European private equity firms are, it seems, forever being besieged by threats of new and painful regulations. Consequently, there is a danger that the European Commission’s Markets in Financial Instruments Directive (MIFID) will be seen as just one of many potential black clouds on the horizon – a matter of concern, certainly, but no more so than many other missives of a similar hue.
Such complacency may be seriously misplaced. Says Carole Collier of global investment management and fund administration business Northern Trust: “Some people are beginning to say MIFID represents the biggest change to the European financial industry for the last five years. And the more I look at it, the more that seems to be true.”
As is normal with roads to hell, MIFID is paved with good intentions. According to EC internal market commissioner Frits Bolkestein, the Directive will allow “reputable investment firms to work anywhere in the European Union (EU) with a minimum of red tape while bolstering our defences against dodgy operators.”
Many private equity firms initially considered – and some may still – that the Directive would not be applicable to the industry. The initial interpretation was that only stock exchanges, investment banks and broker/dealers were in the regulatory firing line.
Octavio Marenzi, founder and CEO of Boston-based research and consulting firm Celent, is keen to disabuse people of that notion, should they still hold it: “Firms that regularly undertake portfolio management, or simply offer investment advice, are covered by the definition and are therefore subject to the Directive,” he says.
What is more, time to put in place the necessary measures is running short. MIFID is currently only in draft form, but has a final implementation date of November 2007.
For firms based in the already well-regulated UK, says Collier, many of MIFID’s demands are already covered by existing legislation drawn up by that country’s Financial Services Authority. But for European countries with a lighter regulatory touch, much work lies ahead – and the clock is ticking ever louder.
According to an internal briefing circulated at a private equity firm and seen by Private Equity Manager, these are understood to be among the key demands made by MIFID:
Systems and controls
Compliance, internal audit and risk: There is an increased focus on the ‘functional independence’ of these control areas and an evidential review to prove such independence will need to be undertaken. MIFID requires the company to have a documented risk management policy. The policy should set out the business risk based on activity and mitigation of those risks.
Action: Review reporting lines and responsibilities of governance structures; review independence and objectivity of compliance, risk management and internal audit; write and implement a risk management policy; review arrangements for risk identification and assessment.
Outsourcing: MIFID requires a review of the regulatory environment and status of any service providers in non-EU countries.
Action: Identify service providers in non-EU countries. Review the regulatory status of those providers. Determine if any notifications should be made.
Conflicts of interest: The Directive requires a conflicts policy to be established and implemented. A conflicts log must also be maintained and appropriate disclosures made to clients where necessary.
Action: Review the conflicts identification and control procedures. Write and implement a conflicts policy and ensure it is disclosed to clients. Design and maintain a conflicts register.
Conduct of business
Client classification: MIFID distinguishes between three types of client that are similar but not the same as current FSA categories. There will be a need to examine the differences between the existing and new classifications.
Action:Write and implement new client classification procedures. Review the classifications of existing market counterparties and intermediate customers, and re-classify them where necessary. Ensure clients are made aware of new classifications. Make appropriate disclosures.
Client “take-on” and client agreements: MIFID will lead to requirements governing information about the firm and its services that must be provided to a client. The Directive also requires firms to keep a record of client agreements.
Action: Formulate procedures and processes for collating and providing the necessary information to clients.
Suitability and ‘know your customer’: The MIFID requirements apply to investment advice and discretionary portfolio management and are likely to be broadly the same as the FSA’s current requirements.
Action: Review the current processes and systems.
This feature was originally published in the May 2006 issue of sister magazine, Private Equity Manager (www.privateequitymanager.com).