Christopher Bond MSI Senior Adviser to SII on

Christopher Bond MSI Senior Adviser to SII on Compliance Presentation on Mi. FID to the Greek Branch of the Securities & Investment Institute 28 June 2006 www. sii. org. uk

“ “ This [Mi. FID] proposal is a cornerstone of the Financial Services Action Plan. If we want a true internal market in financial services, with all the enormous benefits that will bring, we need investors large and small to be able to invest across borders easily and with confidence Fritz Bolkstein EU Internal Markets Commissioner on Mi. FID in November 2002 when the proposal was launched.

The Challenge and Opportunity of Mi. FID “ The clear cost of implementation of Mi. FID will only prove justified if firms take the opportunities generated to raise revenues. ” (John Tiner’s Speech to the UK Financial Services Authority’s (FSA) Mi. FID Conference on 15 May 2006. )

Mi. FID at a Glance Scope of Mi. FID increased e. g. Investment advice Regulated Markets and Alternative Trading Systems e. g. MTFs Mi. FID Conduct of Business e. g. home country rules (separate slide) Internal Organisation e. g. Conflicts of Interest (separate slide)

Lamfalussy Process Framework Directive Implementing Directive/ Regulation Regulatory Convergence Monitoring & Enforcement Level 1 Level 2 Level 3 Level 4 Mi. FID Directive Implementing Measures FSA Rules Member States From May 2006 Ongoing April 2004 July 2006

Draft EU Commission Level 2 Directive and Regulation Who? Why? • ISD Firms new activities eg Advice and additional instruments eg commodity derivatives, - some carveouts eg group firms What? EU Commission Level 2 • Internal requirements for Firms eg under Article 13 • Relations with customers and counterparties eg under Article 17 • Regulation of exchanges, multilateral trading facilities (MTFs) and Systematic Internalizers (broadly OTC market makers) • Level 1 (High Level Directive) • Level 2 (More detailed Directive and Regulation explaining Level 1) • Level 3 ( EU Commission ensuring consistent adoption of Directive by different countries) • Level 4 (Implementation of Mi. FID by each country) When? • 31 January 2007 – the Transposition Date for each country finalizing detailed rules for its Firms • 1 November 2007 – the Implementation Date for each country to have new Rules in force. (EU Parliament and ESC to vote on Level 2 in mid July 2006).

Draft EU Commission Level 2 Documents Progress since February Draft June 2006 EU Parliamentary Committee examines draft Level 2 Directive and Regulation EU Parliament votes to approve Level 2 documents September 2006 ESC votes to approve Level 2 documents EU Commission approaches Level 3 harmonization of implementation by different EU countries Review of Mi. FID exemptions starts January 2007 Transposition Date for each country to finalize Mi. FID implementation wording (Level 4) November 2007 Start date of Mi. FID

The Possible Impact of Mi. FID Largest Firms Absorb extra IT and Regulatory costs Save cost of complying with 26 different Business requirements Use market making to challenge traditional exchanges Midsized Firm Smaller Firm Struggle to meet extra IT regulatory costs No savings if no international operations No savings but less expenditure than mid-sized Decide whether to start/ expand EU cross-border business to make up for new competition Decide whether new competition likely to damage retail customer If decide not to do so, need to narrow focus and expand in areas of strength If so, change business model, sell out or join network If not, do nothing?

The Possible Impact of Mi. FID Larger IT and Regulatory Costs Larger Firms absorb costs and target first institutional and later retail customers in larger EU markets Smaller firms reduce revenues and profit Investors receive better service and lower costs Smaller firms narrow scope of business to areas of strength, or merge with larger firms or networks

Regulatory Impact Analysis High Moderate Low Client Classification PA Dealing Outsourcing Risk Management Client Order Handling Conflicts of Interest Suitability Internal Audit Appropriateness Best Execution Safekeeping Assets Record Keeping Client Reporting Information to Clients Inducements Transaction reporting Marketing Compliance Internal Audit

Mi. FID for Investment Managers – Relations with Customers Retail Customer Agreements Permitted investments including limits Method and frequency of valuations Objectives and permitted levels of risk Reporting percentage of loss Reporting to Retail Customers Frequency eg quarterly Investment Management No prescription on content or frequency for professional clients Best Execution responsibility Transaction execution details eg venue Break down of commission fees and charges Information on corporate actions

Mi. FID for Brokers – Relations with Customers and Counter Parties New client agreement eg best execution New client classification eg experts Order handling eg exposure of limit orders to market New best execution test eg including transaction costs Restrictions on execution only eg derivatives New definition of investment advice Pre trade price transparency and obligations to deal on Systematic internalisers New definition of investment research Reporting to customers eg execution venue Appropriateness test Post trade pan Europe price transparency

Which Regulated Firms come under Mi. FID? Investment Banks Multilateral Trading Facilities Most Brokers Many Commodities Firms Funds and Some Fund Operators Financial Advisers without client assets Investment Managers Regulated Exchanges Some transmitters of buy/sell orders Life Companies Corporate Finance Authorized Professional Firms NOTE: The country regulator can decide if firms below the line can opt out of Mi. FID. They are not Mi. FID firms but will still be regulated. Some Mi. FID rules may apply to them e. g. in Conduct of Business

Which Firm Functions are Affected? Front Office e. g. Sales, Trading and Investment Management e. g. Conduct of Business HR Operations e. g. Training e. g. trade reporting Senior Management Mi. FID I. T. Technology e. g. data collection Legal e. g. Client Agreements Internal Audit Compliance e. g. authority

Systems and Controls Conflicts of Interest Independence of Risk Function Independence of Compliance Function Mi. FID Independence of Internal Audit Internal Organisation e. g. Operational Risk Outsourcing Restrictions

What is the new approach to internal systems and controls? Current Approach of SYSC under Chapter 3 (FSA Rules) Future Approach under Article 34 (CAD) and Article 22 BCD (together CRD, and under Article 13 of Mi. FID. ) • Establish effective systems and controls • Periodically review them • Allocate responsibility to individual managers • “Material” outsourcing • Separate front and back office NB More detail on a few areas such as money laundering • Robust Governance • Internal Controls • Administration and Accounting • Sufficient capital for risks, and effective risk management • Manage Conflicts of Interest • Business Continuity • Outsourcing controls • SM responsible for internal audit, compliance and risk

Mi. FID – IT/Operations Perspective Account opening eg new client classifications Best Execution venue analysis and monitoring Post trade reporting including new products 5 year record keeping – 1 year phone recording Pre-trade price reporting for equities from S. I. s and MTFs IT/Operations Instrument data problem eg ISIN contrast RIC Order execution and routing systems Increased product scope eg OTC Derivatives NOTE: The Capital Requirements Directive preparation is at the same time.

Clients Professional Retail Eligible Counterparty References to clients and to professional clients include eligible counterparties

What is Best Execution? New Factors under Mi. FID Level 1 Article 21 Best Result for client taking into account: • Price (including disclosed charges) • Speed • Likelihood of execution and settlement • Size • Nature of investment and of client

Best Execution Evidence of achievement of Policy Effectiveness of Policy Execution Policy disclosed to Clients Affects buy side and sell side Applies to new and existing ISD instruments Best Execution Firms must have “Execution Policy” with chosen execution venues Applies to agency and principal dealing Duty is owed to Professional and Retail Clients

Some Best Execution Questions • How do investment managers satisfy their duties to clients if categorized as Eligible Counterparties by executing firms? • Can a firm direct all its trades to one execution venue or dealer? • What sources of price comparison do you use in markets without public data e. g. OTC markets?

Do you start, or do you wait for more? “ The area of where significant change (to the Level 2 EU Commission Mi. FID documents) is likely are now few and we all need to start preparing for Mi. FID now. ” (John Tiner’s Speech to the FSA’s Mi. FID Conference on 15 May 2006. )

Start Now! • GAP Analysis/Implementation plan • Budget (HR and IT) • Review client – classifications – agreements – information held – information provided • Plan communication with clients • Review internal policies and procedures