The Incentives of the MiFID Directive

The MiFID Directive was designed to create a single and transparent financial services market. With a focus, mainly on consumer protection and competition in the markets. Therefore, MiFID regulates measures such as customer classification, suitability assessment, conflicts of interest and incentives.

In this entry, we are going to examine incentives, particularly what they are and thus what MiFID requires from the investment companies (referred to as the ESIs (in Spanish las empresas de inversion)).

What is an incentive?

Incentives are the fees, commissions or non-monetary profits that an ESI pays or receives from third parties for providing services to its clients.

To protect investors, the MiFID Directive creates restrictions when paying or receiving incentives. Therefore, this Directive establishes that payment of incentives can only be made when:

1. The cost of the service accurately reflects the quality of the service provided.
2. the responsibility has successfully been carried out to act honestly, impartially and professionally in the interest of the client.

Equally, the incentive must not directly or indirectly benefit the company receiving the incentive nor benefit its shareholders or employees. Especially in the scenario that the service is wrongly biased or distorted by the perception of the investment incentive.

When is an incentive considered to have raised the quality of service?

An incentive is considered to have raised the quality of service when it provides an additional service or a higher-level quality of service to the customer.

In addition to that explanation, we should highlight that an incentive also raises the quality of service when:

1. The delivery of an additional service to the client, which is proportional to the incentive.
2. There is no indirect or direct benefit to the ESIs, shareholders, employees or to the customer.
3. The incentive is continuous and therefore provides a long-term profit for the customer.

What are the incentive responsibilities of the ESIs?

The ESIs must have the evidence that proves the incentive raises the quality of service. Therefore, as evidence, the companies must produce and keep an internal list of all the incentives (both paid and received) which relate to the service provided. Additionally, they must record the specific way in which the incentives improve the quality of the service.

Similarly, the ESIs will inform the client of the predicted payments and profits before the provision of the service. If the ESIs cannot determine the ex-ante payment or profit before the provision, they will have to provide ex-post information. The information should be provided at least once a year, on a case-by-case basis.

Incentives and Independent Investment Advice

ESIs that provide independent advice will return to the clients the incentives paid from third parties which relate to the services. All incentives received by third parties relating to independent advice will be transferred to the client in full.

ESIs will inform clients of the incentives that have been transferred to them in the periodic information statements sent.

However, in terms of independent advice, there are certain profits which will not be considered as incentives as such, instead, they are defined as “small non-financial profits”, which we specify below:

1. General financial information on a financial instrument or investment service.
2. Personalised information from a financial instrument or investment service if it reflects the circumstances of a client.
3. Third party instruments, created to promote new investments. The issuer hires a company to prepare such materials on an ongoing basis, which reflects the relationship. The materials must be made available to the desired ESIs at the same time.
4. Attendance to conferences or training activities about the characteristics of a financial instrument or service.
5. Cost expenses for representation of a “derisory” value, such as expenses or training activity.

In any case, the small non-financial profits should always be realistic, with no potential harm or impact on the behaviour of the ESIs nor the client.

The disclosure of the small non-financial profits shall also be required before the provision of services. However, they can be described in the generic form of client information.

Conclusion

The MiFID Directive generally prohibits incentives related to the provision of services to a client. Regardless, the directive allows this practice in certain cases. The most common exception is the incentive closely linked to the quality of the service provided to the client. In the case of independent advice services, any incentive received must be returned in full to the client. ESIs must always inform clients of the incentives paid and received at all times. Additionally, information is to be provided, in general, before the service is provided.