Markets in Financial Instruments Directive and Its Implications on the Financial Services Authority - Literature review Example

Markets in Financial Instruments Directive and Its Legal Implications on Financial Services ity of UK 0 Introduction: Originally formed as The Securities and Investment Board Limited in 1985 and later on restructured as Financial Services Authority (FSA) in 1997, this quasi-judicial body regulates the financial services industry in the United Kingdom. In addition to exercising the powers conferred by the Financial Services and Markets Act, 2000 FSA also regulated banks, insurance companies, financial advisors, mortgage companies and general insurance intermediaries. With a more or less similar objective of regulating the investment services across all member states of the European Union, Markets in Financial Instruments Directive (MiFID) has been introduced. While replacing the Investment Services Directive (ISD), MiFID proposes to achieve the objectives of protecting the investors in the EU as well as responding to changes and innovations in the securities market. No doubt MiFID has its own influence on the effectiveness of the functions of FSA in that there may be some overlapping of the initiatives as laid down by both the regulations in achieving the purposes for which they have been introduced. With this background this paper attempts to bring out a detailed report on the legal implications of MiFID on the FSA and the extent of the exposure of its authority on the activities of different organisations, which are supposed to be regulated and controlled by FSA. 2.0 Financial Services Authority (FSA): Financial Services Authority is an independent non-government body, set up under the Financial Services and Markets Act (FSMA) 2000. The important role of this authority funded by the industry is to regulate the financial services industry. Under FSMA the FSA has the following statutory objectives: maintaining confidence in the UK financial system; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and helping to reduce financial crime. (FSA Web Page) In addition to the statutory objectives there are the following principles of good regulation to be followed by the FSA relating to: most efficient and economic use of resources; being proportionate; responsibility of firms' own management; maintaining the UK's competitive position; competition; and facilitating innovation. 2.1 Replacement of the Financial Services Act 1986 by the new Financial Services and Markets Act 2000: The New Financial Services and Markets Act 2000 provide a framework within which the Financial Services Authority (FSA) will operate as the UK's sole, statutory, financial services regulator. (Lindsey Hemingway 2001) The policy objectives of FSMA 2000 are to create an efficient and effective transparent framework for financial services regulation in the UK which promoted market confidence and protects consumers. According to HM Treasury Note (2005) "these Regulations fulfill these objectives by enabling the FSA, the UK's single regulator of financial services, to operate more effectively by permitting independent actuaries who assist the FSA in its regulatory functions to disclose more information to the FSA in certain circumstances." According to Lindsey Hemingway (2001) the New Act would introduce the following significant changes in the financial services law, although the fundamental principles of the Old Act will be maintained. These will include: the FSA as the sole financial services regulator in place of the various regulatory and professional bodies created under the regime of the Old Act; a revised Financial Promotion scheme; powers to impose penalties for market abuse; regulation, marketing and promotion of collective investment schemes; recognition of investment exchanges and clearing houses; delegation to the London Stock Exchange of the relevant powers to regulate listing activity and to approve all prospectuses; establishment of a single Ombudsman and compensation scheme, replacing the various schemes already in existence, to provide further protection for consumers; establishment of a Financial Services and Markets Tribunal to hear appeals against decisions of the FSA. 2.2 Structure of FSA: The Organisation structure of FSA is based around three Managing Directors and a Chief Operating Officer reporting to an Executive Chairman. Each of these three directorates has a distinct area of primary interest and is each regulated institutions is allocated to five supervisory divisions namely: The Major Financial Groups Division The Deposit Takers Division The Insurance Firms Division The Investment Firms Division and The Markets and Exchanges Division. Currently independent actuaries appointed to assist the FSA in its regulatory function are restricted in what information they may disclose to the FSA. This impairs the FSA's ability to be kept informed of facts that are relevant to its function. The revised disclosure provisions would apply the same provisions to independent actuaries as already apply to other independent persons appointed to assist the FSA in its regulatory functions. 2.3 FSA Conduct of Business Sourcebook: The FSA's consultation paper 45 entitled 'The Conduct of Business Source Book' was published in the year 2000. COBS contain the rules and guidance which will apply principally to firms dealing with private and intermediate customers and relates mainly to the business of the investment firms. It also contains rules and guidance of relevance to deposit takers, general insurers and certain participants to the Lloyd's market. Most of these provisions are designed to give effect to the requirements of the Financial Services and Markets Bill which was later converted in to FSM Act 2000. (FSA Consultation Paper 45a 2000) 3.0 MiFID: The Markets in Financial Instruments Directive (MiFID) is a key part of the Financial Services Action Plan (European Single Market). MiFID covers a broader range of investment services, activities and financial instruments and therefore come activities and firms will fall within the scope of regulation for the first time. The Scope of the European Passport will also thus be wider. MiFID is more perspective than the ISD and firms will have to comply with new conduct of business rules and make changes to their internal organization in order to be in compliance with MiFID. The Markets in Financial Instruments Directive comes in to effect on 1st November 2007 when it will replace the current Investment Services Directive (ISD). Amendments to national legislation and rules to carry out to its provisions must be made by 31st January 2007. The FSA paper on MiFID says that MiFID extends the coverage of the current ISD and introduces new and more extensive requirements that firms will have to adapt to, in particular for their conduct of business and internal organisation. The aim of the ISD was to set out some basic high-level provisions governing the organisational and conduct of business requirements that should apply to firms. It also aimed to harmonise certain conditions governing the operation of regulated markets. While MiFID has the same basic purpose, it makes significant changes to the regulatory framework to reflect developments in financial services and markets since the ISD was implemented. 3.1 Organisations within the purview of MiFID: MiFID will directly affect the following organizations which will come within the purview of the directive from the date of the implementation: retail banks investment banks venture capital firms stockbrokers investment managers proprietary trading firms corporate finance firms wholesale market brokers providers of custody services. 3.2 Exemptions under MiFID: Article 2 of the MiFID incorporates various exemptions including: members of professions providing incidental investment services professional investors who invest only for themselves company pension schemes collective investment undertakings and their operators commodity producers commodity traders certain local organisations especially in Denmark and Italy In addition to these exemptions article 3 allows an optional exemption for certain receivers, transmitters and advisers who do not hold client money or securities and comply with other prescribed conditions. 3.3 Key Areas of Change under MiFID: According to Linklaters MiFID applies to all investment firms covering a broader list of instruments than the ISD. In general: It gives firms the right to carry out business on a cross-border basis but, in contrast to the ISD, it applies home state, rather than host state, rules to passported business; Adopts a harmonised set of conduct of business rules; Butwhere business is conducted from a branchwithin a Host Member State, the COB rules of that Host Member State will apply. The key areas where MiFID proposes to introduce changes are: Widening the scope of coverage including the range of 'core' investment services and activities that can be passported Broader approach to conflicts of interest and less reliance on client disclosures Increased obligations to institutional clients Best execution requirements to all the products Efficient client categorization Establishment of policies and procedures to ensure introduction of systems and control including internal audit, risk management and compliance function Outsourcing of portfolio management for retail clients Ensuring pre-trade transparency with systematic internalisers Requiring post-trade transparencies through additional disclosures Ensuring costs and fees transparencies in transactions Providing risk warnings and Promoting healthy cross border businesses 3.4 MiFID and the Role of FSA: MiFID, replacing the current Investment Service Directive will significantly alter how firms carrying on investment business organize their internal systems and controls and how they interact with their customers. Thus in the UK several key FSA directive sourcebooks will need to be amended to take account of the provisions of the directive. According to Grainger Consulting (2006) because of this firms which might otherwise be out with the directive such as financial advisors who have a potential exemption under Article 3 will be affected by the changes to the detailed rules that will affect all the regulated firms in the UK to a greater or lesser extent. 3.5 MiFID and Changes in the COB Sourcebook Structure: It is planned by the FSA to change the structure of the COB Sourcebook with the aim recasting the requirements round the core MiFID provisions and reduce existing requirements not struck down by MiFID for firms and investments, within and also without the scope of the Directive. It is however planned to retain some key existing provisions when the existence of those provisions is justified. The FSA has issued a consultation paper CP 06/9 entitled: "Organisational Systems and Controls - Common platform for firms: which contains a unified ser of requirements applying to firms subject to MiFID as also with the proposed Capital Requirements Directive (CRD(). This consultation paper also includes transitional provisions to deal with the different implementation dates for CRD and MiFID. Till such implementation the common platform will not be mandatory for firms that are subject solely to MiFID. Such firms will however have the option of adopting the common platform from 1st January 2007 if they wish. The unified approach demonstrates the FSA's move to a more principles-based approach to regulation that emphasizes senior management responsibility. Linklaters states that the consultation has two principal purposes. First, it aims to reform the COB sourcebook, by acting upon the commitments proposed by the FSA in its FSA Business Plan for 2006/7 and the FSA's Better Regulation Action Plan. Second, it consults on the FSA's proposed implementation of the conduct of business requirements of MiFID and its implementing legislation. MiFID and its implementing legislation must be transposed by 1 November 2007. Chapter 3 of the Senior Management Arrangements, Systems and Controls (SYSC), within the High Level Standards section (Block 1) of the FSA Handbook will be replaced with seven new chapters for common platform firms. Each new chapter covers a particular subject and these new chapters are collectively known as the Common Platform. (Grainger Consulting, 2006) The FSA has issued further consultation papers outlining the policies and procedures relating to the implementation of MiFID. Consultation paper 06/19 specifically deals with the reforming of the Conduct of Business Regulation. The proposed new conduct of business rules will be contained in a new sourcebook, referred to as NEWCOB, which, due to its less prescriptive nature, will be significantly shorter. The NEWCOB will have 21 chapters dealing 50 policy issues and incorporating the proposed Level 2 measures of MiFID and all other changes proposed to be brought in by MiFID in respect of the regulation of Financial Services. Several other parts of the handbook will be affected by these changes, but the most significant ones covered by these consultations are to DISP and SYSC. 4.0 Conclusion: Thus MiFID requires EU countries to regulate firms providing services linked to the buying and selling of financial instruments such as shares bonds and derivatives, MiFID is a considered to be a cornerstone of the EU's Financial Services Action Plan. MiFID also requires revisions to UK legislation mainly to Financial Services and Markets Act 2000 and also to the Financial Services Authority's Handbook containing the Conduct of Business rules. The UK Treasury and FSA are working together on the implementation of the MiFID by doing an extensive research and releasing various consultation papers suggesting the broad framework of the possible changes that can be made to the existing legislations to make them adaptable to the implementation of MiFID. Much remains to be seen about the practicalities of these changes when they are put to effect in November 2007. References: 1. FSA Consultation Paper 45a (2000) Financial Services Authority: The Conduct of Business Source Book [Online] Available from http://www.fsa.gov.uk/pubs/cp/cp45.pdf Accessed on 11th March 2007 2. FSA paper on MiFID Markets in Financial Instruments Directive (MiFID) [Online] Available from http://www.fsa.gov.uk/Pages/About/What/International/EU/fsap/mifid/index.shtml Accessed on 11th March 2007 3. FSA Web Page Overview of the FSA [Online] Available from http://www.fsa.gov.uk/Pages/Information/Overview/index.shtml Accessed on 11th March 2007 4. Grainger Consulting (2006) Organisational Systems and Controls: A "Common Platform" Paper on MiFID and CRD [Online] Available from http://www.graingerconsult.com/topics/0606.shtml Accessed on 11th March 2007 5. HM Treasury Note (2005) Explanatory Memorandum to the Financial Services and Markets Act 2000 (Disclosure of Information by Prescribed Persons) (Amendment) Regulations 2005 [Online] Available from http://www.opsi.gov.uk/SI/em2005/uksiem_20050272_en.pdf Accessed on 11th March 2007 6. Lindsey Hemingway (2001) Replacement of the Financial Services Act 1986 (the "Old Act")by the Financial Services and Markets Act 2000 (the "New Act")Middleton Potts Updates February 2001 [Online] Available from http://www.middletonpotts.co.uk/library/default.aspp=88&c=83 Accessed on 11th March 2007 7. Linklaters MiFID [Online] Available from http://www.linklaters.com/microsites/mifid/english/detail.asplocalnavigationid=4958 Accessed on 11th March 2007 Read More