On 29 September 2016, the FCA published its third Consultation Paper (“CP”16/29) on its approach to implementing the recast Markets in Financial Instruments Directive (“MiFID II”). Although not quite the final word from the FCA – an unexpected fourth CP is now promised before the end of the year – we believe that there is now clarity on most of the main impact points of MiFID II. In this paper, we update clients on the scope of MiFID II’s application, the FCA’s latest proposals (mainly relating to the conduct of business), and look ahead to how we intend to assist clients with their MiFID II Implementation Plans.
MiFID II: which parts apply to my firm?
Uncertainty around the scope of MiFID II, particularly the organisational requirements and conduct of business rules, makes it difficult for individual firms to plan ahead. Until the introduction of AIFMD in 2013, almost all investment managers (including those which became AIFMs) were subject to MiFID rules as transposed by the FCA. AIFMD reinforced some of the organisational requirements for such firms, but generally its conduct rules are broadly equivalent to those derived from the first MiFID.
Initially, our working assumption under MiFID II was that the FCA would seek to apply rules across all categories of investment manager in order to maintain “a level playing field”. However, the FCA chose, in its first CP to carve out collective portfolio managers (“CPM”) from the transaction reporting requirements. To be clear, the term CPM is used to describe portfolio management activity purely relating to AIFs and UCITS. In the latest CP, the FCA highlights just two conduct of business areas which will apply to such firms in respect of their CPM business (inducements and research, and best execution), with a third (recording of telephones and electronic communications) applying to all discretionary managers.
By omission, therefore, in our view the FCA is signalling that MiFID II does not apply to pure AIFMs and UCITS managers, except where it explicitly states that it does. Although this approach awaits confirmation in a final Policy Statement from the FCA next year, this is our assumption going forward. The impact on individual categories of firms (summarised in the table underneath) is:
- MiFID investment firms:MiFID II is broadly applicable, although it should be noted that many of the investor protection measures are only relevant to firms with retail clients.
- CPM: pure AIFMs and UCITS managers currently need to address only MiFID II’s new requirements on paying for research, best execution and recording of “relevant” conversations. Whether the FCA will require such firms with algorithmic or high-frequency trading strategies to meet the organisational requirements applying to such firms remains an open question.
- CPMI:collective portfolio management investment firms (CPM firms who also undertake MiFID business such as segregated account portfolio management) will be subject to MiFID II’s requirements in respect of their non-AIF business only, save for the areas noted in the CPM bullet point above. However in practice, many organisational requirements are not divisible in this way – for example, those applying to the firm’s governing body.
Does this have implications for my FCA permissions?
Potentially, yes. Because a CPMI firm gets caught by most of MiFID II’s organisational requirements, clients may want to consider removing their MiFID investment management permissions if they are not actually undertaking MiFID activity such as managing segregated accounts. Additionally CPM firms need not maintain an ICAAP or a Liquidity Assessment document, and are not required to compete the FSA019 (Pillar 2) and FSA055 (Systems and controls) returns. However, once lost, the MiFID permission may take several months to re-acquire should it subsequently be needed.
The other point to note is that a MiFID firm that converts to AIFM status is likely to be rid of some MiFID II requirements, albeit replaced by some AIFMD equivalents.
CP16/29: the other main points
Even though significant parts of MiFID II, especially in the Level 2 implementing acts, are in the form of a Regulation, and therefore carrying direct application across the EU, the FCA is taking a different approach compared to recent reforms such as AIFMD and the Market Abuse Regulation. Whereas the FCA Handbook in these past measures simply contains references to the relevant Articles, with MiFID II they have decided to copy out in full significant sections of the EU text. This should make for a clearer, albeit longer, set of rules.
Inducements and paying for research
As expected, the FCA will require CPMs (in addition to CPMIs and other MiFID managers) to adhere to the greatly revised rules, including the use of Research Payment Accounts (“RPA”) if wanting to pass charges through to clients. The current Handbook section on the use of dealing commission will be replaced by an expanded chapter on inducements, to cover both minor non-monetary benefits and research (COBS 2.3). The FCA has also provided some useful clarifications, some of which represent a degree of gold-plating:
- “Execution-related” services can no longer be paid for via a dealing commission-funded RPA;
- A separate RPA is not needed for every client – these can be grouped, provided they are to be used to administer payments for accounts following similar objectives and strategies and in accordance with a clear allocation methodology;
- Research commissions must be paid into the RPA, and not retained by the broker;
- Sell-side firms must identify separate charges for their services – in other words they may not bundle charges into a single execution rate – and must do so for all buy-side clients, not just MiFID ones; &
- Corporate access services may still not be paid for out of the RPA (this contradicts the interpretive position taken by the French AMF).
Again, the expanded requirements on best execution policies, and disclosures on execution venues for each instrument class traded, will be applied to all firms, including CPMs.
Recording of telephones and electronic communications
The FCA confirms its proposal that all discretionary investment managers will be fully subject to the taping requirements, including CPM firms. The required retention period is confirmed as five years, but the FCA has retained the option (as permitted by MiFID II) to extend this to seven years “on request”.
Controlled Functions for senior managers
The FCA is also consulting on a new Controlled Function application form for senior managers – this aspect of consultation closes earlier, at the end of October, to enable firms that are required by MiFID II to seek authorisation for the first time to apply in early 2017. This appears to be a mechanism for firms to provide information to the FCA on their governing body and organisational structure (itself a MiFID II requirement), although the FCA may also have one eye on its new Senior Managers and Certification Regime which will be extended to all regulated firms from 2018. The FCA also plans to release a MiFID II Application and Notification Guide towards the end of 2016.
As stated above, the FCA will publish a fourth CP before the end of this year addressing “consequential” changes to the Handbook. We expect these to be relatively minor, chiefly proposals to ensure internal consistency across the FCA Handbook. They will follow this up in the first half of 2017 with a single Policy Statement which will confirm the final changes to the FCA Handbook. We also expect further guidance including Q&As, throughout the year. The “go live” date for MiFID II remains 3 January 2018.
After the EU Referendum, does any of this matter?
Yes in the short term, as the FCA’s stance remains that UK regulated firms continue to be subject to EU regulations and must continue to plan for legislation that is still to come into effect. However, most predictions about the likely terms of the UK exit initially focussed on the need for “equivalence” in financial regulation in order to retain access to the Single Market or for UK regulated firms to operate in Europe under MiFID II’s third country regime. Therefore, whilst the UK regime is likely to remain similar (or at least equivalent) to the MiFID II framework, some divergence in its application should also, in time, be expected.
Preparing your MiFID II Implementation Plan
ACA’s internal MiFID II working group has been working for over two years to ensure that our consultants are equipped to help clients understand the relevant deadlines, the main issues and the specific areas of focus based on their structure and strategy. ACA will shortly be contacting our clients to translate these into a meaningful and tailored action plan to assist with implementing the required changes.