With just 3 months left to achieve compliance with the introduction of MiFID II on 3 January 2018, we've highlighted below the 7 key areas that are pertinent to most firms across financial services.
1. Inducements and Research
In agreement with ESMA, the FCA has stated that there is no exemption to the MiFID II obligations for an investment firm; should an investment firm wish to receive third party research, it must either pay for it from its own account (P&L) or from a Research Payment Account (RPA).
COBS 2.3B contains the relevant rules in relation to research requirements that must be met in order for research to not be considered an inducement. COBS 2.3C goes on to provide the relevant rules applicable to investment firms who are providers of research.
COBS 2.3B.23 includes a list of services that the FCA considers NOT to be research and therefore cannot be paid for out of an RPA. An example of something that the FCA does not consider to be research would be “Corporate Access Services”. This stance by the FCA is considered to be more stringent than other EEA member states, such as France. The FCA is also taking a firm view on macro-economic research, expecting it to be separately priced and paid for, which reinforces the position outlined in ESMA’s ‘Q&A on MiFID II and MiFIR Investor Protection and Intermediaries topics’.
2. Client Categorisation
The FCA has highlighted that it will not provide a definition of what can be considered a Local Authority (LA) and it will be left to firms to interpret the definition. The re-categorisation of LAs as professional or Eligible Counterparties (ECP) is subject to the more defined qualitative and quantitative criteria. The criteria provided for you to assess your clients (whether a legal entity or natural person) is defined in the
PS17/14.
Transitional rules allow firms to opt-up their clients, ahead of Jan 2018, but this is now a tight timescale, especially as MiFID II has a non-harmonised approach to LAs based in different member states. Complexities could arise where EEA Member States set alternative or additional quantitative criteria. As such, firms may need to defer to the criteria deemed appropriate for the local government in that territory.
3. Best Execution
The FCA will extend the MiFID II best execution provisions to UCITS management companies, as consulted on in
CP16/29, but with some modifications:
- application of the EU Regulatory Technical Standard (RTS) 28 reporting is to be treated at the level of the firms, not the individual funds. The applicable rules are set out in COBS 11.2B;
- the FCA has decided NOT to apply the RTS 28 reports and other aspects of the enhancements of the best execution rules to full-scope UK AIFMs currently. It will however, further consider the interaction between MiFID II and AIFMD later in 2017.
4. Disclosures
The FCA clarified that the requirements will apply to discretionary investment management activities.
- COBS 9A has been included to address the MiFID II Suitability requirements and firms should follow our communications for an update on further ESMA guidance that is expected later this year;
- in terms of an update regarding the Appropriateness requirements - contrary to the June ESMA Q&A update, the FCA has maintained the view expressed in CP16/29 that investment trusts are not automatically non‑complex, nor automatically complex. They need to be assessed against the criteria in the MiFID II delegated regulation;
- the FCA also stated that when firms apply the ‘complex’ criteria, a measured and more cautious approach should be applied if there is any doubt over whether a financial instrument is non-complex;
- the FCA is not proposing to establish a standardised format for disclosing point-of-sale (ex-ante) or post-sale (ex-post) information (relating to areas such as costs and charges) and expects firms to develop their own approach.
5. Product Governance
PROD 3.1.3 contains ‘Proportionality’ principles for simple products being manufactured for the mass retail market, which is considered as a welcome move from the FCA. We would encourage firms to pay careful attention to PROD 3.2.11, which sets out the Target Market Assessment (TMA) that should be considered in conjunction with PROD 3.2.14 and 3.2.15. Some firms are using the European Working Group templates (which includes European asset managers, banks, insurers and distributors) for the industry, as these incorporate the key criteria as highlighted by ESMA. The criteria includes:
- the type of client to whom the product is targeted;
- knowledge and experience;
- financial situation (with a focus on the ability to bear losses);
- risk tolerance and compatibility of the risk/reward profile of the product target market;
- client's objectives and needs, distribution strategy, costs & charges ex ante, costs & charges ex post.
6. Recording of telephone conversations and electronic communications
The FCA clarified that the requirements will apply to discretionary investment management activities and the FCA’s rules on recording will apply in relation to the investment activities specified under SYSC 10A. The FCA will continue to require firms to record conversations relating to portfolio management activities, but remove the obligation, if the communication is not linked to instruments traded on a trading venue (ToTV). As previously anticipated, the new recording regime will apply to Retail Financial Adviser (RFA) firms and to UK branches of non-EEA firms.
7. Territorial issues
Industry participants are considering how best to apply MiFID II requirements with key considerations for non-EU service providers relating to:
- the implications for non-EU product manufacturers servicing EU clients, and;
- differential transaction reporting standards which mean that non-EU Brokers who service EEA firms need to undertake transaction reporting, but non-EEA subsidiaries do not need to do so.
The issues pertaining to territory cannot be considered in isolation and the challenge for a number of firms operating outside of Europe is trying to address these considerations and a differentiated regime, together with those MiFID II requirements on product governance.
There are obviously many layers to MiFID II and above we have highlighted seven of the key strands that are likely to affect the majority, if not all Financial Services firms, depending on your regulatory permissions and activities. For assistance in finalising your response, please
contact us to discuss your needs.
[1] COBS 2.3B.23 (5) – Corporate Access Services - a service of arranging or bringing about contact between an investment manager and an issuer or potential issuer.
[2] Section 7 – Inducements: Question 8- https://www.esma.europa.eu/sites/default/files/library/esma35-43-349_mifid_ii_qa_on_investor_protection_topics.pdf