Markets in Financial Instruments Directive – MiFID

“When funds flow from surplus economic units to a financial institution to a deficit economic unit, the process is known as intermediation. The financial institution acts as an intermediary between the two economic units.” (Gallagher and Andrew, supra at 45 – see reference list). Major financial intermediaries are: banks, insurance companies, investment firms, pension funds, and collective investment undertakings [Mutual Funds: US; UCITS: EU]. The major deficit economic units are government and firms. The function of financial intermediaries is to draw funds from numerous small surplus economic units, pool their resources into large funds, and purchase securities from, and/or lend capital to, firms and government. The services of financial intermediation range in cost, and when an initial public offering is involved, the flotation costs to the firm are substantial.

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Without getting into the nuts and bolts of order routing of customers’ orders, the practice of executing an order “in-house” requires discussion because of the important role it plays in MiFID. Large brokerage houses, such as Charles Schwab and Merrill Lynch, often do not route client orders to market venues but match buy and sell orders internally or draw upon their own inventory to execute the trade. In principle, there is nothing wrong with this practice provided the firm acts consistently with its duty of best execution. The MiFID defines a firm engaging in this activity a “systematic internaliser”, and provides a “systematic internaliser means an investment firm that which, on an organised, frequent and systematic basis, deals on own account by executing client orders outside a regulated market or an MTF” (Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, Article 4(7); Directive 2006/73/EC of 10 August 2006 implementing Directive 2004/39/EC of the European Parliament and of the Council as regards organisational requirement and operating conditions for investment firms and defined terms for the purposes of the Directive).

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