Introduction

The Markets in Financial Instruments Directive II (MiFID II) is the key piece of legislation for standardising financial practices and increasing investor protections in the EU following the Global Financial Crisis (GFC) in 2008. 

Unveiled in 2018, 11 years after part one of the directive, MiFID II looks to improve transparency in transactions and costs of financial products, bring more trading onto exchanges, combat conflicts of interest within investment managers and introduce greater scrutiny of innovations such as algorithmic trading and client sustainability preferences. 

Crucially, it differs from the original MiFID by broadening its focus beyond equities and EU entities to also cover fixed income, derivatives, commodities, currencies and investment products issued outside of the EU. 

MiFID II cornerstones

Part two of the directive covers standards for a range of financial practices, however, its key facets span trading, transparency, reporting and sustainability preferences. 

On trading, a key aim of MiFID II was to push onto ‘lit’ venues – exchanges – and away from over-the-counter (OTC) trading and dark pools. 

As part of this, the directive created the organised trading facility (OTF) to capture previously unregulated non-equity trades while requiring investment firms executing client orders to be a multilateral trading facility (MTF). 

It also places additional scrutiny on algorithmic and high frequency trading. Market participants are required to report on the algorithms and strategies employed in high frequency trading, their algorithms must be easy to audit and clear standards are in place for the use of algorithms across market making, tick size arbitrage and the prevention of quote stuffing. 

Next, MiFID II fosters transparency across key areas including security pricing, by requiring regulated markets and MTFs to continuously publish bid and offer prices on securities. 

Similarly, for transparency in the cost of services, the directive prevents banks and brokerages from bundling the cost of research and transactions, enabling investors to compare prices for each service in isolation. 

On reporting requirements, MiFID II obligates sell-side firms – such as brokers – and counterparties to report on each transaction they execute by the following day as well as keeping a record of all communications. 

Another key element of the directive is that investment firms are required to ask clients about their individual sustainability preferences, which will inform them on whether criteria such as minimum investment thresholds, EU Taxonomy alignment or principal adverse impacts should be factored into their investments. 

Further developments

Looking ahead, several components of MiFID II were reviewed for years after its introduction, with some changes yet to be implemented and other areas still being debated.  

For instance, the directive intends to further investor protection by restricting inducements paid to investment firms and advisers by third parties for preferential treatment of their products, even if these products may not represent a client’s best interests. 

However, the EU has fallen short on an outright ban on inducements, instead proposing in 2023 to only ban inducements on advice-free sales of products. 

Elsewhere, the EU agreed to establish a consolidated tape, which is a centralised data feed to aggregate price and trading volume data across venues. 

While the political agreement outlining an initial vision of the tape was finalised in June 2023, there will be a review in June 2026 where market participants will be able to recommend changes to the contents of the consolidated tape. 

Coinciding with the political agreement on the consolidated tape, EU bodies agreed to ban payment for order flow (PFOF), preventing brokers from receiving kickbacks for driving client orders to specific trading platforms. 

While the UK already had a ban on PFOF practices, some EU member states have been given until 2026 to enforce the new rules. 

A final change outlined in the MiFID II review put before the European Parliament in October 2023 was the requirement for regulated markets to be able to halt or limit trading during emergencies or short-term fluctuations in the price of a particular instrument.