What it means
The first directive came into force in 2007 and aimed to create a single market for investment services across member states. A firm authorised in one country could offer services in others using a passport.
Over time, regulators concluded that the rules needed to be broader and more detailed, especially after the 2008 financial crisis, which led to MiFID II. MiFID II and its companion regulation expanded coverage to more products and trading venues.
They require firms to act in clients' best interests and to obtain the best possible result when executing orders, which is known as best execution. Firms must also classify clients as retail, professional or eligible counterparties, and give more protection to retail investors.
Transparency is another focus. Trading venues must publish information on prices and volumes so that investors can see what is happening, and firms must report their trades to regulators.
Investors also receive detailed disclosure of costs and charges, both before they invest and each year afterwards. A well-known change concerned research.
Asset managers were required to pay for investment research separately rather than bundling it into trading commissions, so that clients could see what they were paying for. This changed budgets at banks, brokers and fund managers.
For businesses outside the industry, the practical effect is more paperwork and clearer information. Suitability questionnaires, cost disclosures and recorded communications all stem from these rules.
The UK kept a version of the rules in domestic law after leaving the EU, and both regimes continue to develop. Firms also have to record certain client conversations and keep the records for years.
The aim is to give regulators and clients evidence of what was agreed if a dispute arises. This adds cost, but it also improves discipline in how advice is given.
In practice
Real-world examples.
Example
A wealth manager in Frankfurt sends a new client a detailed statement showing the total cost of the proposed investment. The client had expected to pay only the management fee. The clearer disclosure leads her to choose a cheaper fund.
Example
A brokerage in Amsterdam must show that it chose the best venue for a client's share purchase. It keeps records of price, speed and cost for each order. A regulator later reviews them and finds the process sound. The firm's compliance team treats the file as proof that it takes the duty seriously.
Example
A fund manager previously received research from banks as part of trading commissions. After the new rules, it budgets for research directly and cuts spending on reports it rarely read. Its investors benefit from lower total costs, and the firm can now show exactly what it spends on research each year.
Formula
Calculation
Total cost percentage = (One-off costs + Ongoing costs + Transaction costs) / Amount invested x 100
Suppose a client invests $100,000 in a fund through an adviser. The one-off entry charge is $1,000, ongoing charges for the year are $750, and transaction costs inside the fund are $250. Total first-year costs are 1,000 + 750 + 250 = $2,000. As a percentage, that is 2,000 / 100,000 x 100 = 2.0%. MiFID-style disclosure requires this kind of all-in figure to be shown, so the client sees the full cost rather than only the headline fee.Case study
Seen in the real world.
Lindenbaum Asset Management is an illustrative, fictional fund manager based in Dublin with $2,000,000,000 under management. Before MiFID II, it paid for research through trading commissions of about $4,000,000 a year, and few clients knew the amount.
After the new rules, the firm has to decide whether to pay for research from its own pocket or charge it to clients transparently. The investment committee reviews each provider and finds that only half the research it receives is genuinely used.
In this illustrative case, Lindenbaum cancels the least useful subscriptions, cutting research costs to $2,500,000, and pays that cost from its own revenue. The change reduces profit slightly but strengthens its pitch to clients, who value the clarity. The saving of $1,500,000 a year on research is tracked as a separate line in the management accounts so the committee can see the effect on margin.
Watch out
Common mistakes.
- Assuming MiFID only affects large banks, when brokers, advisers, fund managers and trading venues are all in scope.
- Treating the rules as paperwork only, when they change how firms charge, report and execute trades.
- Believing the directive applies only to shares, when it covers bonds, derivatives and many other instruments.
Questions
People also ask.
What does MiFID stand for?
It stands for the Markets in Financial Instruments Directive.
What is best execution?
It is the duty to take sufficient steps to obtain the best possible result for clients when executing orders, considering price, costs, speed and likelihood of completion.
Do the rules protect all investors equally?
No, retail clients receive the highest level of protection, while professional clients and eligible counterparties receive less.
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