It will directly affect only the investment arms of insurance companies.

ABI comment

Peter Montagnon, Head of Investment Affairs at the ABI said: "We are supportive of MiFID's key objectives and the creation of a single European market for investment and trading of securities. It is imperative that the implementation is proportionate and does not end up being too expensive.

"We have sought proportional implementation in those areas where we would like to see the level playing field preserved between insurance and other savings products and between investment managers and investment banks."

Background
Adopted in 2004 to replace the Investment Services Directive, which had been in place since 1993, it is a part of the Financial Services Action Plan, an EU initiative designed to improve the single market in financial services. Other Directives under this Plan include those on Market Abuse, Prospectus and Transparency.

Objective
The overall aim of MiFID is to break down barriers to cross-border financial services business through a single EU "passport" that allows firms registered in one member state to do business in another, and harmonising various organisational and Conduct of Business requirements across all member states.

An important additional change is that countries will no longer be able to require that shares be traded only on their national stock exchange. This ends the so-called concentration rule, which some observers believe could lead to a major shift in market share of stock market trading.

General impact
While these changes are aimed at benefiting the overall market, they will involve substantial regulatory change in the short term and involve firms in investing heavily in new computer systems to meet the data and reporting requirements of the legislation.

How it affects investment management

1. Changes to systems, controls and Conduct of Business rules - This will force investment managers to
   • reclassify clients
   • review and update various policies and procedures for dealing with them
   • change outsourcing agreements to be MiFID-compliant
2. Best execution - MiFID has introduced new requirements on best execution, the obligation of a broker or other trade to provide the best possible deal for its client. Investment managers will now also owe a duty of best execution to their clients. There has been a lengthy debate about what this involves and it remains to be seen how this will be enacted in markets where there is little price transparency
3. Conflicts of interest - Also relevant for investment managers - both in terms of their own systems and controls and those of their counterparties - will be changes to conflicts of interest requirements. Firms have hitherto relied on simple disclosure of conflicts, but will now only be able to do this when they have exhausted all the other methods of managing conflicts.
4. Indirect effects - Some of the changes instigated by MiFID will affect investment managers indirectly, as users of the market. Their impact may therefore be more perceptible in the long-term. MiFID aims to create a single market for European trading and securities, by abolishing the concentration rule and encouraging competition between various trading venues. These venues include not only different exchanges but also less formal arrangements such as the so-called multilateral trading facilities (MTFs) and systematic internalisers (SIs). On and off exchange trading will therefore be regulated similarly, with equal transparency for liquid shares.

The impact of these changes on market structures is likely to be significant, in continental Europe more so than in the UK. Investment managers in the UK already use different venues and for them the key concern will be to avoid a fragmentation of liquidity, leading to bigger spreads and higher dealing costs. If that happens, the benefits of competition will be wiped out by higher costs.

There appears to be little consensus about what will happen and whether the new venues will be able to move liquidity away from exchanges. For example, Project Turquoise, which will compete with the London Stock Exchange, is not up and running yet.

How it affects insurance companies

Insurance products are formally outside the remit of MiFID. However, the FSA has adopted a case-by-case approach to the implementation of MiFID concepts and rules to "non scope" business, including retail insurance. So, in some respects, MiFID will be applied, for example, to packaged products (including life policies, units in a regulated collective investment scheme, an interest in an investment trust savings scheme and stakeholder pension schemes).

This case-by-case approach to changing conduct of business rules will help to deliver the shift to more principles-based regulation. It is based on sound analysis and is something the ABI has long advocated.

The FSA will conduct a post-implementation review of the new rules in early 2008 to assess whether the desired outcomes for consumers and firms alike are being achieved in practice.