Since 2007, MiFID – the Markets in Financial Instruments Directive, and its associated rules and regulations – has been a key pillar of the European Union’s regulatory framework. However, in the aftermath of the financial crisis, European lawmakers began working on an upgrade and, after several years of discussion, MiFID’s successor will become effective on 3 January – just over six weeks from now.
Although not as famous as the AIFMD in private equity circles, MiFID’s rules affect European venture capital and buyout firms in various important ways, and MiFID II will require many to adjust their policies and procedures. But private equity firms have been struggling to understand the precise impact, largely because the new rules were not written with them in mind.
Designed primarily to improve transparency among those who deal in securities on organised markets, MiFID II directly affects some private equity firms that are structured as advisers in the EU, while others will be impacted if they engage a placement agent or other third party who is regulated by MiFID. And, in the United Kingdom, some fund managers will be affected by a decision to “gold-plate” the European requirements and apply some of them more broadly, including to Alternative Investment Fund Managers (AIFMs).
Regulation that is clear and proportionate, and which targets well-defined policy goals, is to be applauded. To the extent that MiFID II affects the private equity industry, there is room for improvement on all three counts. And – although the industry associations have been working with regulators to clarify the application of the rules, in many cases successfully – there are still several areas where firms will find it hard to find a clear answer in the rulebooks.
By way of example: the rules on record-keeping (or telephone taping) are clearly designed for participants in public markets and seem hard to apply to those advising on the acquisition and disposal of private companies; the categorisation of local authorities as retail investors (requiring a bureaucratic “opt-up” process for those who want to be treated as professionals) fails to take account of the activities and scale of many of these authorities, which often manage significant pension scheme assets; and the inducements and best execution rules do not sit well with the way private equity firms operate.
Despite valiant attempts by some local regulators to make the rules work in a proportionate way, internal procedural changes and amendments to documents will be needed to adapt to rules that are ill-suited to some of the firms to which they apply. Most of these changes will seem pointless, offering little additional regulatory benefit. And – although the peg can be made to fit the hole – it will need to be forced.