MiFID and Outsourcing

October 2008
Ashley Winton

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The Markets in Financial Instruments Directive (Directive 2004/39 EC) ("MiFID") came into force on 1 November 2007. Its essential aim is to liberalise the European market for certain investment services.

MiFID seeks to do this by: (i) establishing a common regulatory framework for the execution of transactions in financial instruments, with the emphasis being on high quality execution for customer transactions; and (ii) facilitating the carrying out of investment transactions by investment firms on financial markets across Europe. MiFID does not apply to a number of bodies including, notably, insurance undertakings, credit institutions and investment funds.

MiFID expressly addresses outsourcing in Article 13(5), which sets forth the outsourcing obligation with which investment firms must comply. Article 13(5) distinguishes between:

• Outsourcing of operational functions which are critical for the provision of continuous and satisfactory services to clients and the performance of investment activities on a continuous and satisfactory basis. In those circumstances, the investment firm must take reasonable steps to avoid undue additional operational risk; and
• Outsourcing of important operational functions, which may not be undertaken in such a way as to impair materially the quality of the investment firm’s internal controls of the ability of the applicable regulatory authority to supervise the firm’s compliance with its obligations.

In the UK, changes have been made to the FSA Handbook to reflect the additional requirements of MiFID. Those changes have been in effect since 1 November 2007 and apply to outsourcing arrangements entered into after that date as well as arrangements already in place at that date. In particular, modifications were made to the SYSC Module of the FSA Handbook and the MiFID requirements are also reflected in the MiFID Connect Outsourcing Guideline, which is FSA-approved industry guidance on the application of MiFID to outsourcing arrangements. It is important to note that, unlike the MiFID Connect Guidelines, the rules set forth in the FSA Handbook are legally binding obligations with which investment firms are required to comply.