Financial Regulation and MiFID II

MiFID II: Context for Lawyers

Directive 2014/65/EU on markets in financial instruments (MiFID II), in force since January 2018, and its Spanish transposition through Royal Decree-Law 14/2018, establish the regulatory framework for investment services in the EU.

For lawyers, MiFID II is relevant in multiple contexts: advising financial entities, litigation over complex financial products, due diligence in corporate transactions, and consumer financial protection.

Client Categories

MiFID II classifies clients into three categories, each with a different level of protection:

Retail Client

Any natural or legal person who is neither professional nor an eligible counterparty. Receives the highest level of protection: more detailed information, mandatory suitability or appropriateness tests, enhanced best execution.

Professional Client

Entities meeting at least two of three criteria: total balance sheet exceeding 20 million euros, net turnover exceeding 40 million euros, or own funds exceeding 2 million euros. Institutional investors (funds, insurers, credit institutions) are also included. They receive an intermediate level of protection.

Eligible Counterparty

Credit institutions, investment firms, insurance companies, collective investment schemes, and national governments. They receive the minimum level of protection and can negotiate directly without most safeguards.

A key point for lawyers: a financial entity can reclassify a professional client as retail (more protection) or request reclassification of a retail client as professional (less protection), but the latter requires express assessment and written consent.

Suitability Test and Appropriateness Test

Suitability Test

Mandatory when the entity provides investment advice or discretionary portfolio management. It must evaluate:

• Knowledge and experience of the client in the product type.
• Financial situation: ability to bear losses consistent with investment objectives.
• Investment objectives: time horizon, risk preferences, purpose of the investment.

If the product is not suitable, the entity cannot recommend it.

Appropriateness Test

Mandatory for services other than advice (order execution, reception and transmission). It evaluates only the client's knowledge and experience. If the product is not appropriate, the entity must warn the client, who may still proceed.

Execution-Only Transactions

For non-complex products (listed shares, UCITS funds, bonds without derivatives), the client can trade without any test if the transaction is self-initiated. However, the entity must correctly classify the product as "non-complex."

Information Obligations

MiFID II strengthens transparency requirements:

• Costs and charges: complete breakdown of all service and product costs, both ex ante (before contracting) and ex post (annual report). Includes commissions, management fees, transaction costs, and inducements.
• Periodic reports: at least quarterly for discretionary management.
• Durable medium: all relevant information must be provided in a medium that allows retention and reproduction.

Product Governance

A core MiFID II pillar: manufacturers of financial products must define a target market for each product, specifying the type of client, needs, characteristics, and objectives. Distributors must verify that the product is compatible with the end client's needs.

This concept is especially relevant in litigation over complex products (preference shares, convertible bonds, derivatives): if the product was sold outside its target market, it constitutes a relevant regulatory breach.

Conflicts of Interest

Entities must identify, prevent, and manage conflicts of interest that may harm the client. This includes:

• A written conflicts of interest policy, updated periodically.
• A record of activities that generate or may generate conflicts.
• Disclosure to the client when preventive measures are insufficient to reasonably ensure the risk of harm is eliminated.
• Prohibition of inducements that may bias advice (except those that enhance service quality and are disclosed in advance).