UK: Miffed About MiFID?

Last Updated: 12 November 2007
Article by Clifford Sims

Readers will recall that in our last issue of Insight we featured an article written by David Viana of PIMCO on the impending introduction of the Markets in Financial Instruments Directive (MiFID), which comes into force on 1 November 2007. With the introduction of the Directive, all customers of authorised investment managers and investment advisers should have received communications asking them to agree to vary their customer agreements in order to make them MiFID compliant.

The key issues on which decisions need to be taken are as follows.

Customer Classification

MiFID changes the existing customer classification under which most trustees and other institutions such as local authorities are currently categorised as "intermediate customers" and instead places an obligation on the authorised firm to determine whether a client in question should be categorised as a "retail client" or a "professional client". There is a separate category of "eligible counterparties", who are in essence authorised persons in their own right.

The reason that this matters is that different categories of client are entitled to different levels of "protection". Also, the authorised firm in question must allow a professional client or an eligible counterparty to request re-categorisation as a client which benefits from a higher degree of protection, ie a retail client or a professional client respectively. In practical terms, what is such "protection" worth?

There are two levels of protection which need to be considered: greater disclosure requirements in relation to particular types of financial instruments and, potentially, access to the Financial Services Compensation Scheme (FSCS), which operates in the event of insolvency of an authorised firm. The FSCS does provide some greater protection for eligible claimants, although the limits of compensation for financial instruments which are not life policies (as recently highlighted in the turmoil caused by Northern Rock) means that access to the FSCS is of very limited value. In any event, trustees of an occupational scheme whose employer is classified as a "large company" (broadly, a company which satisfies at least two of the following conditions: a balance sheet in excess of £11.4 million, a turnover of more than £22.8 million and more than 250 employees) are excluded from the operation of the FSCS and are not eligible for any claims other than in respect of long term insurance contracts.

As many trustees will have already found out, if they have been tempted to exercise their rights to ask to be re-categorised as retail clients, the vast majority of investment managers are reluctant to agree to treat them as retail clients, for the following reasons.

Best Execution And Conflicts Of Interest

MiFID codifies, for the first time under UK financial services legislation, how "best execution" can be demonstrated by an authorised firm. It also requires authorised firms to have a policy which must be supplied to customers on the way in which best execution is to be achieved and further requires that customers must consent to that policy. It would be tempting to think that "best execution" should be an absolute concept which means the same thing regardless of customer categorisation, but life is not so simple. MiFID requires authorised firms to take into account different criteria and methods of achieving best execution depending on whether the client is a retail or other category.

Separate to the issue of consideration of these factors is the facility to execute orders outside of a "Regulated Market" or a "Multilateral Trading Facility". Consent to an authorised firm using such venues must be given in writing and cannot be deemed by reference to conduct regardless of the status of the client.

In practice this means that investment managers will ask their professional clients to give such consents in order to achieve what they believe is best execution. They will not want to be constrained by the factors which govern best execution for retail clients and accordingly may threaten (justifiably) to cease to act for professional clients who insist on opting for the higher level of protection of retail client status.

One other practical consequence of MiFID which clients should be aware of is that they should receive from their authorised investment managers a formal conflicts of interest policy. In the past, it was sufficient for firms to disclose generic types of conflicts of interest which might arise in the course of business. Now authorised firms have to review their own procedures and disclose to all clients how they will deal with actual conflicts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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