The Markets in Financial Instruments Directive (Mifid) has been described as one of the most significant changes in the EU financial services regulatory environment.
It is already clear, however, that many European Economic Area (EEA) states will be late in implementing Mifid and that it will be implemented in different ways across Europe. Mifid itself contains a number of options as to precisely how implementing states should give effect to its provisions, some countries have already applied for derogations from the directive and different member states are very likely to interpret the provisions of Mifid differently.
So what happens now with regard to Mifid implementation?
There are a number of directives already applicable to the financial services sector, which seek to integrate further the EU financial services market using the cross-border passport mechanism. Investment firms have previously relied upon the Investment Services Directive (ISD), which is to be replaced by Mifid, under this banks have passporting potential within the Banking Coordination Directive; regulated funds passport on the basis of the various Undertakings for Collective Investment in Transferable Securities directives; and there are a range of insurance directives providing for passports. There is also the Reinsurance Directive and the Insurance Mediation Directive (IMD) was the most recent example in 2005.
Mifid is of particular importance in the context of passporting as it aims to improve the previous passporting regime available for investment firms under the ISD.
Whereas the ISD provided for passporting subject to home state prudential regulation and host state conduct of business regulation in all cases, Mifid distinguishes between a services passport and a branch passport and leaves all regulation in the hands of the home state regulator, except in the case of branch passports where local operational matters are regulated by the host state regulator.
For this purpose Mifid draws a distinction between organisational regulation and operational regulation. The precise difference between ‘organisational’ and ‘operational’ is to some extent open to interpretation, but it is worthy of note that Mifid itself categorises rules applicable to the handling of client assets as organisational rather than operational.
Prior to Mifid, the IMD was Europe’s worst implemented directive. Only a handful of member states met the implementation deadline of 15 January 2005 and it was not until many months (in some cases years) after that deadline that a number of European jurisdictions caught up and complied with their implementation obligations.
It is interesting to note that many consider the main motivational force causing late-implementing states to actually implement the IMD was not the continued threat of enforcement action from the European Commission. Rather it was the entreaties of insurance broking firms within the non-implementing states that eventually managed to persuade their host regulators to implement IMD to enable them to compete on a pan-European basis with insurance broking firms from implementing states who had the benefits of cross-border passports available to them.
The transposition (implementation) deadline for Mifid was 31 January 2007: only the UK met this deadline. The Republic of Ireland fulfilled its transposition obligations belatedly in February and Romania did the same in March. On the 24 April the Commission instigated automatic enforcement procedures against the remaining 24 EU member states for failing to have met the deadline. Those proceedings continue to apply, but a number of misfeasors have now notified the Commission of their implementation legislation and it is being examined by the Commission prior to end October.
At the time of writing, an astonishingly high number (11 in total) of EU member states have yet to notify the Commission of any implementation measures that have been undertaken. Of most significance among those 11 are Spain, Italy and the Netherlands. Indeed it is interesting to note that some jurisdictions have indicated to the Commission that they will not be in a position to implement Mifid until 2009.
It is acknowledged that Mifid implementation within Continental Europe is a significantly more burdensome undertaking than in the UK or even Ireland. The Mifid model is clearly along Anglo-Saxon lines. Nevertheless, it is submitted that a flagrant disregard for implementation obligations is again in evidence.
The Commission has indicated that it intends to take this very seriously, saying: “The Commission will launch immediate infringement procedures – no exceptions.” It adds that Governments could face “law suits from market participants” in their national courts.
It remains to be seen what, if any, heed will be taken of these comments.
The UK Financial Services Authority (FSA) has been faced with a difficult issue when considering how to deal with investment firms operating in the UK through branches with a head office located in a non-implementing state. Although ISD passports are, under Mifid, grandfathered to become Mifid passports (ie, no action is required to give effect to existing ISD passports as Mifid passports), difficult questions have arisen where the relevant investment firm’s home state has failed to implement Mifid by the 1 November 2007 ‘go live’ date.
Simply put: how can one passport on the basis of a Mifid derived regulatory status where Mifid does not exist?The FSA has very recently published notice of its intentions on how to deal with this quandary. It proposes a temporary FSA rule to take effect from 1 November 2007 for a period of 12 months, during which time all incoming investment firms from late-implementing EEA states will be accepted as properly passported into the UK provided they comply with the organisational and operational provisions of Mifid as if it were properly implemented in their home state.
At a stroke the FSA has removed any uncertainty and eased the way for investment firms operating in the UK on the basis of an ISD passport – at least for the next 12 months. The FSA has described this temporary rule as “proportionate and pragmatic solution to a temporary situation”. Indeed, one has to sympathise with the FSA’s approach and it is worth #continuedemphasising that this temporary rule fits very clearly with the FSA’s regulatory objectives (as set out in Section 2 of the Financial Services and Markets Act 2000).
Those regulatory objectives require inter alia that the FSA has regard to maintaining the competitive position of the UK in financial services and that the FSA endeavours to minimise the adverse effects of regulation on competition within the UK. Clearly easing the way for incoming investment firms in this manner appears to fit with those regulatory objectives.
The immediate difficulty that is apparent, however, is that the FSA in adopting this approach has removed one of the major incentives to implementation by those late implementing states. No longer will be they be subject to lobbying pressure from their local investment firms to implement Mifid on the grounds that those investment firms risk suffering competitive disadvantage.
One of the key levers (which proved decisive in the context of the IMD implementation experience) to promote implementation will no longer apply. We are left to rely upon the threat of enforcement proceedings by the EC. Many in the European financial services world have a healthy scepticism for the effectiveness of such enforcement action threats.
Creeping towards a single market
It is already clear that Mifid will not land in Europe with the ‘big bang’ initially anticipated. There will be a protracted implementation period to follow the 1 November ‘go live’ date during which period late implementing states will have the time to get their house in order.
In addition of course, post 1 November we have been told to expect a considerable amount of Mifid guidance from the Committee of European Securities Regulators (CESR). CESR itself has said that it will put much effort into harmonising each member state’s approach to and interpretation of Mifid. It is clearly anticipated that the ‘holy grail’ of a single market can only emerge over time, but with Mifid we have the requisite toolkit.
David Heard is a partner at Reed Smith Richards Butler