The Directive on Financial Instruments Markets (FIMD), proposed in 2002 to overhaul outdated legislation affecting today’s fast-moving investment markets, was adopted by the EU’s Council of Ministers at the end of April.
This framework legislation which updates the 1993 Investment Services Directive, is a core component of the Commission’s Financial Services Action Plan. Its objective is to give investment firms an effective ‘Single Passport’, allowing them to operate throughout the EU on the basis of authorisation in their home Member State. It will also mean that investment firms can process client orders outside regulated exchanges, which is not currently possible in some Member States.
Whilst stimulating investment in the EU, the legislation also aims to ensure that investors enjoy similar high levels of protection when employing investment firms located in any of the EU countries.
Overhaul of legislation
EU financial markets have seen some far-reaching structural changes over the past decade. These changes include greater participation of retail investors in financial markets, increased competition between exchanges and trading systems and the growth of cross-border equity transactions (by 20%-25% annually between 1996 and 2001). In consequence, it was felt necessary to overhaul existing laws.
The new legislation sets out to establish a comprehensive regulatory regime to ensure high quality execution of investor transactions wherever they take place either on ‘regulated markets’, through a new generation of organised trading facilities known as either Multilateral Trading Facilities (MTFs) or Alternative Trading Systems, or off-exchange. It lays down a package of safeguards which regulated markets and investment firms should respect.
The new EU legislation is a Lamfalussy-type Directive. It establishes a framework (level 1) which sets out the general high-level obligations which Member State authorities should enforce. More detailed implementing measures (level 2) will be set down by the Commission following consultations with market participants and Member States, and advice provided by the Committee of European Securities Regulators (CESR). Member States have to implement the Directive (together with necessary level 2 legislation) within two years.
Clarification and extension of scope
As a response to innovation in the marketplace, the Directive expands the list of financial instruments covered to include certain commodity derivative instruments and other derivative instruments with similar characteristics. The inclusion of the ‘new’ financial instruments, together with commodity derivatives as originally proposed by the Commission, will help protect investors against ‘Enron-type’ manipulations and help guarantee the reliability, fairness and stability of financial markets.
It also enlarges the range of investment services for which authorisation is required, notably to include investment advice. Financial analysis and research is also covered by the Directive, when undertaken in conjunction with core investment services. This means that essential rules of this Directive such as investor protection and conflict of interest rules also apply to financial analysis.
Home market authorisation
The Directive sets out to greatly enhance the practical application of the ‘Single Passport’ for investment firms, by reinforcing and extending the principle that firms should have the right to operate anywhere in the EU on the basis of authorisation and supervision by the competent authority in their home Member State.
It will bring closer into line national rules on the provision of investment services and the operation of exchanges, with the ultimate aim of creating a single European ‘securities rule book’.
FIMD updates and harmonises the regulatory conditions with which investment firms must comply, at the time of initial authorisation and afterwards. In particular it provides:
clearer and more precise rules on the conduct of business that investment firms must respect when providing services to their clients;
reinforced organisational requirements, particularly regarding conflicts of interest
reinforced ‘best execution’ obligations and provides for new rules for handling clients’ orders;
transparency obligations for investment firms executing clients orders against their positions (internalisation of orders)
Comprehensive investor protection
A key objective of the legislative package is to enhance investor protection and it incorporates a series of provisions for this purpose, the requirements of which have to be adapted to the particularities of each category of investors (e.g. retail investors).
Under the terms of the Directive, investment firms are permitted to ‘internalise’ their client orders. Internalisation is where banks and other investment institutions process client orders in-house without going through a regulated market. However, ‘internalisation’ would be limited to situations where it is demonstrably in the client’s best interests.
Through a comprehensive pre- and post-trade transparency regime, the Financial Instruments Markets Directive sets out to enable market participants to observe conditions for the most recent sale/purchase of an equity instrument at all execution points, thereby identifying the best trading opportunities. Such transparency contributes greatly to efficient investor protection. In addition, it is a powerful tool for ensuring that competition between markets and trading venues contributes to, rather than impairs, overall market efficiency. For the time being this obligation is restricted to shares but could be extended to bonds in the future.
A set of protective measures for ‘internalisers’ have also been included in the Directive when they are obliged to quote, so that they can provide this essential service to their customers without incurring undesirable risks. These measures include the possibility to update and withdraw their quotes.
The Directive will in addition establish a fair marketplace for retail investors and prevent financial institutions from discriminating between small investors, for example by offering some of them undisclosed improvements to prices publicly quoted - so-called ‘price improvement’.
In order to promote consistent enforcement throughout the EU, the Directive sets minimum standards for the mandate and the powers national competent authorities must have at their disposal. It will establish effective mechanisms for real-time cooperation in investigating and pursuing breaches of the Directive’s obligations, by upgrading the obligations of competent authorities to assist each other, exchange information and facilitate joint investigations.
To facilitate and accelerate cooperation, and more particularly exchange of information, the Member States will have to designate one single competent authority as a contact point.
For further information: http://ec.europa.eu/internal_market/en/finances/mobil/isd/index.htm
TEL: +32 (0) 2.295 1723
FAX: +32 (0) 2.295 5606