MIFID II

MiFID II makes a major play on product governance, ie how should investment firms, primarily investments banks, ensure that they create proper products that are wanted by investors and appropriate to their needs.

Much of the talk has been around the need for banks to continue to monitor and assess products through their lifetime, ie they cannot adopt a “fire & forget” approach, and the amount of information that needs to be exchanged between manufacturer and distributor. But this is not the point of this post. Instead there is a key piece within the Delegated Regulations that were adopted by the European Commission, back in April last year, namely paragraph 2 of Article 9 which reads thus:

In particular, investment firms manufacturing financial instruments shall ensure that the design of the financial instrument, including its features, does not adversely affect end clients or does not lead to problems with market integrity by enabling the firm to mitigate and/or dispose of its own risks or exposure to the underlying assets of the product, where the investment firm already holds the underlying assets on own account.

which seems to have attracted little or no comment, but seems to strike at some of the bad practices of investment banks in the past, eg MBS or mortgage back securities.

No longer can a bank accumulate (shall we be polite?) low grade assets (intentionally or accidentally) and then repackage them, sexing them up with some clever maths and gilding them with beguiling statistics (remember what they say about statistics) before shining this new “product” ready for sale to new/different investors.

Since the opening up of markets this has been a possible exit strategy for traders with bad positions or balance sheet managers with poor assets, but no more, at least not in Europe. No more shining of turds in order to a) shift the risk to someone else and b) make even more money.

Instead the rules look to manufacturers/banks to first determine if a product is needed and will not damage its clients or the markets. Assuming the idea passes these tests the bank can then acquire the building blocks of the product specifically for the product.

I wonder how many people have really read these words? It seems that most are trying to find ways to avoid other aspects of the rules and may have missed this passage hidden in the middle.

The regulators have clearly set out to change behaviours and this type of activity was one of the acts of financial mis-direction that contributed to the crash of 2008/9. I am not sure that the mind-set has really changed yet, but maybe when the implications of this part of MiFID II sink in, we will see the end of polishing turds….at least until some other bright spark dreams up a new way within the rules.

This article is written by Ian J Sutherland. He is an experienced regulatory expert and associate of Healy Hunt.

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