MiFID II

What Is MiFID II?

MiFID II is a legislative framework instituted by the European Union (EU) to regulate financial markets in the bloc and improve protections for investors. Its aim is to standardize practices across the EU and restore confidence in the industry, especially after the 2008 financial crisis.

Understanding MiFID II

A revised version of the original MiFID, MiFID II rolled out on Jan. 3, 2018, more than six years after the European Commission, the EU's executive branch, adopted a legislative proposal for it. Technically, MiFID II applies to the legislative framework, and the rules it outlines are actually the Markets in Financial Instruments Regulation (MiFIR); but colloquially, the term MiFID is used to mean both.

The original Markets In Financial Instruments Directive (MiFID) went into effect in November 2007. The onset of the subsequent global financial crisis exposed some weaknesses in its provisions. It focused too narrowly on stocks (ignoring fixed-income vehicles, derivatives, currencies, and other assets) and did not address dealings with firms or products outside the EU, leaving the rules about those to be decided by individual members.

MiFID II harmonizes the application of oversight among member nations and broadens the scope of the regulations. In particular, it imposes more reporting requirements and tests in order to increase transparency and reduce the use of dark pools (private financial exchanges that allow investors to trade without revealing their identities) and over-the-counter (OTC) trading. Under the new rules, the trading volume of a stock in a dark pool is limited to 8% over 12 months. The new regulations also target high-frequency trading. Algorithms used for automated trading have to be registered, tested, and have circuit breakers included.

MiFID II extends the scope of requirements under MiFID to more financial instruments. Equities, commodities, debt instruments, futures and options, exchange-traded funds, and currencies all fall under its purview. If a product is available in an EU nation, it is covered by MiFID II — even if, say, the trader wishing to buy it is located outside the EU.

MiFID II not only covers virtually all aspects of financial investment and trading but also covers virtually all financial professionals within the EU. Bankers, traders, fund managers, exchange officials, and brokers — and their firms — all have to abide by its regulations. So do institutional and retail investors.

MiFID II places restrictions on inducements paid to investment firms or financial advisors by any third party in relation to services provided to clients. Banks and brokerages can no longer charge for research and transactions in a single bundle, forcing a clearer sense of the cost of each, and possibly improving the quality of research available to investors. Brokers have to provide more detailed reporting on their trades — 50 more pieces of data, in fact — including price and volume information. They also have to store all communications, including phone conversations. Electronic trading is encouraged since it is easier to record and track.

Who Does MiFID II Affect?

MiFID II is a legislative framework instituted by the European Union (EU) to regulate financial markets in the bloc and improve protections for investors. It not only covers virtually all aspects of financial investment and trading but also covers virtually all financial professionals within the EU. Bankers, traders, fund managers, exchange officials, and brokers — and their firms — all have to abide by its regulations as must institutional and retail investors. In particular, it reduces the use of dark pools and over-the-counter (OTC) trading. 

What Does MiFID II Do?

MiFID II places restrictions on inducements paid to investment firms or financial advisors by any third party in relation to services provided to clients. Banks and brokerages will no longer be able to charge for research and transactions in a single bundle, forcing a clearer sense of the cost of each, and possibly improving the quality of research available to investors. Brokers will have to provide more detailed reporting on their trades — 50 more pieces of data, in fact — including price and volume information. They will have to store all communications, including phone conversations; electronic trading is encouraged since it is easier to record and track.

What Is a Dark Pool?

Dark pools are private asset exchanges designed to provide additional liquidity and anonymity for trading large blocks of securities away from the public eye. They provide pricing and cost advantages to buy-side institutions such as mutual funds, and pension funds, which claim that these benefits ultimately accrue to the retail investors who invest in these funds. However, dark pools’ lack of transparency makes them susceptible to conflicts of interest by their owners and predatory trading practices by HFT firms.