MiFID aims to synchronize regulations across Europe

LONDON — The Markets in Financial Instruments Directive — new regulations that could significantly affect U.S. financial services institutions — promises to level the asset management playing field in Europe while raising the bar on accountability to investors.

The broad objective of MiFID is to create a single financial services market within the 25 European Union members states along with Norway, Iceland and Liechtenstein, by introducing higher levels of compliance regulating three areas:

• Conduct of business, which introduces a classification system for all clients along with investment suitability assessments, commission disclosure and other transactional information requirements.

• Market activities, which involves best execution, pre- and post-trading reporting, and allocation policies.

• Organizational standards, which governs senior management responsibilities, internal audits, and compliance and risk functions.

Set to take effect November 2007, the aim is to synchronize regulations in order to make it easier for investment banks, brokers and asset managers to operate across Europe, said Catherine Doherty, London-based principal at Investit Ltd, a consultant for fund managers.

"Theoretically, at least, it opens up the market," Ms. Doherty said.

But extending way beyond Europe's borders, the new rules affect "anybody who's licensed to act on behalf of investors" in Europe, including U.S. money managers, said Chris Pickles, chairman of the MiFID Joint Working Group, and manager of industry relations for network provider BT Radianz, London. The working group was established to help businesses to better understand the impact of the new directive.

One of the biggest impacts of MiFID is that it will shift more power to consumers, he said.

"Basically, you need to understand the investment approach that's appropriate for clients; it goes beyond simply just knowing your client," Mr. Pickles said. "You need to demonstrate the appropriateness and suitability of a particular transaction for each client at a particular point in time."

Clients will be classified three ways: retail, professional and eligible counterparty. However some pension funds and other institutional investors may qualify as a retail investor unless they opt to be considered a professional client. The categories determine the level of investor protection to which a particular client is entitled.

For U.S. managers operating in Europe, MiFID could affect the way the way a firm conducts business globally, said David Viana, London-based vice president and risk and compliance manager of Pacific Investment Management Co. LLC, Newport Beach, Calif. PIMCO managed $600 billion worldwide as of June 30, of which $273 billion is in Europe.

"It is conceivable that a client who's contracted with us here in the U.K. will have money managed out of Newport Beach," Mr. Viana said. "So if we're looking to do things on a consistent basis as part of a global firm, the thing that worries us is that the challenge of making any changes to one part of the company will potentially impact all of our other locations."

Another question is: "Will U.S. customers have the rights to the same (investor) protection if they're investing with a manager with a European-based operation?" said Matthew Jones, manager of regulatory and legal issues for the London-based Alternative Investment Management Association, which primarily represents hedge funds in 46 countries. "And if (U.S.) investors have the same rights from a European manager, would they then want the same rights from a U.S. manager?"

The preliminary framework of MiFID is being assessed by member states and scheduled to be finalized in early 2007. Each country will be allowed some flexibility to incorporate the new rules into its national legal systems, according to a preliminary draft released earlier this year, so it could be implemented "slightly differently" in each country, Mr. Pickles said.

Best execution is another key component of the directive that's a point of contention between regulators and investment firms. MiFID requires transactional protection that surpasses similar rules in the United States under the Securities and Exchange Commission's Regulation NMS, Mr. Pickles said. For example, while U.S. rules direct sell-side firms to prove that they have obtained best execution for clients, MiFID goes further by "not only requiring the best price on screen, but also takes into account such factors as the right trading venue and whether the transaction ultimately gets the best results for clients," he said.

Mr. Viana of PIMCO added: "One of difficulties for us will be how to document the process to show that we've got the best possible outcome for clients.

"This is easier in equities. But since PIMCO is a fixed-income specialist, it is much more difficult to find a reasonable reference price to measure against. The regulators seem to have used a regime that works for equities and copying it over to the fixed-income market, and it just doesn't work."

Todd Ruppert, president and CEO of T. Rowe Price Global Investment Services Ltd., Baltimore, said his company has set up an internal team to analyze the impact of MiFID. Although T. Rowe Price has not implemented major internal changes to tackle the new rules, it is closely monitoring the developments.

"We're all in the same boat and a lot of people (in asset management) are concerned," Mr. Ruppert said. T. Rowe Price managed $293.7 billion globally as of June 30; a breakout of European assets was not available.