Sapienza Università di Roma
International Banking
Lecture eight
The Markets in Financial Instruments
Directive & Sarbanes–Oxley Act
Prof. G. Vento
Agenda
1.
2.
3.
4.
5.
The MiFID
Core principles of the directive
Key impacts of MiFID
Conclusions: main changes
The Sarbanes–Oxley Act
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Int. nal Banking - Prof. G. Vento
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1. The Markets in Financial Instruments
Directive (MiFID)
• The Markets in Financial Instruments Directive (MiFID) as
subsequently amended is a European Union law which
provides a harmonised regulatory regime for investment
services across the 30 member states of the European
Economic Area (the 27 Member States of the European Union
plus Iceland, Norway and Liechtenstein).
• The main objectives of the Directive are to increase
competition and consumer protection in investment services.
As of the effective date, 1 November 2007, it replaced the
Investment Services Directive.
• MiFID is the cornerstone of the European Commission's
Financial Services Action Plan whose 42 measures will
significantly change how EU financial service markets operate.
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Int. nal Banking - Prof. G. Vento
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1. Key issues on MiFID
• MiFID retained the principles of the EU 'passport'
introduced by the Investment Services Directive (ISD)
but introduced the concept of 'maximum
harmonization' which places more emphasis on
home state supervision.
• This is a change from the prior EU financial service
legislation which featured a 'minimum harmonization
and mutual recognition' concept.
• Another change was the abolition of the
'concentration rule' in which member states could
require investment firms to route client orders
through regulated markets.
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1. The MiFID Structure
• The MiFID is composed of a level 1 text that serves as
a superstructure setting out the core principles of
legislation, while the more detailed provisions are set
out in level 2 texts, so called implementing measures.
• The implementing directive covers issues that are
essentially applicable to investment firms, especially
conduct-of-business rules such as: exercising due
diligence in selling services to retail clients, best
execution, safeguard client assets, conflict of
interest.
• The implementing regulation covers the area of preand post-trade transparency, as well as record
keeping and transaction reporting.
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1. Scope of MiFID
• In order to determine which firms are affected by MiFID and
which are not, MiFID distinguishes between "investment
services and activities" ("core" services) and "ancillary
services" ("non-core" services).
• If a firm performs investment services and activities, it is
subject to MiFID in respect both of these and also of ancillary
services (and it can use the MiFID passport to provide them to
member states other than its home state). However if a firm
only performs ancillary services, it is not subject to MiFID (but
nor can it benefit from the MiFID passport).
• Under MiFID, a study estimates that the three largest EU
jurisdictions (France, Germany, and the UK) will surface over
100 million additional trades annually.
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1. A comparison with Investment Services
Directive
• MiFID is more onerous and detailed than its
predecessor
• It is the price to pay for wanting to create a level
playing field through the implementation of statutory
rules rather than through the establishment of
common principles
• The more level playing field introduced by MiFID
means that large investment firms with operations in
several member state no longer need to comply with
a panoply of different conduct-of-business rules
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Int. nal Banking - Prof. G. Vento
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2. Key aspects of MiFID: Authorisation, regulation
and passporting
• Firms covered by MiFID will be authorised and
regulated in their "home state" (broadly, the country
in which they have their registered office).
• Once a firm has been authorised, it will be able to
use the MiFID passport to provide services to
customers in other EU member states.
• These services will be regulated by the member state
in their "home state" (whereas currently under ISD, a
service is regulated by the member state in which
the service takes place).
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Int. nal Banking - Prof. G. Vento
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2. Key aspects of MiFID: Client categorisation
• MiFID requires firms to categorise clients as "eligible
counterparties", professional clients or retail clients
(these have increasing levels of protection).
• Clear procedures must be in place to categorise
clients and assess their suitability for each type of
investment product.
• That said, the appropriateness of any investment
advice or suggested financial transaction must still be
verified before being given.
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2. Key aspects of MiFID: Client order handling
• MiFID has requirements relating to the
information that needs to be captured when
accepting client orders, ensuring that a firm is
acting in a client's best interests and as to
how orders from different clients may be
aggregated.
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2. Key aspects of MiFID: Pre-trade transparency
• MiFID will require that operators of
continuous order-matching systems must
make aggregated order information on "liquid
shares" available at the five best price levels
on the buy and sell side.
• For quote-driven markets, the best bids and
offers of market makers must be made
available.
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2. Key aspects of MiFID: Post-trade
transparency
• MiFID will require firms to publish the price,
volume and time of all trades in listed shares,
even if executed outside of a regulated
market, unless certain requirements are met
to allow for deferred publication.
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2. Key aspects of MiFID: Best execution
• MiFID will require that firms take all reasonable steps to
obtain the best possible result in the execution of an order for
a client.
• The best possible result is not limited to execution price but
also includes cost, speed, likelihood of execution and
likelihood of settlement and any other factors deemed
relevant.
• Provisions on best execution are part of conduct-of-business
rules and aim to maximise the value of a client’s portfolio, in
the context of the client’s stated investment objectives and
constraints
• This does not necessary mean the lowest price of a trade.
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2. Suitability
• Investment firms ensure that the products being
marketed to retail investors correspond to their
levels of financial education and wealth
• The MiFID adopts detailed provisions on the exercise
of due diligence by investment firms in the
recommendation and sale of products and services
to non-professional clients
• If retail clients fail to provide such documentation on
request, an investment firm may feel uneasy about
providing them with anything but the most basic,
low-yield products
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2. Price transparency
• Under the new regime investment firms and
banks will be allowed to create a market for
shares by trading on own account.
• Generally speaking, the ISD did not allow
transaction to take place outside the
exchange, or regulated market.
• The MiFID abolished the concentration
provision.
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3. Key Impacts of MiFID 1/2
• MiFID will accelerate some important ongoing
changes in European financial markets that are
driven primarily by technological improvements and
enhanced competition in the provision of financial
services arising from globalisation
• MiFID directly touches four distinct groups of actors
within the financial services industry: investment
firms (which may have fairly different organisational
models across countries), exchange and quasiexchange (multilateral trading facilities), data
vendors and specialised IT firms and solution
providers.
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3. Key impacts of MiFID 2/2
1.
2.
3.
4.
5.
6.
As a result of high compliance costs and greater operational
complexity, MiFID will lead to a further consolidation phase in the
brokerage industry
Exchanges are expected to remain the main source of liquidity
and price formation for the time being, but they will be subject to
more competition in their trade reporting and settlement
activities
OTC markets are going to be more heavily regulated than in the
past under MiFID.
A significant rise in algorithmic trading is almost a certainty.
Trading volumes should increase as a result of greater
competition.
A massive market for market data will arise out of MiFID.
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3. MiFID contradiction
•
•
•
Although MiFID was intended to increase transparency for
prices, in fact the fragmentation of trading venues has had
an unanticipated effect.
Where once a financial institution was able to see
information from just one or two exchanges, they now have
the possibility (and in some cases the obligation) to collect
information from a multitude of multilateral trading
facilities, and other exchanges from around the European
Economic Area.
This results in an additional amount of work to benefit from
the transparency that MiFID has introduced.
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3. Dealing with Fragmentation
•
•
The number of additional pricing sources
introduced by MiFID means that Financial
institutions have had to seek additional data
sources to ensure that they capture as many
quotes/trades as possible.
Numerous Financial data vendors have worked
with the MiFID Joint Working Group and Regulators
to make sure that they are able to help financial
institutions to deal with the fragmentation and
benefit from the increased transparency, while
helping them to fulfil their new reporting liabilities.
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4. Conclusions: main changes
• The harmonisation of conduct of business rules for securities trading,
including strict rules on best execution of trades, client categorisation
and client reporting
• Rules on internal governance of investment firms, requiring them to
tackle conflict of interest, maintain good governance and ensure
continuity of their services
• The abolition of the concentration rules of the ISD, by which member
states could require trades to be executed on the main exchange or on
the regulated market
• The much greater possibility for investment firms to internalise trades
• The European passport for Multilateral Trading Facilities, which can be
created by investment firms and exchanges
• The extension of the single passport regime to some other services
(i.e. investment advice) and some other markets (commodities, more
derivatives).
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Int. nal Banking - Prof. G. Vento
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The Sarbanes–Oxley Act
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act
• The Sarbanes–Oxley Act of 2002, also known as the 'Public
Company Accounting Reform and Investor Protection Act‘,
is a United States federal law enacted on July 30, 2002.
• The bill was enacted as a reaction to a number of major
corporate and accounting scandals including those affecting
Enron and WorldCom.
• The legislation set new or enhanced standards for all U.S.
public company boards, management and public
accounting firms.
• Sarbanes–Oxley contains 11 titles that describe specific
mandates and requirements for financial reporting.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 1 Public Company
Accounting Oversight Board
• Public Company Accounting Oversight Board, to
provide independent oversight of public accounting
firms providing audit services ("auditors").
• It also creates a central oversight board tasked with
registering auditors, defining the specific processes
and procedures for compliance audits, inspecting
and policing conduct and quality control, and
enforcing compliance with the specific mandates of
SOX.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 2 Auditor
Independence
• Title II establishes standards for external
auditor independence, to limit conflicts of
interest.
• It also addresses new auditor approval
requirements, audit partner rotation, and
auditor reporting requirements. It restricts
auditing companies from providing non-audit
services (e.g., consulting) for the same clients.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 3 Corporate
responsability
• Title III mandates that senior executives take individual
responsibility for the accuracy and completeness of corporate
financial reports.
• It defines the interaction of external auditors and corporate audit
committees, and specifies the responsibility of corporate officers
for the accuracy and validity of corporate financial reports.
• It enumerates specific limits on the behaviors of corporate officers
and describes specific forfeitures of benefits and civil penalties for
non-compliance.
• For example, Section 302 requires that the company's "principal
officers" (typically the Chief Executive Officer and Chief Financial
Officer) certify and approve the integrity of their company financial
reports quarterly
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 4 Enhanced
Financial Disclosures
• Title IV describes enhanced reporting requirements
for financial transactions, including off-balance-sheet
transactions, pro-forma figures and stock
transactions of corporate officers.
• It requires internal controls for assuring the accuracy
of financial reports and disclosures, and mandates
both audits and reports on those controls.
• It also requires timely reporting of material changes
in financial condition and specific enhanced reviews
by the SEC or its agents of corporate reports.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 5 Analyst
Conflicts of Interest
• Title V includes measures designed to help
restore investor confidence in the reporting of
securities analysts.
• It defines the codes of conduct for securities
analysts and requires disclosure of knowable
conflicts of interest.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 6 Commission
Resources and Authority
• Title VI defines practices to restore investor
confidence in securities analysts.
• It also defines the SEC’s authority to censure
or bar securities professionals from practice
and defines conditions under which a person
can be barred from practicing as a broker,
advisor, or dealer.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 7 Studies and
Reports
• Title VII requires the Comptroller General and the
SEC to perform various studies and report their
findings.
• Studies and reports include the effects of
consolidation of public accounting firms, the role of
credit rating agencies in the operation of securities
markets, securities violations and enforcement
actions, and whether investment banks assisted
Enron, Global Crossing and others to manipulate
earnings and obfuscate true financial conditions.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 8 Corporate and
Criminal Fraud Accountability
• Title VIII is also referred to as the “Corporate
and Criminal Fraud Act of 2002”.
• It describes specific criminal penalties for
manipulation, destruction or alteration of
financial records or other interference with
investigations, while providing certain
protections for whistle-blowers.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 9 White Collar
Crime Penalty Enhancement
• Title IX is also called the “White Collar Crime
Penalty Enhancement Act of 2002.” This
section increases the criminal penalties
associated with white-collar crimes and
conspiracies.
• It recommends stronger sentencing guidelines
and specifically adds failure to certify
corporate financial reports as a criminal
offense.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 10 Corporate
Tax Returns
• Title X states that the Chief Executive Officer
should sign the company tax return.
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Int. nal Banking - Prof. G. Vento
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5. The Sarbanes–Oxley Act: title 11 Corporate
Tax Returns
• Title XI recommends a name for this title as
“Corporate Fraud Accountability Act of 2002”. It
identifies corporate fraud and records tampering as
criminal offenses and joins those offenses to specific
penalties.
• It also revises sentencing guidelines and strengthens
their penalties. This enables the SEC the resort to
temporarily freeze transactions or payments that
have been deemed "large" or "unusual".
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Next Lecture :
BANK FAILURES
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