MiFID II/PRIIPs

Directive 2014/65/EU of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II) entered into force on 3 January 2018. It amended the European Markets in Financial Instruments Directive that was applicable from 2007 (Directive 2004/39/EC of 21 April 2004 on markets in financial instruments). MiFID II also entailed the introduction of Regulation (EU) No 600/2014 of 15 May 2014 on markets in financial instruments (MiFIR) as well as several delegating acts.

Following up on the financial crisis of the late 2000’s, the purpose of this new set of legislation was to put in place a more transparent financial market at European level. It targeted issues identified with regard to the functioning and transparency of the financial markets and the provision of better protection to financial consumers. The mentioned concerns resulted in the revision of the regulatory framework for investment firms and trading venues.

The notion of “financial instruments” is essential to the implementation of MiFID II as it determines its material scope. MiFID II rules cover not only dealing with equities/shares but also, for instance, derivatives or bonds.

With regard to the financial consumer protection under MiFID II, the directive establishes obligations for professionals in order to guarantee that they act in the best interest of their clients, notably by:

• regulating governance and issuing detailed organisational requirements for professionals;
• strengthening conduct of business rules;
• enabling national and European supervisors to monitor compliance with the MiFID II framework and issue delegated acts that complete, clarify or explain the rules and regulations.

In addition, MiFIR empowers national competent authorities (such as the CSSF) to prohibit or restrict the marketing, distribution and sale of financial instruments when necessary (by taking into consideration high risks that may be linked to the financial instruments at stake or the inability for some clients to understand the said risks).

MiFID II ensures that professionals act in the best interest of their clients by, inter alia, imposing extensive information obligations. Such information cover notably the costs of the provided investment service and the impact of the aforementioned costs on the investment yield.

Another issue that was taken into consideration under MiFID II is the independence of investment advice. Investment services providers must inform their clients on whether or not their service is provided on an independent basis.

MiFID II rules also cover the supervision of the remuneration of staff policies as well as the detection and monitoring of conflicts of interests.

For the same purposes, the directive also contains strict rules on accepting inducements from third parties.

In summary, the rules on inducements now expressly prohibit the reception and retention of inducements:

• when investment advice is said to be provided to the client “independently”; and
• when the service provided is portfolio management.

For other services, the reception of inducements is only allowed provided the following cumulative conditions are met:

• the payments or benefits improve the quality of the service;
• the reception of inducements they do not affect the respect of the provider’s obligation to act in an honest, fair and professional manner in the best interests of its clients;
• the customer is clearly informed of the existence, nature, amount or method of calculation of the inducement(s) before the provision of the service.

In addition to the above, the MiFID II framework:

• harmonises professional competence requirements for employees of investment firms making sure that there are internal policies and procedures in place to ensure that staff members understand the nature and features of the financial products they offer and select for their clients;
• obliges professionals to assess whether alternatives would better meet their clients’ objectives;
• requires firms to assess whether their clients have the required experience and knowledge in order to understand the product they wish to purchase (the ‘appropriateness test’)

For transparency purposes, investment firms must publish annually per category of financial instrument and per type of client the top 5 venues for execution (i.e. this obligation is intended to enable the public and investors to evaluate the quality of a firm’s execution practices by requiring publication of valuable information about how and where the firm has executed client orders) of client orders and/or the top 5 investment firms to whom orders are transmitted.

Product issuers have to specify the target market (i.e. the clients for which the product has been manufactured). In doing so, criteria such as clients’ knowledge and experience, financial situation, risk-bearing capacity, risk tolerance, investment objectives and needs must be taken into consideration by the product issuer/manufacturer.

The client must receive a statement on suitability before entering into a transaction that he has been advised on. Some exceptions to the delivery of this suitability statement exist.

Similarly, acting in the best interest of the client requires that the chosen execution venue offers the highest probability of the best possible result for the client.
Firms must have in place execution policies that are clear, sufficiently detailed and written in an understandable manner for the client. The effectiveness of the execution policies must be monitored on an ongoing basis and the policy has to be adequately adjusted if needed.

The relationship with the client must also be carefully documented: the firm must be in a position to prove that and how its actions respect the best interest of its clients. This documentation implies, inter alia, recording of external and internal electronic communication and telephone conversations relating to client orders. Clients must be informed of this in advance and may object to the recording of conversations. The records must be kept for a period of five years.

When a professional advices you or sells you an investment where the amount repayable to you is subject to fluctuations because of exposure to reference values or to the performance of one or more assets which you do not directly purchase (like structured securities or derivatives), this professional should provide you with a key information document (a KID) in good time before you are bound by any contract or offer relating to this investment.

These kinds of investments called “packaged retail and insurance-based investment products” (or PRIIPs) are regulated by Regulation (EU) N° 1286/2014 of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs) which is applicable since 1 January 2018.

Moreover, please note that before a PRIIP is made available to retail investors, the PRIIP manufacturer shall draw up for that product a KID and shall publish the document on its website.

The KID shall be drawn up as a short document written in a concise manner and of a maximum of three sides of A4-sized paper when printed.

The KID shall contain different sections and in particular the following sections:

• a section titled “What is this product?”;
• a section titled “What are the risks and what could I get in return?”;
• a section titled “What happens if [the name of the PRIIP manufacturer] is unable to pay out?”;
• a section titled “What are the costs?”;
• a section titled “How long should I hold it and can I take money out early?”; and
• a section titled “‘How can I complain?”.