategy. This information shall be used and followed, although some deviance may be admitted for diversification purposes, by any investment firm when distributing these products. The latter is also expected to provide feedback to the manufacturer on how and to whom the product has been distributed. It should be noted that the new rules apply to all the products should they be complex or not. Finally, in some cases a manufacturer may not be submitted to MiFID II requirements, for example, a collective undertakings manager which provides no investment services. In such instances it is the responsibility of the distributor to define the target market. ESMA is currently consulting on product governance to prepare future guidelines. Regarding costs and charges, MiFID II imposes ex ante information, and in most cases ex post information. Both concern, at least, investment services – including ancillary ones – and can be extended to product costs and charges. This issue has not yet been addressed in detail and there are still several unanswered questions.

Adams: Firms should be taking efficient prioritised steps to achieve compliance in the run up to 3 January 2018. Investment managers will need to be particularly wary of the technological issues associated with monitoring modern-day investment management activities under MiFID II. Fund managers will need to establish methods for compiling distribution data and ‘know your client’ due diligence information. Issues might arise for managers during the collation of information in preparation for reporting if they have failed to create their own processes for delivery, file formatting and systems for naming. Failure to comply with MiFID II will impact the ability of fund managers to do business, and could also damage their regulatory and business reputation. In the UK, depending on the nature and scale of the compliance breach, the FCA has powers to impose monetary penalties on individuals and firms, as well as administrative sanctions such as revoking or placing conditions on their regulatory permissions.

Baker: The ways in which MiFID II will impact firms will vary considerably between firms, but also across different areas within firms. To help prepare, investment managers should carefully chart all the ways in which the business will be impacted. To do this, they should look up, down and sideways to check all possible impacts. A particular area for investment managers to think about is how MiFID II will impact their other regulated service providers such as distributors, brokers, dealers, custodians and prime brokers. Early engagement to see what they are planning on doing is likely to be crucial so that you can ensure that the changes that you are building in are compatible with theirs. Another huge area for investment managers – at least, for ones that are not used to dealing with retail customers in UCITS or similar funds – is likely to be the product governance requirements. The effort to meet these duties should not be underestimated. The primary consequence of non-compliance is that regulators can, and increasingly are, taking action against the firm, and even senior individuals within the firm. For MiFID I, the FSA was relatively sympathetic with firms that were unable to be fully compliant in time. The message from the FCA this time round is already very different.

As a manufacturer of products, investment managers should define and maintain for each product the target market and their distribution strategy.
— Etienne Deniau

FW: To what extent are investment managers grappling with the cost, complexity and risk management obligations of MiFID II?

Adams: Most large fund managers have been proactive in managing their obligations. However, smaller funds with fewer resources may be pressed to grapple with the added compliance costs. We have already seen the investment management sector react with increases both in compliance and in-house legal hires. One area of particular concern is the changes in relation to dealing commission and investment research. Effectively, the new rules require unbundling, or separation, of research costs from execution fees. Using Commission Sharing Agreements (CSAs) is clearly going to be more difficult, and perhaps more expensive, although these problems are not insurmountable.

Baker: Firms are likely to be struggling here. For firms that need to be investing in systems, for example, because they will become SIs, or for the enhanced transaction reporting requirements, there is a huge potential cost. Even for other firms that are ‘simply’ facing a compliance and re-papering cost, this is likely to be significant. Firms are also inevitably battling with regulatory fatigue having already battled through AIFMD, UCITS V and other similar implementation projects. All of which are likely to have an impact on budgets within firms.

Deniau: The main investment companies have been involved in following the legislative and regulatory work for many years in order to understand and influence the objectives and content of the texts. Discussions with regulators are still ongoing. They are consequently aware of the complexity of the regulatory package and conscious of the level of impact it may have on their organisation and resources in relation to the services they provide or intend to provide. Smaller players have perhaps been less involved in the process and have discovered the issues more recently. However, even with the one year postponement of the directive and the support from local regulators, professional associations and securities services providers, who are proactive in communicating information and accompanying investment managers to assess the burden of compliance, it will be a real challenge for the market to meet the deadline because the detailed levels of the Directive have not be made official yet.

FW: With MIFID II being one of several changes being made to Europe’s financial regulatory regime – alongside EMIR, Basel III and others – what advice can you offer to investment funds on managing the interconnectivity of regulations?

Deniau: The overall context of compliance has dramatically changed since the financial crisis. The moves are of a different nature, numerous, individually complex to understand and assess and are often interconnected. In addition, the rhythm of change and cost for adapting are increasing. It is of the utmost importance for each player to try and ensure that they monitor these changes in order to adapt and to seize any possible opportunities. To do so is very demanding in terms of availability and resources. Not all players, individually, have the time and resources to do so. That is why it is critical for them, and particularly for small and mid-size players, to collaborate with their peers and with professional associations, exchange ideas with regulators and to partner with their main providers.

Baker: It is definitely true to say that there are a lot of competing pressures on compliance and project team’s budgets and time. The risk is that too many workstreams are being undertaken on a siloed basis and changes that are fine for one set of requirements may contradict work being done on another project. As such, a good project management team is invaluable. At a more fundamental level, getting senior management buy-in can also make or break a project of this type. Providing sufficient training on the likely issues to people working in the individual business teams will also help to ensure that the project is properly embedded, and also that practical issues are noted – and resolved – at an early stage.

Adams: MiFID II should not be viewed in isolation; it operates within the broader context of current and future regulatory reforms within the EU and worldwide. We often see firms take a proactive approach in managing their business objectives with the aim of factoring in key regulatory considerations. The issue of interconnectivity of regulatory reforms is not a new phenomenon. In this context, investment managers need to have good informative resources and expert guidance to effectively monitor regulatory developments while being able to efficiently update their systems and processes. Many of our clients with operations that span multiple jurisdictions must be vigilant, including getting to grips with duplicative, overlapping and sometimes seemingly contradictory requirements, gaps and inconsistencies.

Firms are also inevitably battling with regulatory fatigue having already battled through AIFMD, UCITS V and other similar implementation projects.
— Matthew Baker

FW: With MiFID II scheduled to take effect from 3 January 2018 – a year later than originally intended – what challenges face investment funds over coming months as implementation approaches?

Baker: A particular challenge will be in getting the business to focus on MiFID II. There are many other demands on their time, including PRIIPS, the likely extension of the senior managers’ regime to investment firms and the bedding down of UCITS V and AIFMD. Plus, of course, there may be a natural reticence to put too much effort into EU compliance projects prior to seeing a clear path on Brexit. On this, the FCA is being very clear that it expects firms to be working toward full compliance irrespective of those negotiations. Based on our experience, many of the difficulties in this type of legislation only become truly apparent once you start applying it to the business.

Adams: The delay in implementation is helpful, although inevitable given how close we are now to the original implementation date. The process is complex and firms will need to be proactive in order to comply in time. Any firm that has not yet considered, in some detail, how MiFID II will affect its business should be doing so now. Then there is the Brexit overlay, which of course adds a layer of complexity in terms of planning. The MiFID II implementation date will be before the end of any formal exit negotiation period between the UK government and the EU. The FCA has made it clear that UK firms should be preparing for MiFID II implementation as normal, and we have certainly seen firms proceeding on that basis, as it seems likely that, whatever the final outcome of the Brexit negotiations, the requirements in MiFID II will apply to firms for some time.

Deniau: The most important challenge for asset managers is to assess the impacts of the regulatory framework regarding their status and organisation, the investment services they provide and the relationships they may have with other players, especially distributors and brokers. They should also have a close look at PRIIPs, whose impacts should not be disregarded.


Matthew Baker is a partner in the financial services department of Berwin Leighton Paisner LLP where he advises a wide range of banks and financial institutions on regulatory and commercial issues that arise within their businesses. He also advises on matters relating to: interpretation of UK rules and regulatory requirements; negotiating and developing new business opportunities; establishing and structuring new business operations in the United Kingdom; compliance matters; and asset management and custody arrangements, among others. He can be contacted on +44 (0)20 3400 4902 or by email:

John Adams is a partner in the UK investment funds practice. He advises on the formation, promotion and operation of all types of private and retail investment funds (including hedge, private equity, infrastructure and UCITS funds), and the drafting and negotiation of associated documentation. Mr Adams also advises sovereign wealth funds and institutional investors in connection with their acquisitions, and disposals, of investments in private investment funds.

He can be contacted on +44 (0)20 7655 5740 or by email:

Etienne Deniau has over 25 years experience in the securities and derivatives servicing industry supporting asset managers, institutional investors and financial intermediaries worldwide. Mr Deniau began his career at Societe Generale in 1990 and has held various management positions in Tokyo, London and Paris since then. He can be contacted on +33 1 5898 7026 or by email:

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