Global capital markets are shaped by various regulations. In particular, the European Union (‘’EU‘’) and the United States of America (‘’USA‘’) stand out as two of the most important regulatory authorities that determine the functioning of capital markets. In this context, the EU’s MiFID II (Markets in Financial Instruments Directive II) and the US SEC (Securities and Exchange Commission) regulations and the Dodd-Frank Act are among the main regulations that directly affect foreign investors’ securities trading.
A. MiFID II
MiFID II is one of the most important legislations in the field of finance and investment. Introduced by the European Union in 2018 to regulate financial markets and increase protections for investors, this legislation aims to standardise financial practices across the EU and restore confidence in the sector, especially after the 2008 financial crisis.
MiFID II covers almost all aspects of financial investment and trading and all financial professionals working in the EU. Banks and bank managers, traders, funds and fund managers, exchanges and stock exchange authorities, brokers, institutional and retail investors must comply with these regulations. It regulates off-exchange trading and over-the-counter transactions and directs investors to official exchanges.
Some of the important changes to trading and investment introduced by MiFID II are mentioned below:
Regulated trade
One of the main objectives of MiFID II was to move transactions out of over-the-counter (OTC) markets and dark pools to regulated and supervised trading platforms. MiFID II created a new trading platform, the organised trading facility (OTF), to cover previously unregulated transactions.
Transparency
Regulated markets and multilateral trading facilities (MTFs) must publish the bid and ask prices of securities on a continuous basis. Banks and brokerage houses cannot charge for research and trading services in a single package. In this way, customers can see the cost of each service separately and thus make more informed decisions.
MiFID II provides more transparency by separating research and trading fees. Investors can now clearly recognise how much they are paying for each service and make more informed decisions about which services they wish to receive.
Investor Protection
MiFID II limits incentive payments made to investment firms or financial advisers by third parties for the purpose of providing indirect access to clients. The aim of this regulation is to reduce conflicts of interest in the advice and services offered by banks and investment services. These services must now be provided directly in the best interests of the client and not in the interests of unknown third parties.
Reporting Obligations
Investment firms are required to submit reports to the regulatory authorities on the day following the day of the transaction, including details of each transaction they execute. They are also required to keep records of all communications, including telephone calls. This allows regulators to better monitor potential market abuse. Transaction reporting is mandatory not only for sell-side firms (e.g. intermediary firms), but also for the counterparties that initiate the transaction.
In summary, the main policies of MiFID II are to increase transparency in transactions and costs, reduce OTC and dark pool transactions, and protect clients against conflicts of interest of investment managers who receive commissions from third parties.
B. Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act, which entered into force in the US in July 2010 following the 2008 global financial crisis, is a comprehensive regulation that aims to establish stricter oversight and supervision mechanisms in financial markets.
Due to the perception of inadequate regulation and high dependence on large banks, it aimed to introduce stricter rules to prevent a re-emergence of the 2008 financial crisis, enhance financial stability and protect consumers from certain financial practices.
Financial Stability Oversight Council
The Act established the Financial Stability Oversight Council (FSOC) to handle issues affecting the financial sector and protect consumers from abusive financial practices. The Council was created together with the Office of Financial Research under Title I of the Act. The two organisations work closely to monitor systemic risk and investigate the state of the economy.
Office of Financial Research
The Office of Financial Research (OFR) works with the FSOC by providing necessary data on the activities of the financial services industry. The OFR is authorised to receive data from any institution in the sector in order to fulfil its duties. It also publishes guidelines to standardise the way firms report data.
Consumer Financial Protection Bureau
The Dodd-Frank law established the Consumer Financial Protection Bureau (CFPB) to protect consumers from large unregulated financial institutions. The CFPB is tasked with preventing risky business practices that are likely to harm consumers. The CFPB requires lenders to disclose information to consumers in a manner that is easy to read and conceptualise.
Volcker Rule
The rule restricts banks from holding more than 3 per cent of the total ownership interest in a private equity fund or hedge fund because they are considered too risky. Thus, it enables banks to reduce risk and create a more secure financial system.
Impact on Financial Institutions
Stricter supervision and reporting requirements were imposed on banks and other financial institutions, and stricter standards on capital adequacy, liquidity and risk management were introduced. Large financial institutions were monitored more closely and restrictions were imposed on their investment strategies.
Impacts on Consumers
Consumers have the chance to be better protected with regard to financial products and services through the Consumer Financial Protection Bureau. The Bureau defends consumer rights, fights against unfair practices and increases the transparency of financial products. Consumers have also become better informed about credit cards and other borrowing products.
The Dodd-Frank Act is still in effect, but its regulatory power was reduced in 2018 with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (‘Economic Growth, Regulatory Relief, and Consumer Protection Act’).
The Dodd-Frank Act introduced additional regulatory costs and supervisory obligations, especially for large institutional investors and hedge funds. This may make it difficult for foreign investors to enter US markets and restrict their access to certain financial instruments.
Regulations on both EU and US capital markets directly affect the securities trading processes of foreign investors. MiFID II provides greater transparency and oversight in EU markets, while increasing reporting obligations for foreign investors. SEC regulations impose certain restrictions and obligations for investors wishing to operate in the US, while the Dodd-Frank Act affects foreign investors’ investment decisions, particularly by limiting risky transactions by financial institutions.
