A consumer’s guide to MiFID - ESMA · 2015. 11. 6. · A consumer's guide to MiFID 7 Part 1: Before investing Trading in products without investment advice (a) the Appropriateness

A consumer’sguide to MiFIDInvesting in financial products

March 2008

11-13 avenue de Friedland – 75008 PARIS – FRANCE – Tel : 33.(0).1.58.36.43.21 – Fax: 33.(0).1.58.36.43.30

Web site: www.cesr.eu

ContentsWhat is MiFID and how does it affect you? 3

Part 1: Before Investing 5

1.1 Which kind of client are you? 51.2 What services might you receive? 61.3 What information will you receive before investing? 9

Part 2: During and after the Investment 10

2.1 What happens when you give an order to a firm? 102.2 What information will you receive during and after the investment? 10

Part 3: Ongoing requirements 11

3.1 Conflicts of interest 113.2 Safeguarding your financial assets and money 113.3 Customer complaints 11

Conclusion 12

3A consumer's guide to MiFID

This guide is for you if you have invested or areplanning to invest in financial products. Itexplains the basics of a new piece of Europeanlegislation called the Markets in FinancialInstruments Directive (MiFID) and how it affectsyou when dealing with firms that provideinvestment services in Europe.

Think about the financial products that you own.You probably have one or more bank accounts, amortgage, a credit card, some shares, a pensionplan, an investment fund… MiFID only applies tosome of these products such as shares, bonds,derivatives and units in investment funds. It doesnot apply to deposits or loans, or to insuranceproducts. For those products which are covered byMiFID, firms may offer you services such asmanaging investments on your behalf, giving youadvice on investments and buying or sellingfinancial products.

One of the main purposes of the directive is toharmonise investor protection throughout Europe.The degree of investor protection that you willreceive is directly related to the reliance that youplace on the firm and on yourself. For example, ifyour financial knowledge and experience are lowand you are asking the firm to advise you or totake decisions on your behalf you will be affordedthe highest degree of protection.

MiFID sets three overarching principles that willapply to firms when they are doing investmentbusiness with you. These are:

• To act honestly, fairly and professionally, inaccordance with your best interests. Thisprinciple protects you when you are dealingwith a firm that, as a professional, is in a strongerposition than you.

• To provide you with appropriate andcomprehensive information which is fair,clear, and not misleading. This will help youto understand products and services so thatyou can make informed decisions and ensuresthat you do not receive biased or confusinginformation.

• To provide you with services that take accountof your individual circumstances. This is toensure that your investments correspond toyour investor profile and requests.

The structure of this guide is broadly chronological,reflecting the different stages of the investmentprocess and how firms organise and conduct theirbusiness with you on a day to day basis. The MiFIDprinciples apply to every step of the firm'srelationship with you.

What is MiFID and how does it affect you?

4 A consumer's guide to MiFID

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Part 1: Before investing

1.1 Which kind of client are you?Before providing you with an investment service,your firm is required to categorise you as a Retailor Professional client. You will normally becategorised as a Retail client, a category whichincludes the majority of individuals.

As a Retail client you receive the highest level ofinvestor protection. MiFID awards more protectionto investors with less investment knowledge andexperience (Retail clients), while investors withmore investment knowledge and experience(Professional clients) are provided with lessprotection. Professional clients include banks,governments, pension funds, large companies andexceptionally some individuals.

What if you want to become aProfessional client? What if a firm asksyou to become a Professional client? Whatare the consequences?

In limited circumstances you can be treated as aProfessional client. You may want to consider this toaccess products which are not available to Retailclients, or if you want to become a client of a firmthat does not do business with Retail clients.

If you want to become a Professional client youneed to feel confident that you are capable ofmaking your own investment decisions, capable ofassessing the risks that you incur, and do not needa high level of investor protection.

If you elect to be a Professional client, you willlose some of the regulatory protections that applyto Retail clients. The firm will explain this to you.For example, you will generally receive lessinformation and fewer disclosures or warnings on anumber of topics.

Before categorising you as a Professional client, afirm will first have to assess whether this categoryis appropriate for you. The purpose of theassessment is for the firm to establish that you arecapable of making your own investment decisionsand you are able to understand the risks involved.

Your firm will be able to categorise you as aProfessional client only if you meet at least two ofthe following conditions:

• you frequently carry out transactions;

• you have a large portfolio;

• you have worked in the field of investmentservices.




1.2 What services might youreceive?In broad terms, you are likely to receive one or moreof the following types of investment services:

• You are provided with personal recommendationson investments, products and courses of action(investment advice);

• You buy and sell financial products withoutinvestment advice;

• Your investments are managed by a firm on yourbehalf (investment management).

In this section we will explain the different types ofservices you may receive from firms and theprocesses they will follow to deliver the appropriatedegree of protection to you.

Investment advice

When you receive investment advice, you areplacing a higher degree of reliance on the investmentfirm than you would do in other circumstances suchas in the case of simple non-advised transactions.You therefore need to have some comfort that thefirm understands your individual needs andcircumstances so that it recommends the rightproducts for you. MiFID requires a process called theSuitability test, where the firm asks you somequestions to reach an understanding of the types ofinvestments that will be suitable for you.

If a firm does not, or cannot, obtain the necessaryinformation to assess Suitability, then it can not makea recommendation. If you provide only limitedinformation, this will affect the nature of the servicethe investment firm will be allowed to provide to you.

As part of the Suitability test, you arelikely to be asked questions about thefollowing:

• Your investment objectives

This can include questions about the length oftime you wish to hold the investment, your riskappetite and profile, whether you wish to investfor income or growth, keep the capital safe andavoid any risk or accept a high level of risk.

• Your financial situation

Information regarding your financial situationmay be obtained through questions aboutmatters such as the source and extent of yourregular income, your assets, real estateproperty, any debts you have and otherfinancial commitments.

• Your knowledge and experience

Questions regarding your knowledge andexperience can include the types of servicesand products you are familiar with; the nature,volume and frequency of your previoustransactions; and your level of education,profession or former profession.



Trading in products without investmentadvice

(a) the Appropriateness test

As we have described, when a firm is giving youinvestment advice, it must ensure that its advice issuitable for you.

When you are not receiving investment advicefrom a firm (or not relying on a firm to manageyour investments) you will generally be expectedto take a greater degree of responsibility for yourdecisions. Where you want a firm simply to followyour instructions to buy or sell an investment adifferent set of protections apply. These protectionsare referred to as the Appropriateness test.

The test aims to protect those who may notunderstand or be aware of the implications and levelof risk involved in a transaction, particularly wherethe products are 'complex' or where you have nottaken the initiative to carry out the transaction.

As part of the Appropriateness test, you are likelyto be asked questions about your investmentknowledge and experience.

• If the firm concludes that you have the necessaryknowledge and experience to understand therisks involved, then the firm may simply goahead with the transaction.

• If the firm concludes that you do not have thenecessary knowledge and experience, or youhave not supplied enough information to enableit to reach a view, then you will receive awarning from the firm saying that either the firmdoes not regard the proposed transaction asappropriate or that the information is notenough to enable it to determineappropriateness. If you insist on going aheadwith the transaction, you must accept the risk.

(b) Trading in 'non-complex' financialproducts on an Execution-only basis

The Appropriateness test does not apply in thecase of some kinds of 'non-advised' transactions.This service can be described as Execution-only.The circumstances where the test does not applyare as follows:

• the product involved in the proposed transactionis what MiFID calls 'non-complex'; and

• you have chosen to contact the firm to carry outyour transaction. This means that you are notresponding to a personalised approach to youfrom the firm which was intended to influenceyou in respect of a specific product ortransaction (for example in certain situationswhen you are buying shares on line).

In such cases, you do not have to answer anyquestions about your investment knowledge andexperience, financial situation or investmentobjectives. The firm may of course ask youquestions for other purposes, particularly if youare a new customer.

Examples of 'non-complex' financialproducts are:

• Shares admitted to trading on a regulatedmarket

• Money market instruments

• Many types of bonds

• Units in certain investment funds

Examples of 'complex' financial products are:

• Options, futures, swaps, and otherderivatives

• Financial contracts for differences

• Convertible bonds

• WarrantsYou will be warned that the firm is notexercising any judgement on your behalf.



Investment management

Finally, when your investments are managed by afirm, you are reliant on the firm's decisions andchoices. As the firm will not communicate withyou every time it makes an investment on yourbehalf, it will need to have enough informationfrom you at the outset to enable it to provide youwith the required service. To achieve this, as in thecase of investment advice above, the firm willcarry out a Suitability test. If you do not supplythe firm with adequate information it cannotprovide the service of investment management toyou. If you provide only limited information, thiswill affect the nature of the services the investmentfirm will be allowed to provide to you.

The diagram below is a summary of what wehave discussed in this section.

You would normally go to a MiFID investment firm for one of the following reasons:

1. To ask the firm to manageyour MiFID investments.

2. To get investment advicefrom the firm on MiFIDfinancial products orinvestment decisions.

3. To ask the firm to buy or sell aMiFID financial product foryou, or to ask the firm to passyour order to someone else toexecute, without the firmadvising you at all.

1 - 2. The firm will ask you for information about yourinvestment objectives, financial situation and knowledge andexperience so that it can provide a suitable investmentmanagement service to you or recommend suitable products ortransactions for you. MiFID calls this the Suitability test.

3. What happens next will depend on whether the product involved in the proposed transaction is 'complex' or 'non-complex'.

If the product is 'noncomplex', theAppropriateness testwill apply unless youare approaching thefirm on your owninitiative to ask thefirm to execute orarrange a transactionfor you. MiFID callsthis serviceExecution only.

If the product is'complex', the firmwill ask you forinformation to enableit to assess whetheryou have thenecessary knowledgeand experience tounderstand the risksinvolved in theproposed transaction.MiFID calls this theAppropriateness test.

What happens next:



1.3 What information will youreceive before investing?All information provided to you throughout yourbusiness relationship with a firm should be ‘fair,clear and not misleading’. This principle refersboth to the content of the information and to theway it is presented to you.

Your firm should provide you with the relevantinformation in good time before you invest sothat you can make informed decisions. Types ofinformation you will receive before investinginclude:

Marketing communicationsWhether or not you are a client of a firm, youmay receive advertisements and othermarketing communications issued by a firm. Alladvertisements and marketing communicationshave to be presented in such a way that you canidentify them as being of a promotional nature.

ContractsIf you are a new retail client that a firm has takenon for the provision of investment services otherthan investment advice, you will be asked to agreein writing to a contract which will contain yourand the firm's essential rights and obligations.

Information about the firmA firm must give you general information aboutitself, including who regulates it and the services itoffers to clients, to help you understand the natureof the services on offer and the risks involved.

Information on investment management Where you have asked a firm to manageinvestments on your behalf, you should expect toreceive information including a description of themanagement objectives and the related level ofrisk, what types of products or transactions maybe involved in your portfolio and informationabout the valuation method and the frequency ofvaluations of your investments.

Information about financial productsYou will receive information explaining the nature,risks and costs of financial products. Suchinformation includes, for example, a description ofthe products' risks and whether prices/valuesmay fluctuate. The amount of information willdepend on the type of product, its complexity andrisk profile.

Information about costs and chargesYou will receive information about the direct andindirect costs and charges of a service or product,including any commission charged or paid. Thisshould clearly show you the total costs.Sometimes, however, the precise amount of thetotal costs is not available at the time when theinformation is communicated to you. In suchcases, you should instead receive sufficientinformation to see how the costs are going to becalculated, so that you can verify the total priceonce it is available.

Before investing, it would be sensible for you tomake sure that you know what the arrangementsare if you need to make a complaint about thefirm or seek redress, and which investorcompensation scheme covers the firm. The firmshould give you this information.


Part 2: During and after the investment

2.1 What happens when you givean order to a firm

How is your order handled?

When you instruct a firm to buy or sell a product,your order should be executed promptly,sequentially (in the order in which it was receivedby the firm) and in a timely manner.

If for any reason a firm has a material difficultyin handling your order sequentially, it shouldnotify you.

What is Best Execution?

To complete the purchase or sale of financialproducts your firm has to execute your orders insuch a way as to consistently achieve the bestpossible result for you. This is referred to as 'BestExecution'.

In essence, your firm will identify 'executionvenues' that enable it to obtain best execution.Examples of execution venues are stockexchanges, trading platforms, other firms, or evenyour firm.

Your firm can achieve Best Execution for yourorders by taking a variety of factors into account,such as price, costs of execution, speed andlikelihood of execution.

The most important factors a firm will take intoaccount when executing your order are price andtotal costs (that is, the total financial considerationto be paid by you for a transaction, including theprice, all expenses, execution venue fees, clearingand settlement fees and any other fees paid tothird parties involved in the execution).

2.2 What information will youreceive during and after theinvestment?

What information should you expect toreceive from firms that execute your orders?

You will receive information about how your firmachieves best execution for you in practice. Suchinformation includes:

• how the firm determines the factors that aremore important for achieving best execution;

• what are the execution venues that the firmrelies on;

• a warning that if you give a specific executioninstruction to the firm this will take priority andthe firm will not be able to follow its ownprocess for achieving Best Execution for you – itwill simply follow your instruction. Forexample, if you instruct your firm to executeyour transaction on a specific market, you maylose the benefit of achieving a better pricesomewhere else.

What reports will you receive?

After you have bought or sold a financial product,your firm will send you a transaction confirmationwith essential information such as name of theproduct, price, date and time and the total sum ofcommissions and expenses charged.

Where your firm manages your investments onyour behalf, the firm should send you periodicreports with information such as the contents andvaluation of your investments, the total amount offees and charges and how your investments haveperformed during the reporting period.

It is in your interest to retain copies of alldocumentation you receive from a firm.

Part 2: During and after the investment


Part 3: Ongoing requirements

3.1 Conflicts of interestFirms should act in accordance with your bestinterests; to this end they should have in placeeffective arrangements to prevent conflicts fromadversely affecting your interests. Your firmshould avoid unduly putting other clients'interests or the firm's interests ahead of yourswhen providing you with a service.

Examples of conflicts of interest are when the firmis likely to make a financial gain or avoid loss atyour expense; or when it has an incentive tofavour another client's interests over yours.

Your firm will also inform you of the key steps itfollows to identify and manage conflicts of interests.

When your firm's arrangements are not sufficientto manage a conflict of interest, then it shoulddisclose to you in a clear manner the nature andsources of this conflict of interest, before it doesbusiness with you.

3.2 Safeguarding your financialassets and moneyWhen you place financial assets or money with afirm, the firm will safeguard your ownershiprights by having arrangements in place to:

• keep them separate from both the firm's andother clients' assets and money;

• keep accurate records and accounts and performregular reconciliations;

• send you a statement at least once a year withdetails of the assets and money held on yourbehalf.

3.3 Customer complaintsFirms are required to establish effective andtransparent procedures for the handling of yourcomplaints. When you send a complaint to a firm,the firm should keep a record of it, including themeasures it has taken to resolve it.

Part 3: Ongoing requirements MiFID establishes organisational requirements on how a firm must run its business at all times. Someof these are especially relevant when doing business with you.

With the publication of this paper, our intention is toraise consumers' awareness of the changes that aregoing to affect you as a consequence of MiFID. Allthe changes and aspects detailed in this guide havebeen designed to ensure that you are adequatelyprotected when investing in financial products.

Conclusion

Remember the key principles that firmsneed to fulfil when dealing with you:

• To act honestly, fairly and professionally,in accordance with your best interests

• To provide you with appropriate andcomprehensive information which is fair,clear and not misleading

• To provide you with services that takeaccount of your individual circumstances

Ref. CESR/08-003

This guide is only a brief overview and not a full description of your rights under MiFID. The contents aremerely descriptive and do not constitute legal advice. The MiFID legal texts are available athttp://ec.europa.eu/internal_market/securities/isd/index_en.htm

CESR is an independent Committee of European Securities Regulators which has contributed to thepreparation of the MiFID legal texts. One of the main objectives of CESR is to foster cooperation between itsmembers in the exercise of their core functions, including raising public awareness on financial services issuesand investor information.

The Guide has been prepared by the MiFID Level 3 Expert Group chaired by Mr Jean-Paul Servais, Chairmanof the Executive Management Committee at the CBFA, and by its sub-Group on Intermediaries, chaired by MrsMaria Jose Gomez Yubero, Director at the CNMV. For more information on this document or on CESRactivities regarding intermediaries please contact Diego Escanero at [email protected].

A new CESR website is currently being developed to provide more information on CESR activities forconsumers. The site, which is expected to be available during the second half of 2008, will include a dedicatedinvestor's corner. The address for this website will be the same as the current one: www.cesr.eu. In themeantime, should you have further queries please contact Victoria Powell at [email protected].

A consumer's guide to MiFID12

Conclusion

CESR11-13 avenue de Friedland 75008 PARIS FRANCETel: 33.(0).1.58.36.43.21 Fax: 33.(0).1.58.36.43.30 Website: www.cesr.eu

Documents

A consumer’s guide to MiFID - ESMA · 2015. 11. 6. · A consumer's guide to MiFID 7 Part 1: Before investing Trading in products without investment advice (a) the Appropriateness