Markets in Financial Instruments Directive (MiFID II)

Markets in Financial Instruments Directive (MiFID II)

MiFID II, the Directive on Markets in Financial Instruments repealing MiFID I, was adopted in May 2014. Its transposition and application dates were delayed by one year: Member States now have to transpose the new rules by 2 July 2017 and they apply as of 3 January 2018.

The revised MiFID builds on the MiFID I rules that are already in place and strengthens the protection of investors by introducing new organisational and conduct requirements. During the legislative process, BIPAR and its Working Party on MiFID have been active in explaining their views to EU and national legislators on provisions affecting intermediaries and financial advisers, such as the ones on the ban of commission in the case of independent advice, the requirement of quality enhancement in the case of commissions, the knowledge and competence requirements, provisions adding unjustified burden to SME intermediaries and financial advisers such as product governance requirements, etc.

Key MiFID II provisions for intermediaries/ financial advisers

Opt-out provisions (Article 3)

Firms that are regulated at national level and that do not hold clients’ money and only receive and transmit orders and/or provide advice, such as financial intermediaries, can be exempted by Member States from the MiFID II regime. Some MiFID II requirements, however, have to be applied in an “analogous” way to opt-out firms. These relate to conditions and procedures for authorisation and ongoing supervision, conduct of business requirements (including the ban on commission for independent advice), organisational requirements (e.g. the requirement to keep records). Opt-out firms have to be covered by an investor's compensation scheme or a PII. Opt-out firms do not benefit from the MiFID II Single Licence to operate cross-border.

Conflicts of interest (Article 23)

Firms have to: “take all appropriate steps to identify and to prevent or manage conflicts of interest between themselves, including their managers, employees and tied agents, or any person directly or indirectly linked to them by control and their clients or between one client and another that arise in the course of providing any investment and ancillary services, or combinations thereof, including those caused by the receipt of inducements from third parties or by the investment firm’s own remuneration and other incentive structures“.

In case the prevention of conflicts of interest does not ensure that risks of damage to clients' interests will be prevented, the firm has to clearly disclose the general nature and/or sources of conflicts of interest and the steps taken to mitigate those risks before undertaking business. The MiFID II Delegated Acts further define the steps to identify, prevent, manage and disclose conflicts of interest and also establish appropriate criteria for determining the types of conflicts of interest whose existence may damage the interests of clients (see below).

Information requirements, independent advice, cross-selling (Article 24)

Firms have to act honestly, fairly and professionally in accordance with the best interests of their clients. All information to clients has to be fair, clear and not misleading and manufacturers have to design products for an identified target market, have a compatible distribution strategy and take reasonable steps to ensure that the instrument is distributed to this target market.

Firms have to understand the products they offer or recommend, assess the compatibility of the financial instruments with the needs of the clients, also taking account of the identified target market of end clients and ensure that financial instruments are only offered or recommended when this is in the interest of the client. Information has to be given about the firm and its services, financial instruments and proposed investment strategies, execution venues and all costs and related charges.

In case investment advice is provided, firms have to inform the client in good time before the advice is provided:

  • whether or not it is provided on an independent basis;
  • whether it is based on a broad or more restricted analysis of types of instruments (close links-concept);
  • whether it will provide the client with a periodic suitability assessment.

The information on all costs and associated charges (regarding investment or ancillary services) must include the cost of advice, where relevant the cost of the financial instrument recommended or marketed and how the client may pay for it, also encompassing any third party payments (this info is to be aggregated and upon request itemised).

Where applicable, such information shall be provided to the client on a regular basis, at least annually, during the life of the investment. The information has to be provided in a comprehensible form (Member States may allow a standardised format).

Where a firm informs the client that investment advice is provided on an independent basis, the firm:

  • shall assess a sufficient range of instruments available on the market (diverse with regard to the type and issuers or product providers, not limited to products from the firm itself/entities with close links)
  • shall not accept and retain fees, commissions or any monetary or non-monetary benefits paid or provided by any third party or a person acting on behalf of a third party in relation to the provision of the service to clients (minor non-monetary benefits are allowed under certain conditions).

Firms are not seen as fulfilling the conflict of interest rules or the requirement to act honestly etc. where they pay or are paid any “remuneration” to or by any party except the client (or a person on behalf of the client), unless this:

  • is designed to enhance the quality of the relevant service to the client; and
  • does not impair compliance with the firm's duty to act honestly, fairly, professionally and in accordance with the best interest of its clients.

There also has to be a clear disclosure of the existence, nature and amount of “payments and benefits” or, where the amount cannot be ascertained, the method of calculating, prior to the provision of the service. Where applicable, the firm shall also inform the client on mechanisms for transferring this “remuneration” to the client.

Remuneration or the assessment of the performance of staff should not be done in a way that conflicts with the duty to act in the best interests of its clients (in particular no incentives should be given to recommend something when a different instrument that would better meet that retail client’s needs could be offered).

Regarding cross-sales, when an investment service is offered together with another service /product as part of a package or as a condition for the same agreement or package, the firm shall inform the client whether it is possible to buy the different components separately and shall provide for a separate evidence of the costs and charges of each component. The text requires that in case of cross-sales the overall package is suitable or appropriate (see below). The European Securities and Markets Authority (ESMA) developed Guidelines for the assessment and the supervision of cross-selling practices (see below).

Member States may, in exceptional cases, impose additional requirements on investment firms in respect of the matters covered by Article 24. There are MiFID II Delegated Acts that further develop the requirement for investment firms to comply with the principles set out in Article 24 (see below).

Knowledge and competence, suitability, appropriateness (Article 25)

Firms have to ensure and demonstrate to their authorities -upon request- that natural persons giving investment advice or information possess the necessary knowledge and competence. Member States have to publish the criteria used to assess knowledge and competence. ESMA has published Guidelines on the assessment of knowledge and competence (see below). The knowledge and competence provision is not amongst the list of requirements for opt-out firms to comply with in an "analogous" way.

The suitability test implies that in case of advice, firms have to obtain the necessary information regarding the client's knowledge and experience in the investment field relevant to the specific type of product or service, his financial situation including his ability to bear losses, and his investment objectives including his risk tolerance. A statement on suitability, specifying the advice given and how that advice meets the preferences, objectives and other characteristics of the retail client, will have to be given in a durable medium.

In case no advice is given, the appropriateness test is required, implying that the firm asks the client to provide information regarding his knowledge and experience in the investment field relevant to the specific type of product or service offered or demanded. In case the firm considers a product to be inappropriate, it has to warn the client – which may be done in a standardised format. Under specific conditions and if firms provide services that only consist of execution or reception and transmission of client orders with or without ancillary services, Member States shall allow firms to waive the appropriateness test.

Levels 2 and 3 and BIPAR action in this respect

ESMA held various consultations on their draft wording for the Delegated and Implementing Acts on the one hand (ESMA technical advice to the European Commission, delivered end December 2014) and on technical standards (implementing and regulatory technical standards - ITS and RTS) on the other hand. BIPAR responded to the consultations preceding delivery of the ESMA advice and also undertook actions once the advice was published, in particular with regard to the rules on quality enhancement, product governance and proportionality of organisational requirements.

With regard to level 3 Guidelines, BIPAR and its working party also responded to the different ESMA consultations and discussed the BIPAR views with EU officials in charge of the dossiers.

  • Delegated Acts

In April 2016, the European Commission published a Delegated Directive and Delegated Regulation covering several issues of importance to BIPAR. The European Parliament and the Council of the EU did not express any objections to these texts during their scrutiny period. The texts were published in the Official Journal of the EU almost a year later, on 31 March 2017. They will apply from the same date as MiFID II: 3 January 2018.

The Delegated Directive contains specifications of the level 1, MiFID II text with regard to the safeguarding of financial instruments and funds belonging to clients, product governance obligations, and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits.

Regarding product governance, BIPAR has always supported the principle of product governance for manufacturers of products. Product governance rules should, however, not lead to a shift of responsibility from the manufacturer to the distributor, something BIPAR believes the Delegated Directive does. BIPAR does not support the requirement for distributors to provide the manufacturer with sales information. Regarding “quality enhancement”[1] on which BIPAR has been very active, BIPAR still regrets and is not, in principle, in agreement that in a highly competitive market, remuneration is supervised and regulated at such a level of detail. BIPAR supports that the list of additional or “higher level services” in the Delegated Directive is not exhaustive. BIPAR believes that the evidence-gathering required from firms to prove quality enhancement, is heavy and bureaucratic, especially for small firms.

The Delegated Regulation deals with “organisational requirements and operating conditions for investment firms and defined terms”. It contains specifications to the level 1 text of MiFID II, amongst others, on:

  • organisational requirements, including conflicts of interest;
  • operating conditions for firms, such as:
    • specifications on how to provide information that is fair, clear and not misleading,
    • specifications on the necessary information to clients such as information about the firm, about the financial instruments, on costs and associated charges,
    • requirements regarding advice: information to be given regarding the type and scope of advice, regarding the range of instruments within the advice and also specifications on independent advice, including the interdiction for the same person to provide independent and non-independent advice,
    • the suitability assessment and suitability reports and the appropriateness assessment,
    • reporting to clients,
    • record keeping, including recording of telephone conversations or electronic communications.

With regard to the Delegated Regulation, BIPAR had made various proportionality-related comments and still considers some of these issues, such as record keeping requirements, disproportionate for the mainly small firms BIPAR represents.

The Delegated Regulation also contains a definition of remuneration: “all forms of payments or financial or non-financial benefits provided directly or indirectly by firms to relevant persons in the provision of investment or ancillary services to clients”.

On 31 March 2017, another Delegated Regulation dealing with (amongst others) product intervention was also published in the Official Journal. It sets out criteria and factors to be taken into account by ESMA, EBA and national competent authorities when they intend to use their product intervention powers. They can do so in case of significant investor protection concern or threat to the orderly functioning and integrity of financial markets or commodity markets or to the stability of the whole or part of the financial system of the Union or respectively of at least one Member State.

  • Regulatory technical standards (RTS) and implementing technical standards (ITS)

RTS and ITS are to be technical in nature, shall not imply strategic decisions or policy choices and their content shall be delimited by the acts on which they are based. They relate, inter alia, to requirements applying on and to trading venues, commodity derivatives, market data reporting, criteria when an activity can be considered an ancillary activity under MiFID, or regarding the information and requirements for the authorisation of investment firms. The latter contain information requirements to be respected at the moment of the process of authorisation (information on capital, information on the organisation of the firm, etc.) and requirements for the management and shareholders and members with qualifying holdings (for ex. requirements in case a natural / single person manages an investment firm).

Some of these RTS are not yet published in the Official Journal of the EU.

  • Level 3 Guidelines
  • Questions & Answers (Q&A)
    • Investment advice on an independent basis
    • Recording telephone conversations and electronic communications
    • Inducements (with regard to research)
    • Information on charges and costs
    • Suitability

ESMA consulted on and published Guidelines on cross-selling, on complex debt instruments and structured deposits and on the assessment of knowledge and competence. ESMA also consulted on Guidelines regarding product governance and regarding the assessment of suitability of the members of the management body and key function holders.

Guidelines are not legally binding but they are subject to the “comply or explain” procedure. From the moment that the Guidelines are published in all languages, a two-month period starts to run during which the national competent authorities have to notify ESMA as to whether they comply or intend to comply with the Guidelines, stating their reasons for non-compliance. The Guidelines follow the application date of MiFID II (3 January 2018).

The Guidelines on complex debt instruments and structured deposits intend to enhance investor protection by offering further clarification on which types of financial instruments and structured deposits can be provided, without an appropriateness test (i.e. without the firm assessing a client’s knowledge and experience).

BIPAR responded to the consultation on the draft Guidelines, broadly supporting the examples and definitions regarding complexity for the purpose of the consultation. BIPAR did request more detailed arguments of why and under which conditions packaged products should be considered complex products for the purpose of the Guidelines.

All language versions of the final Guidelines were published on 4 February 2016. ESMA removed packaged products from the scope of the Guidelines, stating they should be classified as “complex” instruments in accordance with criteria applicable to any other financial instruments.

The Guidelines on the assessment of knowledge and competence are intended to “enhance investor protection by increasing the knowledge and competence of natural persons giving investment advice or providing information about financial instruments, investment services or ancillary services to clients on behalf of investment firms”. The knowledge and competence provision of MiFID II is not part of the requirements that Member States have to apply in an analogous way to “opt-out firms” if they decide to make use of the optional exemption from MiFID II.

BIPAR responded to the consultation on the draft Guidelines, supporting the grandfathering clause for staff already active but expressing concern regarding the level of detail of the knowledge and competence requirements.

All language versions of the final Guidelines were published on 22 March 2016. The final Guidelines are more stringent than those on which ESMA consulted. In this respect, BIPAR and its members have criticized the deletion of the grandfathering period for existing staff and the introduction of a requirement of six months’ experience.

The Guidelines on cross-selling were initially meant to be joint ESAs’ Guidelines (EIOPA, EBA and ESMA) covering all cross-selling practices taking place in the banking, insurance and securities sectors. The final Guidelines however, are ESMA-only Guidelines regarding MiFID II (ESMA refers to legal and timing reasons for this reduction in scope).

All language versions of the final Guidelines were published on 11 July 2016. They intend to:

  • improve disclosures when different products are cross-sold with one another;
  • require firms to provide investors with all relevant information in a timely and clear manner;
  • address conflicts of interest arising from remuneration models; and
  • improve client understanding on whether purchasing individual products offered in a package is possible.

BIPAR responded to the joint ESAs’ consultation, amongst others criticizing the inclusion of a guideline on demands and needs or suitability and appropriateness since these are already regulated in specific legislation and this should not be contradicted or duplicated. This guideline was not withheld.

Between October 2016 and January 2017, ESMA consulted on draft Guidelines on product governance, in particular on the target market assessment. In its response to the consultation, BIPAR expressed serious concern about the way the draft guidelines shift responsibility for the assessment of the target market from manufacturers to distributors, for instance the shift of responsibility to distributors for setting the target market for products manufactured before the entry into force of MiFID II.

The final Guidelines are still expected to be published in the second quarter of 2017.

Between October 2016 and January 2017, ESMA and EBA (the European Banking Authority) consulted on draft joint Guidelines on the Assessment of the Suitability of the Members of Management Body and Key Function Holders under MiFID II and the Capital Requirements Directive (CRD). The draft Guidelines tackle, amongst others, criteria to assess the knowledge (individual and collective) of the members of the management body, they state the need for good repute, diversity, training of the members of the management body, etc. The draft Guidelines refer to the need to apply proportionality and list criteria to be taken into account for applying the proportionality principle such as the size of the firm, authorised activities, nature and complexity of products, contracts or instruments offered. In its response, BIPAR supported this reference to proportionality but questioned the application of the principle in practice, in particular, to small companies.

In 2016 and 2017, ESMA published several sets of Q&A regarding the implementation of investor protection topics under MiFID II. The purpose of these Q&A is to “promote common supervisory approaches and practices in the application of MiFID II/ MiFIR for investor protection topics, providing responses to questions posed by the general public, market participants and competent authorities in relation to the practical application of MiFID II/ MiFIR requirements”.

They deal with topics such as:

Q&A are not meant to constitute new policy and are periodically reviewed to update them where required and to identify if some of the material has to be converted into Guidelines and recommendations.

Delay of MiFID II

Since the development of the level 2 rules of MiFID II took much longer than foreseen, various stakeholders, including BIPAR, called for a delay of the application of MiFID II. BIPAR called for a delay of the whole MiFID II, including the important provisions regarding investor protection (some parties suggested a partial delay of MiFID II, limited to those parts of MiFID related to data collection infrastructure only).

In the end, a 1-year delay of the transposition and application of the full MiFID II text was agreed upon by the European institutions and published in the Official Journal of the EU on 30 June 2016.

[1] BIPAR has been very active on the interpretation of this concept. ESMA draft advice on the Delegated Acts had given an interpretation to quality enhancement which led to a de facto ban on commissions.

For more recent news concerning this dossier, please contact your national association.

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