MiFID II Academy: Information and reporting to clients. Floortje Nagelkerke 21 November 2017

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1 MiFID II Academy: Information and reporting to clients Floortje Nagelkerke 21 November 2017

2 The countdown to MiFID II / MiFIR implementation as of 8:30am this morning 42 DAYS 15 Hours 30 Minutes But if you take away weekends and public holidays it is really 28 working days! 2

3 Dutch transposition MiFID II implementation Article 93 MiFID II: Member States shall adopt and publish, by 3 July 2016, the laws, regulations and administrative provisions necessary to implement this Directive Status of implementing legislation in the Netherlands: Act implementing MiFID II: adopted by the Dutch Parliament on 26 September 2017 and preliminary report published by Dutch Senate on 31 October Decree implementing MiFID II: no updates since the public consultation of the draft decree in March - April Draft of Regulation competence employees investment firms published for consultation on 17 November How to keep informed: AFM MiFID review page

4 Information to clients

5 Information to clients (and potential clients) Source of legislation: Article 24 (3), (4), and (5) MiFID II Articles 44 to 52 of Delegated Regulation 2017/565 Guidance: (last updated on 10 November 2017) ESMA Guidelines for cross-selling practices (last updated on 11 July 2016) No amendments to the basic rule but scope is extended: applicable to any client (retail, professional and ECPs) taking into account the nature and the business of the client 5

6 Information to clients: level 1 All information addressed to clients or potential client, including marketing communication, should be fair, clear and not misleading (Article 24(3) MiFID II) Firms should provide "appropriate" information to (potential) clients "in good time (Article 24(4) MiFID II): (i) on the investment firm; (ii) on its services; (iii) on its financial instruments; (iv) on its proposed investment strategies; (v) on its execution venues; and (vi) on all costs and related charges. Information to be provided in a "comprehensible" format and in such a manner that clients are reasonably able to understand the nature and risks of the service and the instrument so as to make informed investment decisions (Article 24(5) MiFID II) 6

7 Legal Uncertainty Meaning of in good time This may vary and firms should take into account the needs, experience and knowledge of the investor (Recital 83, MiFID II). Recital 84, MiFID II: Provided that the information is communicated to the client in good time before the provision of the service, nothing in MiFID II obliges firms to provide it: immediately at the same time as other information requirements separately or by incorporating the information in a client agreement Plain meaning: Before + sufficiently early that there is time to spare Note: Loss of distance communication carve-out in order to provide information after and not before Minimum time period Reading time period Comprehension Time Period Tailoring to customer Based on method of delivery of information Vary depending on length of document / format Vary depending on the target market / complexity of what has been provided Due to category of customer may need additional time Objective assessment on the subjective needs of customer Any set-off factors 7

8 Overview Advice Must provide information on investment advice Detailed requirements to explain scope and features of advice Applies to professional clients as well Financial instruments Must provide information on financial instruments e.g. warnings, risks Information to be tailored for the target market Information on how the instrument operates in negative market conditions Where the risks are being disclosed that as well as explaining leverage and its effects, firms are also required to explain risks with insolvency of issuer or related events such as bail-in Client agreement Also applies to professional clients, in ongoing advisory relationships and custody relationships and scope expanded significantly No distance communicating exemption to providing terms of business before providing a service 8

9 Information to clients: level 2 MiFID I vs. MiFID II MiFID I Articles Commission Directive 2006/73/EC: Information fair, clear and not misleading (Art. 27) Information concerning client categorisation (Art. 28) General requirements info to clients (Art. 29) Info on firm and services for retail clients (Art. 30) Info about financial instruments (Art. 31) Info on safeguarding client financial instruments or funds (Art. 32) Info about costs and charges (Art. 33) Info regarding collective investment undertakings (Art. 34) MiFID II Articles Delegated Regulation 2017/565: Information fair, clear and not misleading (Art. 44) Some changes Information concerning client categorisation (Art. 45) No changes General requirements info to clients (Art. 46) No changes Info on firm and services for retail clients (Art. 47) No changes Info about financial instruments (Art. 48) Some changes Info on safeguarding client financial instruments or funds (Art. 49) No changes Info about costs and charges (Art. 50) Largely changed Info regarding collective investment undertakings or PRIIPs (Art. 51) Some changes Information about investment advice (Art. 52) - New 9

10 Information to clients: costs and charges Level 1 Level 2 Level 3 10 Provide appropriate information in good time to clients / potential clients Information means: all costs and associated charges relating to investment and ancillary services including cost of advice, financial instrument recommended or marketed those related to the occurrence of underlying market risk how the client pays third-party payments aggregated and, when requested, an itemised breakdown Provide in a comprehensible form Provide on regular basis at least annually during the life of the investment Member States may mandate standardised disclosure Total aggregation plus separate aggregation for initial costs, ongoing costs and exit costs and % Includes costs charged by other firms where the client has been directed to such other parties Includes product manufacturing costs and cost of managing products Third party payments itemised separately Annex II to the Delegated Regulation contains the list of costs Limited application with professional clients and ECPs in particular circumstances If using UCITS KIID / PRIIPs KID for product costs, check for any gaps Use actually incurred costs (or reasonable estimation) as proxy for expected costs Provide illustration of cumulative effect Post-sale disclosure where there is an ongoing relationship: based on actual costs incurred and personalised Directly applicable into the Netherlands Various additional information provided Confirmation that PRIIPs KID is complete for covering all product costs, but UCITS KIID is not (does not disclose transaction costs) No prescribed format for the illustration Theme of greater liaising between MiFID firms and manufacturers to obtain necessary information. Note: Development of European MiFID Template (EMT) Use PRIIPs methodology for packaged products that are otherwise a PRIIP but not sold to retail but not for instruments that are not PRIIPs Transaction costs for UCITS and non- UCITS (i.e. funds not using a PRIIPS KID) should be assessed using the PRIIPS methodology Implicit and explicit transaction costs assessed on same basis as in PRIIPs (Note: This includes slippage methodology) Limited transitional provisions for first year post MiFID implementation

11 Information to clients: ESMA Q&As Question (Section 11 - #1): Are investment firms required to inform of their MiFID categorisation all their clients, including those already categorised under MIFID I, or should they just provide such information to new clients or to clients which categorisation has changed under MIFID II? 11

12 Information to clients: ESMA Q&As Question (Section 11 - #1): Are investment firms required to inform of their MiFID categorisation all their clients, including those already categorised under MIFID I, or should they just provide such information to new clients or to clients which categorisation has changed under MIFID II? Summarised answer: ESMA s view is that under Article 45(1) of Delegated Regulation 2017/565, firms only have to notify information on their categorisation to: (1) new clients; and (2) clients whose categorisation has changed under MiFID II. Such is the case for instance for certain local public authorities or municipalities which could have been categorised as professional clients under MiFID I and will now be considered as retail clients. 12

13 Information to clients: ESMA Q&As (1) Question (Section 9 - #16): How is Recital 79 of the MiFID II Delegated Regulation The costs and charges disclosure is underpinned by the principle that every difference between the price of a position for the firm and the respective price for the client should be disclosed, including mark-ups and markdowns. to be interpreted with regard to the position for the firm? 13

14 Information to clients: ESMA Q&As (1) Question (Section 9 - #16): How is Recital 79 of the MiFID II Delegated Regulation The costs and charges disclosure is underpinned by the principle that every difference between the price of a position for the firm and the respective price for the client should be disclosed, including mark-ups and markdowns. to be interpreted with regard to the position for the firm? Summarised answer: When an investment firm holds a financial instrument on its own account before offering it to a client, the price of the financial instrument may change due to market value fluctuations. Costs and charges that are caused by the occurrence of underlying market risk shall not be included in the aggregated information about costs and charges. Hence, the price of a position of the firm as referred to in Recital 79 of Delegated Regulation 2017/565 should be understood as the current (fair market) value of the financial instrument held by the firm when the firm offers the instrument to the client (exante) or when it sells it to the client (ex-post). 14

15 Information to clients: ESMA Q&As (2) Question (Section 9 - #17): How should investment firms identify and disclose mark-ups and structuring costs embedded in the transaction price (Recital 79 of the MiFID II Delegated Regulation)? 15

16 Information to clients: ESMA Q&As (2) Question (Section 9 - #17): How should investment firms identify and disclose mark-ups and structuring costs embedded in the transaction price (Recital 79 of the MiFID II Delegated Regulation)? Summarised answer: According to Recital 79 of Delegated Regulation 2017/565, practices where there is netting of costs should not be excluded from the obligation to provide information on costs and charges. As a result, mark-ups and structuring costs that are embedded in the transaction price need to be identified and disclosed to clients by the investment firm. Based on Recital 79, investment firms should identify such costs by calculating the difference between the price of the position for the firm and the price for the client. In case of PRIIPs, ESMA would expect the investment firm to apply the calculation methodology in paragraphs 36 to 46 of Annex VI of the PRIIPS RTS. 16

17 Information to clients: ESMA Q&As (3) Question (Section 9 - #20): How should the cost disclosure be made regarding the respective figures that are to be disclosed in aggregated and itemized form ( ) in case the respective costs or charges are zero? 17

18 Information to clients: ESMA Q&As (3) Question (Section 9 - #20): How should the cost disclosure be made regarding the respective figures that are to be disclosed in aggregated and itemized form ( ) in case the respective costs or charges are zero? Summarised answer: The firm should explicitly show a zero for the individual figure that is to be disclosed. As one of the purposes of the cost disclosure regime is comparability of products and services, it is important that clients receive explicit figures for every item to be disclosed, even if it is zero. Leaving out a cost component which value is zero might lead to misinterpretations. 18

19 Information to clients: ESMA Q&As (4) Question (Section 9 - #21): At what date should investment firms send their first annual ex-post information to their clients? 19

20 Information to clients: ESMA Q&As (4) Question (Section 9 - #21): At what date should investment firms send their first annual ex-post information to their clients? Summarised answer: ESMA expects firms to provide such information on the basis of a time period that ends at the latest one year (12 months) after the date on which the ongoing relationship has started and that this information should be provided to clients as soon as possible after the above annual anniversary of the relevant service commencing. Where an existing ongoing relationship between a firm and a client ends during 2018, ESMA expects firms to provide information at that period end. Where part of the reporting period would fall under MiFID I and part under MiFID II regime, investment firms may choose to calculate, on a best effort basis, the costs and charges in line with MiFID II requirements for the entire reporting period or provide this first ex-post report with a breakdown of costs for the two periods and a clear explanation of the basis on which costs have been calculated. 20

21 Reporting to clients

22 Reporting to clients Source of legislation: Article 25 (6) MiFID II Articles 59 to 63 of Delegated Regulation 2017/565 Guidance: (last updated on 10 November 2017) 22

23 Reporting to clients: level 1 Firms to provide clients with adequate reports on the service provided in a durable medium, including (Article 25(6), first subparagraph MiFID II): (i) periodic communications; (ii) taking into account the type and the complexity of financial instruments involved; (iii) taking into account the nature of the service provided; (iv) where applicable, the costs associated with the transactions and services undertaken. Where an investment firm provides portfolio management or has informed the client that it will carry out a periodic assessment of suitability, the periodic report shall contain an updated statement of how the investment meets the client s preferences, objectives and other characteristics of the retail client (Article 25(6), fourth subparagraph MiFID II) 23

24 Reporting obligations: level 2 Overview of level 2 reporting obligations Delegated Regulation 2017/565 Article 59: Reporting obligations execution of orders other than for portfolio management Some changes Article 60: Reporting obligations portfolio management Some changes Article 61: Reporting obligations eligible counterparties New Article 62: Additional reporting obligations portfolio management or contingent liability Transactions New Article 63: Statements of client financial instruments or client funds Some changes 24

25 Reporting to clients: what s new under MiFID II? To retail Portfolio Management Reports: Minimum quarterly intervals Further report where portfolio depreciates by (multiples of) 10% No report where client accesses online system / durable medium Client Asset Reports: Minimum quarterly intervals Statements to identify protected assets, assets subject to liens, market / estimated value of assets (on a best efforts bases) and indicate a lack of a market price is likely to be indicative of a lack of liquidity No report where client accesses online system / durable medium Provide ad hoc reports on request (can charge for ad hoc reports) To professional Trade Confirmations: Must provide trade confirmations at T+1 Must have same content as for retail confirmations Portfolio Management Reports: Do not apply to professional clients To ECPs Reporting obligations apply to all clients including ECPs However, ECPs are able to agree different standards for content and timing of reports 25

26 Reporting to clients: ESMA Q&As Question (Section 8 - #1): How does a firm fulfil the obligation to report on the overall value of a client s portfolio depreciating by a 10% threshold on a particular business day if a firm s automated systems do not provide valuations throughout the day for all the portfolios it manages? In line with this question: could a firm use a single daily valuation point as the basis for the evaluation? 26

27 Reporting to clients: ESMA Q&As Question (Section 8 - #1): How does a firm fulfil the obligation to report on the overall value of a client s portfolio depreciating by a 10% threshold on a particular business day if a firm s automated systems do not provide valuations throughout the day for all the portfolios it manages? In line with this question: could a firm use a single daily valuation point as the basis for the evaluation? Summarised answer: A firm is obliged to value the overall portfolio at the beginning of the reporting period and evaluate the overall portfolio at least once each day, but is not obliged to have systems in place that calculate valuations on an ongoing basis throughout each day. One way a firm could provide the required reports would be to set a fixed portfolio valuation point for each day, for example at hours after any overnight reconciliation is complete, and identify whether the depreciation threshold is exceeded by comparing this value with the valuation of the portfolio at the beginning of the reporting period. Then, if the portfolio value is shown to have depreciated by 10% or more, the firm would inform the client by the end of that business day. Assuming its business day ends at hours, this approach would give firms 11 hours in which to report to clients during working hours. Adopting one fixed valuation point for each day would also avoid multiple reports being triggered during volatile market periods. 27

28 Reporting to clients: ESMA Q&As (1) Question (Section 8 - #2): When fulfilling the obligation to report on a portfolio depreciating by the 10% threshold, does the firm need to report if a portfolio value drops by more than 10% as a result of the client making cash withdrawals? 28

29 Reporting to clients: ESMA Q&As (1) Question (Section 8 - #2): When fulfilling the obligation to report on a portfolio depreciating by the 10% threshold, does the firm need to report if a portfolio value drops by more than 10% as a result of the client making cash withdrawals? Summarised answer: The obligation is to report if the overall value of a portfolio depreciates by 10% and thereafter at multiples of 10%. When cash withdrawals are made from a portfolio, the value of the managed financial instrument or funds is reduced by the amount of the client money transferred; but the overall value of the portfolio, as evaluated at the beginning of the previous reporting period, includes the value of the cash withdrawn. So, if clients withdraw cash from a portfolio, until a periodic statement is provided that discounts the cash withdrawn, when calculating the overall value of a portfolio, to see whether the 10% thresholds are exceeded, a firm will need to take this cash into account by adding its value to the value of remaining financial instruments or funds in the portfolio. 29

30 Reporting to clients: ESMA Q&As (2) Question (Section 8 - #5): When fulfilling the obligation to report on a portfolio depreciating by the 10% threshold, how should a firm value on a daily basis, as requested by the answer to question 1, financial instruments within the portfolio for which there is no secondary market or daily price reference? 30

31 Reporting to clients: ESMA Q&As (2) Question (Section 8 - #5): When fulfilling the obligation to report on a portfolio depreciating by the 10% threshold, how should a firm value on a daily basis, as requested by the answer to question 1, financial instruments within the portfolio for which there is no secondary market or daily price reference? Summarised answer: Such financial instruments could be UCITS or AIFs for which managers do not calculate or publish a daily net asset value, unlisted securities, or shares of companies which are otherwise illiquid or subject to collective proceedings. For these types of financial instruments, investment firms should use appropriate methods to estimate what a fair value might be that should be consistent with the ones used for periodic statement provided to client under Article 60 Delegated Regulation 2017/

32 Reporting to clients: ESMA Q&As (3) Question (Section 8 - #8): Article 62(2) of the MiFID II Delegated Regulation states Reporting under this paragraph should be on an instrument-byinstrument basis, unless otherwise agreed with the client What kind of flexibility could be allowed by such an agreement with clients? 32

33 Reporting to clients: ESMA Q&As (3) Question (Section 8 - #8): Article 62(2) of the MiFID II Delegated Regulation states Reporting under this paragraph should be on an instrument-byinstrument basis, unless otherwise agreed with the client What kind of flexibility could be allowed by such an agreement with clients? Summarised answer: Under Article 62(2) of Delegated Regulation 2017/565, investment firms should have the possibility to agree with their clients on the possibility to assess the 10 % depreciation on a aggregated basis, for example: (1) on the overall value of the portfolio, as required under Article 62(1) of Delegated Regulation 2017/565; (2) on the global value of all leveraged financial instruments or contingent liability transactions in the client s portfolio. In any case, the client should give his/her express consent to assess the 10% depreciation on an aggregated basis and the client should have the capacity to terminate it at any time. 33

34 Reporting to clients: ESMA Q&As (4) Question (Section 8 - #9): When reporting to clients information required under Articles 62(1) and 62(2) of the MiFID II Delegated Regulation, can firms agree with clients to assess the depreciation of the overall value of the client s portfolio, or of leveraged financial instruments or contingent liability 63 transactions included in a client s account, on a threshold higher than the 10% and thereafter at multiples of 10%? 34

35 Reporting to clients: ESMA Q&As (4) Question (Section 8 - #9): When reporting to clients information required under Articles 62(1) and 62(2) of the MiFID II Delegated Regulation, can firms agree with clients to assess the depreciation of the overall value of the client s portfolio, or of leveraged financial instruments or contingent liability 63 transactions included in a client s account, on a threshold higher than the 10% and thereafter at multiples of 10%? Summarised answer: No. The requirements set out in Article 62 of Delegated Regulation 2017/565 do not allow firms to agree with clients to assess the depreciation on a threshold higher (e.g. 15%) than that set out in Article 62 of Delegated Regulation 2017/

36 Reporting to clients: ESMA Q&As (5) Question (Section 8 - #10): Does the obligation in Article 62(1) of Commission Delegated Regulation (EU) 2017/565 to report on the overall value of a client s portfolio depreciating by a 10% threshold on a particular business day apply only to retail clients? 36

37 Reporting to clients: ESMA Q&As (5) Question (Section 8 - #10): Does the obligation in Article 62(1) of Commission Delegated Regulation (EU) 2017/565 to report on the overall value of a client s portfolio depreciating by a 10% threshold on a particular business day apply only to retail clients? Summarised answer: No. The obligation in Article 62(1) of Delegated Regulation 2017/565 relates to retail and professional clients. 37

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