MiFID
A Practical Guide to MiFID Compliance
How Advent can help investment management firms
Clare Vincent-Silk
June 2007

...
MiFID
How Advent can help investment management firms


Contents


1.0   Introduction 1

2.0   What is MiFID? 2

3.0   Who...
1.0 Introduction

         The EU requires all investment firms to be compliant with the Markets in Financial Instruments
...
2.0 What is MiFID?

         MiFID comes into force on 1 November 2007. It will significantly change the financial service...
3.0 Who is impacted?

         All investment firms established in the EEA that provide investment services or activities ...
Companies who fall outside the scope of MiFID include:
                 Insurance undertakings (including reinsurers).
   ...
4.0 Which financial instruments are covered
    by MiFID?

         MiFID applies only in relation to a specified list of ...
5.0 How will MiFID impact investment
    management companies?

         MiFID impacts an investment management company at...
The compliance capability can be used to stop trading for clients that have not yet approved
            the execution pol...
5.4 Marketing
            Check that marketing material is compliant; rework material, including fund fact sheets, if
    ...
5.6 Outsourcing
            Review all operations and middle office outsourcing arrangements; introduce extra controls
   ...
Contacts
          Advent Software
          One Bedford Avenue
          London WC1B 3AU
          England
          Tele...
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MiFID A Practical Guide to MiFID Compliance How Advent can ...

  1. 1. MiFID A Practical Guide to MiFID Compliance How Advent can help investment management firms Clare Vincent-Silk June 2007 Our experience Your success
  2. 2. MiFID How Advent can help investment management firms Contents 1.0 Introduction 1 2.0 What is MiFID? 2 3.0 Who is impacted? 3 4.0 Which financial instruments are covered by MiFID? 5 5.0 How will MiFID impact investment management companies? 6 This report has been prepared on behalf of Advent by Clare Vincent-Silk, Senior Consultant at Investit, the specialist investment management consultancy. www.investit.com.
  3. 3. 1.0 Introduction The EU requires all investment firms to be compliant with the Markets in Financial Instruments Directive (MiFID) by 1 November 2007. Advent recognises that many of their clients are still working through complex MiFID projects and that the deadline is fast approaching. With this in mind, Advent asked Investit to put this document together to help Advent clients understand the impact that MiFID will have on their businesses. In particular, Investit point out how Advent’s Moxy (trade order management system) and APX (portfolio management and client relationship management) applications can be used to help investment management firms meet MiFID requirements. Why Investit? Investit is a specialist investment management company that has completed more than 20 buy-side MiFID engagements. page 1 © Investit
  4. 4. 2.0 What is MiFID? MiFID comes into force on 1 November 2007. It will significantly change the financial services regulations throughout the EEA, how organisations operate their business and the way they interact with their clients. MiFID is intended to deliver the following: Improved competition between trading venues by recognising new types of trading venue and removing barriers to investment firms connecting with trading venues in other states. Increased transparency on equities markets. Appropriate levels of protection for investors and consumers of investment services across Europe covering the whole spectrum of investment services from the provision of advice through to execution of orders. Increased disclosure to the retail investor including greater transparency on charges and fees. 2.1 Background The Markets in Financial Instruments Directive (MiFID) is a major part of the European Union’s Financial Services Action Plan (FSAP). The plan is designed to create a single European market in financial services and to harmonise regulations for all European Economic Area (EEA) firms as well as foreign firms operating inside the EEA. It covers investment services and financial markets. MiFID replaces the Investment Services Directive (ISD). The ISD introduced the concept of a ‘’European Passport’’ which would allow firms to carry out a wide range of investment business across member states, open up membership of exchanges in other member states and reduce local regulatory barriers. However, the ISD allowed each country to have its own conduct of business rules, making it complex to comply with multiple rules and to open offices and sell products in different European countries. MiFID will harmonise the conduct of business rules across Europe. page 2 © Investit
  5. 5. 3.0 Who is impacted? All investment firms established in the EEA that provide investment services or activities to others on a professional basis in relation to MiFID financial instruments will be impacted. MiFID distinguishes between investment services and activities and ancillary services: A firm that performs only ‘ancillary services’ is not a MiFID firm, does not have to comply with MiFID and cannot benefit from the MiFID passport in respect of those activities; A firm which carries on investment services and activities as well as ‘ancillary services’ is subject to MiFID in respect of all those activities and therefore can benefit under the MiFID passport regime. It will however be competing in the ancillary services market against firms which do not have to be MiFID compliant. These definitions are from Annex 1 Section A and B of the Level 1 MiFID documentation: Investment services and activities Reception and transmission of orders in relation to one or more financial instruments. Execution of orders on behalf of clients. Dealing on own account. Portfolio management. Investment advice. Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis. Placing of financial instruments without a firm commitment basis. Operation of multilateral trading facilities (MTFs). Ancillary services Safekeeping and administration of financial instruments, including custody and related services. Granting credits or loans to an investor to allow him to carry out a transaction in one or more financial instruments, where the firm doing so is involved in the transaction. Advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to mergers and the purchase of undertakings. Foreign exchange services connected with the provision of investment services. Investment research and financial analysis. Underwriting services. Investment services and activities related to the underlying of the derivatives, where these are connected to the provision of investment or ancillary services. page 3 © Investit
  6. 6. Companies who fall outside the scope of MiFID include: Insurance undertakings (including reinsurers). Investment services provided purely for intra-group activities. Persons who provide investment services only on an incidental basis in the course of a professional activity, which is already regulated in its own right. Administrators of employee-participation schemes. Central banks and similar bodies. Collective investment undertakings and pension funds and the depositaries or managers of such undertakings. This is because they are subject other rules. In areas where investment managers are not directly impacted by some of the articles there are potential indirect implications as the diagram below illustrates. It is important to read MiFID from the point of view of both a client and a supplier. MiFID scope – business relationships Trading Venues manage your Market Data Services Brokers execution quality revise contracts fragmentation Transaction Investment Service Providers Reporting Management - Administrators, ensure this Enterprise revise Prime Brokers etc is done contracts revise contracts Clients: Institutions Intermediaries Investors page 4 © Investit
  7. 7. 4.0 Which financial instruments are covered by MiFID? MiFID applies only in relation to a specified list of financial instruments. When dealing with these instruments the whole range of MiFID rules apply apart from those for market transparency, which only apply to equities. The list is defined in Annex I Section C of the Level 1 documentation. Broadly speaking it covers all market-traded instruments and their derivatives. Transferable securities. Money-market instruments. Units in collective investment undertakings. Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash. Options, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event). Options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and/or a multilateral trading facility (MTF). Options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in C.6 (previous bullet) and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls. Derivative instruments for the transfer of credit risk. Financial contracts for differences. Options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event), as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to regular margin calls. Instruments out of scope of MiFID are: FX transactions with settlement less than T+5. Cash. Commodities not traded for investment purposes. Property. page 5 © Investit
  8. 8. 5.0 How will MiFID impact investment management companies? MiFID impacts an investment management company at two distinct levels: It will involve changes to policy, business processes and technology to become MiFID compliant. It will result in a rethink of current business models both from a strategic and operational perspective. MiFID is not just about changing systems to comply with the new regulations. It introduces: New pre and post trade transparency requirements for equity markets, which will generate new liquidity opportunities for the buy-side and potentially reduce transaction fees. Rules on how regulated markets and Multilateral Trading Facilities (MTFs) will operate which has a knock-on impact for the buy-side, which now has more execution venues from which to choose. New regime for ‘systematic internalisers’ of retail order flow in liquid equities, which will potentially change the relationship between brokers and the buy-side. More extensive transaction reporting requirements. More specific requirements for managing conflicts of interest and for managing best execution. Redefined client classifications, with more protection given to the new category of ‘retail’ client. More interactive relationships with clients, providing more transparency on fees and greater investor protection. Much more definite requirements for the management of outsourcing relationships. The following checklist shows the key MiFID impacts that would be expected in an investment management company. 5.1 Compliance Review reports which go to senior management on compliance, risk and internal audit. Ensure that the conflicts of interest policy is adequate. Ensure that the personal transactions policy is appropriate. Agree activities which count as an ‘inducement’ (gifts, entertainment etc) and put in place the processes to report these to clients and show how they enhance the quality of service. How Advent can help Moxy provides a pre-trade compliance checking capability that will help the firm follow each client’s investment objectives. page 6 © Investit
  9. 9. The compliance capability can be used to stop trading for clients that have not yet approved the execution policy. The compliance capability can also be used to prevent dealing with brokers with which a firm has not yet agreed a terms of business. Restrictions can be created to prevent staff dealing. These restrictions can be lifted once dealing has been authorized. APX has a commission management enquiry and reporting capability. This includes a report that breaks commission down into execution and research as required by PS05/9. 5.2 Operational risk management Make sure that business continuity plans have been tested, rather than just IT disaster recovery. Make sure that where risks are identified, tolerable risk levels have been actively defined and are being monitored. 5.3 Client management Check each client’s classification. Expand know your client (KYC) information for both retail and professional clients to be able to conduct suitability and appropriateness tests where necessary. Review client classifications and send out notifications where required. Rework client agreements. Include statement about aggregating orders. Include statement about inducements (gifts/entertainment), and if required define a policy for reporting these on an ongoing basis. Include statement about inducements (dealing commission and broker services), and if required define a policy for reporting these on an ongoing basis. If financial instruments are to be used for ‘securities financing transactions’, get consent from clients. Include client agreement to receive material via the web, if required. Create reports that can be given to the client on valuation, benchmark, delegation, etc (see ‘client agreements’ section). How Advent can help APX provides a client relationship management system that allows the storage of 100 data items on a client. APX can provide links to scanned Investment Management Agreements (IMA). It is also possible to set up IMA standard templates and to then create the IMA directly from APX. APX has the ability to produce client reports that can be produced on an ad-hoc basis or set up to run at set intervals. A client distribution pack can be created which lists the contents of the report, who it should be sent to and how frequently so each client can have their own report structure. Reports can be produced in html format and made available to clients over the Internet. page 7 © Investit
  10. 10. 5.4 Marketing Check that marketing material is compliant; rework material, including fund fact sheets, if necessary. 5.5 Dealing Rewrite broker agreements. Put in place an order allocation policy. Create a best execution policy, and put in place a method for reviewing it at least annually. Create a method for monitoring and reporting on conflicts of interest when dealing. Ensure that broker relationships are fully documented and that (if required) the firm is given Professional client categorisation by the broker. Ensure that the responsibility for trade and transaction reporting is clearly agreed in the broker agreement. Make commission costs visible to dealers, either when selecting venues or as an overall guideline. Where appropriate, extend the range of venues used to get best execution. Create method for evidencing best execution for non-quoted instruments. How Advent can help Moxy records orders and executions. It has the ability to allocate orders using different allocation methods in line with an order allocation policy, including pro-rata and manually adjusted allocation overrides. Personal staff transactions can be removed from a client block order if necessary. Moxy supports the order management and trade execution of equities, fixed income, OTC and exchange traded derivatives and treasury functionality. Moxy uses the SolutionForge FIX engine to provide automated connectivity to brokers. 11 broker algorithmic and direct market access (DMA) applications have been embedded into Moxy. Moxy has a broker commission calculator that adds commission costs to the trade details. This allows a user to set up different commission rates for different brokers and asset types. It is possible to store client-specific instructions against an order. Both Moxy and APX have audit trail capability. There is date and time stamping for the creation, approval, placement and allocation of the order. It is possible to fully reconstitute the lifecycle of an order in-line with MiFID requirements. If an investment management firm would like additional data records recorded, there are a number of user-definable fields available. page 8 © Investit
  11. 11. 5.6 Outsourcing Review all operations and middle office outsourcing arrangements; introduce extra controls and monitoring as appropriate. You may need to add in personal account (PA) dealing and conflicts of interest management. 5.7 Safeguarding of client assets Ensure accurate records and accounts are kept that can clearly identify what belongs to the client. Reconcile records against the custodian records. Third party records where client funds are deposited should be able to be identified separately. Where the firm selects a custodian, make sure that the requirements for custodian selection are followed. How Advent can help APX is a portfolio management application that provides shadow accounting and reporting functionality. APX has automated electronic interfaces that can be used to reconcile trade information, settlement data, transactions and positions with brokerage firms and custodians. APX will update each client’s portfolios for any relevant corporate actions that occur. APX provides stock lending activity including collateral management. Moxy has an interface capability into confirmation systems such as Thomson Oasys that will be used to confirm transactions and allocations with the broker. Transactions are only passed to APX after they have been successfully confirmed with the broker. 5.8 Investments Review all investment outsourcing arrangements and introduce extra controls and monitoring as appropriate. You may need to add in PA dealing and conflicts of interest management. Create a policy for managing inducements (commission and broker services). 5.9 IT Review all business-critical IT outsourcing arrangements; introduce extra controls and monitoring as appropriate. May need to add in PA dealing and conflicts of interest management. Make sure that all client-related records are kept for the lifetime of the client and for at least five years afterwards. Make sure that all stages of dealing transactions, including changes, can be reconstructed from the systems (this may be a manual process). page 9 © Investit
  12. 12. Contacts Advent Software One Bedford Avenue London WC1B 3AU England Telephone: +44 20 7631 9240 Contact: Paul Watthey, Marketing Director, Advent Software EMEA Email: paul.watthey@advent.com Web: www.advent.com Investit 11 Austin Friars London EC2N 2HG England Telephone: +44 20 7920 9000 Contact: Clare Vincent-Silk, Senior Consultant, Intelligence and Technology, Investit Email: clare.vincent-silk@investit.com Web: www.investit.com page 10 © Investit

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