MiFID II. user guides

Transcription

1 MiFID II user guides

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3 Contents Transaction reporting Inducements and investment research RDR equivalent Appropriateness Suitability Best execution Conflicts of interest Client assets and client money Product governance

4 Introduction Welcome to Taylor Wessing s User Guides to MiFID II. In each of our User Guides we: XX XX XX XX XX Identify the key changes Give an indication of work-stream priority List key source materials Summarise the FCA s implementation proposals Add our commentary and insight We use the following symbols to indicate where we think a change will most impact a firm s operations: 1 Client documentation Governance HR IT/Ops Reporting Revenue Service offering SYSC Member States should transpose the MiFID II framework into national law by 3 July 2017 and firms should comply with most provisions from 3 January We hope you find our User Guides helpful. Please do not hesitate to contact us in the case of any questions. Please note that the User Guides are for information only and should not be relied on as legal advice. Key contact Jonathan Rogers Partner, Financial Services Regulatory +44 (0) jonathan.rogers@taylorwessing.com Last edit: January 2017

5 Topic: Transaction reporting Impact severity: red MiFID II project timetable: Priority workstream: this is an area that requires significant operational changes to ensure that firms are able to meet more extensive and complex transaction reporting obligations. Priority impact areas: FCA current proposal regarding implementation: 1 1 Reporting IT/Ops SYSC The FCA has decided not to extend MiFIR transaction reporting requirements to managers of collective investment undertakings or pension funds. These firms will no longer be subject to transaction reporting. As MiFIR and RTS 22 are directly applicable, transaction reporting rules will not be replicated in the FCA Handbook and SUP 17 is deleted. A new SUP 17A is introduced to cover connectivity to the FCA s systems. Third country branches carrying on equivalent MiFID business will be subject to transaction reporting. In particular, GEN A applies MiFIR and any regulations made under MiFID II or MiFIR to such third country firms. Key changes: The scope of reportable transactions is wider and now covers financial instruments admitted for trading on any trading venue and OTC derivatives based on such instruments (or an index that includes such instruments). The timing for making reports is still on a T+1 basis. The reporting obligation applies to firms executing transactions. The exemption for firms transmitting orders has been narrowed and now requires an agreement with the receiving firm. The information to include in trade reports is expanded to 81 fields, including the identification of decision makers (whether natural persons or algorithms), short sales, use of transparency waivers and, in the case of commodity derivatives, whether the trade is for objective risk reduction purposes. Investment firms can make transaction reports directly or through Approved Reporting Mechanisms (ARMs) or trading venues. There are minimum requirements for reporting processes, including the requirement to test processes and carry out reconciliations. Key sources: MiFIR: Article 26. RTS 22. ESMA Papers: ESMA Guidelines on Transaction reporting, order record keeping and clock synchronisation under MiFID II (10 Oct 2016 ESMA/2016/1452) and ESMA Consultation Paper Guidelines on Transaction reporting, order record keeping and clock synchronisation (2015/1909). Draft FCA Rules: Chapter 7 and Annex E of CP15/43. Key contact Christopher Ratcliffe Senior Associate, Financial Services Regulatory +44 (0) c.ratcliffe@taylorwessing.com

6 Comments and observations on transaction reporting Scope of reportable transactions: in a change from current rules, reportable transactions will now include financial instruments admitted to trading on MTFs and OTFs as well as regulated markets (whether or not the actual transaction takes place on market). OTC derivatives based on such instruments, or based on an index or basket that is composed of such instruments, are also within scope. Who do the rules apply to: the obligation to report transactions to Competent Authorities applies when firms execute transactions. Under RTS 22, execution is defined widely and includes the execution of client orders, the reception and transmission of orders, dealing on own account, making investment decisions in accordance with a discretionary mandate and transferring financial instruments to or from accounts. Currently, discretionary managers benefit from an exemption when they have reasonable grounds to be satisfied that a third party broker will report the trade. This exemption is narrowing. Under MiFIR, firms that transmit orders are only exempt from reporting the transaction if the order (including certain reportable order details) is sent to another firm which is subject to the reporting obligation and has agreed to report it (or has agreed to transfer the order to another executing firm who will report). The agreement must require the receiving firm to check the order details for obvious errors or omissions. Information to be reported: the extent of information to report under MiFIR is broader and more complex with the number of fields increased to 81. Notable changes include the requirement to report the persons or algorithms within the firm that are responsible for the investment decision and the execution of the trade, and reporting whether the order pertains to a short sale, is made under a transparency waiver or, in the case of commodity derivatives, reduces risk in an objectively measurable way. Another marked feature of the new reporting regime is the extensive information that must be submitted to identify natural persons firms must submit full name, date of birth and their national ID number. LEI: under RTS 22, firms must obtain LEIs from their clients (if the client would be eligible for one) before providing services that would trigger reporting obligations for transactions entered into with or on behalf of the client. Branches: where transactions have been executed partially or wholly through a branch, the investment firm should report the transaction to its home state authority unless otherwise agreed between home and host states. ARMs: firms can report directly to their competent authority or use a registered ARM or trading venue to report on their behalf. Even if not directly reporting, the investment firm remains responsible for the completeness, accuracy and timeliness of the transaction reports unless any failure is attributable to the part of the relevant ARM or trading venue (and even then, firms must take reasonable steps to verify reports made on their behalf). Reporting processes: RTS 22 imposes minimum requirements for reporting processes used by firms and trading venues, including in respect of the security and confidentiality of data, identifying errors and omissions and avoiding duplicate reports. Firms are required to test their reporting processes and carry out regular reconciliations of reports against front-office records. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

7 Topic: Inducements and investment research Impact severity: red MiFID II project timetable: Priority workstream: the way in which discretionary managers and independent advisers are able to obtain investment research will fundamentally change. These firms will need to identify where across their business they receive investment research and decide how they will comply with MiFID II they must either pay for it out of their own resources or through client research charges (in which case significant operational changes will be required). Priority impact areas: Key changes: The general rule for all MiFID firms on permitted inducements is tighter with a new requirement that inducements must be designed to enhance the quality of the firm s service. Investment research (IR) will be subject to the inducement restrictions in MiFID II unless it is purchased from the firm s own resources or a research payment account (RPA) funded by clients. For discretionary managers and independent advisers, these are the only means for them to procure IR (as they are prohibited from accepting inducements). Sellside firms providing execution and research services will also need to adapt to MiFID II and price and supply their research separately Key sources: MiFID II: Recitals 74 to 76 and Articles 24(7) (9). MiFID II Delegated Directive C(2016) 2031: Recitals and Articles Service offering SYSC Revenue FCA current proposals regarding implementation: The rules on inducements and investment research will apply to Article 3 firms and third country branches carrying on equivalent MiFID business. The FCA intends to extend these provisions to MiFID exempt fund managers including UCITS management companies, fullscope AIFMs, small authorised AIFMs, CIS operators as well as incoming EEA AIFM branches. The MiFID II rules on inducements will be set out in new COBS chapters: COBS 2.3A, 2.3B and 2.3C. COBS 11.6 (on soft commissions) is superseded by these new rules and will be largely deleted. Existing general inducement rules in COBS 2.3 will remain for non-mifid business. ESMA Papers: ESMA Q&A on MiFID II and MiFIR investor protection topics (2016/1444). Draft FCA rules: Chapter 10 of DP15/3 and Chapter 3 and Appendix 1, Annex H of CP16/29. Key contact Caroline Bystrom Professional Support Lawyer, Financial Services Regulatory +44 (0) c.bystrom@taylorwessing.com

8 Comments and observations on inducements and investment research General restriction on inducements: the general restriction on inducements will be tighter under MiFID II. In particular, firms may only accept inducements which do not impair the firm s duty to act in the client s best interest and which are designed to enhance the quality of the relevant service. The MiFID II Delegated Directive introduces prescriptive criteria as to what enhancing the quality of a service can consist of, with correspondingly tight rules around record keeping and disclosure. Also note that independent advisors and discretionary managers are prohibited from accepting any inducements under MiFID II unless they are acceptable minor nonmonetary benefits. Read RDR equivalent for more information. Research and acceptable minor non-monetary benefits: the prohibition against discretionary managers and independent advisors accepting inducements does not apply to acceptable minor non-monetary benefits. The scope for IR to fall within this category is very limited and recitals to the MiFID II Delegated Directive indicate that only nonsubstantive material or promotional material commissioned by an issuer is likely to be exempted. Investment research as an inducement: however, IR will not be regarded as an inducement (and so is permitted) if it is paid for out of the firm s own resources (as to which there are limited guidelines although research would need to be purchased at its unbundled price) or out of an RPA which is funded by clients and meets certain conditions. For discretionary managers and independent advisers subject to the prohibition on inducements, these are the only means for them to procure IR. Research Payment Accounts: RPAs are a new concept under MiFID II. The core features of an RPA are as follows: It is funded by a specific research charge to clients set by the firm in accordance with a research budget (and not based on the volume or value of transactions). The FCA has indicated that the research budget does not need to be set at an individual portfolio level, but can apply to a number of portfolios that share similar strategies and objectives. Firms must have robust systems and controls to ensure a fair allocation of research costs between clients and be able to justify any budgetary groupings. The firm must regularly assess its research budget and the quality of the research purchased (in accordance with a robust quality criteria). To that end, firms must maintain a written RPA policy which is available to clients. Funds in the RPA can only be used to purchase research. If there is a surplus in the RPA at the end of a period, it must be rebated to clients or offset against the budget and charges for the following period. Clients must be provided with information about the research budget and estimated charges before the provision of services. Furthermore, clients must be provided on an annual basis with information on the research costs incurred and, on request, the payments made. Funding RPA by collecting charges alongside transaction costs: MiFID II does allow for research charges to be collected at the same time as other transaction costs although research charges collected in this way would need to be swept into a segregated RPA that the firm has control over. Firms with Commission Sharing Agreement accounts with brokers will need to make significant changes to their account arrangements to comply with the new rules. Unbundling of services: firms that provide execution and research services to certain regulated firms will be required to price and supply them (or any other service) separately. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

9 Topic: RDR equivalent Impact severity: red MiFID II project timetable: Priority workstream: this is an area where MiFID II imposes new concepts that could impact the shape of revenue streams and client relationships. The concepts echo RDR in objective, but apply to a wider range of products than RDR and also apply to portfolio management and professional clients. Firms should regard it as a priority to identify whether they are impacted by these rules. Priority impact areas: Key changes: MiFID II introduces a new independent adviser standard, echoing RDR, but with wider scope. Discretionary managers as well as those providing independent advice are banned from accepting and retaining commissions, fees or non-monetary benefits. These standards apply to professional client business as well as retail business. The standards apply to MiFID financial investments generally as well as structured deposits and so extends beyond Retail Investment Products (RIP) as defined by the FCA for the purposes of its RDR regime. Key sources: FCA current proposal regarding implementation: 1 1 Revenue Service offering Client documentation The FCA s proposals for implementing the new requirements are complex given the need to take account of the existing RDR regime: Where firms provide portfolio management and independent investment advice to professional clients, the MiFID II inducements ban and independence requirements will apply, but not be enhanced. Where these services are provided to retail clients, the MiFID II inducements ban will be enhanced by: (i) extending it to restricted advice; (ii) banning commission rebates; and (iii) applying the standard to advisory business generally (not just recommendations ). Article 3 firms and third country branches carrying on equivalent MiFID business, will be subject to the same requirements as MiFID firms. MiFID II: Recitals and Article 24(7) (9). MiFID Delegated Directive C(2016) 2031: Recitals and Articles 11 and 12. MiFID Delegated Regulation C(2016) 2398: Recitals and Articles Draft FCA Rules: Chapter 4 of DP15/3 and Chapter 2 Appendix I, Annex 4 of CP16/29. Key contact Jonathan Rogers Partner, Financial Services Regulatory +44 (0) jonathan.rogers@taylorwessing.com

10 Comments and observations on RDR equivalent Overall inducements standard: supplemental to the general MiFID II rule on inducements, MiFID II prohibits portfolio management and independent advisory firms from accepting and retaining monetary or non-monetary benefits, other than acceptable minor non-monetary benefits. In contrast to RDR, MiFID II does allow firms to rebate these benefits to clients, but the FCA s proposal is to disapply this allowance in connection with retail business. FCA proposal for application of inducements standard: a new MiFID II regime on banning commissions will apply to professional client business as well as retail business. This means that professional business will be subject to the rules for the first time with regards to both independent advice and discretionary services. For retail business the focus will more be on upgrading the RDR approach to additionally cover discretionary services. Whereas the MiFID II standard only applies to independent advice, the FCA will continue to apply the RDR commission ban to retail restricted advice. Relevant Investments: firms will need to assess the nature of the products they work with and identify where the rules apply. There is both overlap and underlap between the current RDR and pending MiFID II scope. For example, the RDR RIP concept includes life policies and certain pension scheme interests, but MiFID II does not. On the other hand MiFID II covers shares, bonds and derivatives, but RIPs do not generally include investments unless they offer exposure to underlying assets in a packaged form, such as units or investment trusts. The MiFID II requirements will also apply to structured deposits. FCA s application of independent advice : MIFID II brings in its own independent advice standard for retail and professional business and the FCA proposes to apply this standard across all financial instruments within MiFID II, RIPs and structured deposits. For professional clients and retail clients outside the UK (RDR does not apply to them), the FCA will only apply the MiFID II independence standard to financial instruments within MiFID II and structured deposits, but not other RIPs. Independent advice : the FCA has concluded after consultation that the MiFID II articulation of independent advice is broadly consistent with its own RDR definition, and for consistency will apply a single MiFID II definition to both MiFID and non-mifid business. If anything, the MiFID II standard is not as emphatic in pushing independent advisers to actively consider the full range of in-scope products where they are not likely to suit their client base, although it is doubtful that the FCA will recognise much if any difference here. Organisational standards: the MIFID Delegated Regulation applies a number of organisational standards to firms. One aspect that could present operational challenge is the need to maintain separation between independent and restricted advice, with individual staff not permitted to provide both. Given the FCA s assessment (para of CP16/29), that only 2.5% of firms provide both restricted and independent advice, the impact of this rule should not be too widespread but will give the 2.5% cause to think. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

11 Topic: Appropriateness Impact severity: red MiFID II project timetable: Priority workstream: firms offering execution only services will have to carry out the appropriateness test for a wider range of products than at present. For those firms offering services in this area, MiFID II will require implementation of an intervening appropriateness test between offer and execution. Priority impact areas: Key changes: The appropriateness test itself remains substantially unchanged. However, MiFID II narrows the scope of investments that can be classified as non-complex, causing a widening in scope of products that are subject to the appropriateness test. MiFID II introduces a specific requirement for firms to keep records of appropriateness assessments. These must include where a warning was given, whether the client decided to go ahead despite the warning and whether the firm accepted the client s request to go ahead with the transaction. Where a bundle of services or products is envisaged, the firm must consider whether the overall package is appropriate. FCA current proposal regarding implementation: 1 1 Service offering IT/Ops SYSC The new provisions for MiFID firms and products (or equivalent third country business) will be set out in a new COBS 10A. The current appropriateness rules in COBS 10 will continue to apply to non-mifid firms when arranging or dealing in non-readily realisable securities, derivatives or warrants for a retail client, or (through COBS 22.2) where a retail client wishes to buy mutual society shares. Article 3 firms will continue to come within the scope of the current appropriateness requirements in COBS 10. However, the FCA considers it unlikely that COBS 10 will apply to them given the restrictions on the activities they can carry out and investments they can deal with. Key sources: MiFID II: Recital 80, Article 25(3) and (4). MiFID II Delegated Regulation C(2016) 2398: Recital 84 and Articles ESMA Papers: ESMA Q&A on MiFID II Investor Protection Topics (2016/1444), ESMA Guidelines for assessment of knowledge and competence (2015/1886) and ESMA Guidelines for complex products and structured deposits (2015/1783). Draft FCA Rules: Chapter 11 of DP15/3 and Chapter 8 & Appendix 1, Annex H of CP16/29. Key contact Peter Wilson Senior Associate, Financial Services Regulatory +44 (0) p.wilson@taylorwessing.com

12 Comments and observations on appropriateness The appropriateness test: Article 25(4) of MiFID II specifies that investment firms providing order-handling services (i.e. reception and transmission of orders, as well as execution of orders on behalf of clients) to retail and professional clients, can do so without performing an appropriateness test. In summary, it only allows this to happen in relation to specified types of products usually termed non-complex. As under MiFID, firms are entitled to assume that a professional client has the necessary experience and knowledge in order to understand the risks involved in relation to those particular investment services and transactions, or types of transaction or product, for which the client is classified as a professional client (Article 56(1) of the MiFID II Delegated Regulation). Expansion of the product range requiring the test: the range of non-complex instruments that the appropriateness test need not be applied to is narrowed to: Listed shares (excluding UCIS or those that embed a derivative). Money market instruments (excluding those that embed a derivative). Listed debt instruments (subject to an ease of understanding test ). Structured deposits (subject to an ease of understanding test ). UCITS (other than structured UCITS). u u Other non-complex instruments. Ease of understanding test : in accordance with Article 25(10) of MiFID II ESMA has published final guidelines in respect of complex debt instruments and structured deposits (2015/1783). The FCA has notified ESMA of its intention to comply with these guidelines, which specify criteria for the assessment of: debt instruments incorporating a structure which makes it difficult for the client to understand the risk involved; and structured deposits incorporating a structure which makes it difficult for the client to understand the risk of return or the cost of exiting the product before term. Other non-complex instruments : this now has two additional tests: Any inbuilt features cannot fundamentally alter the investment proposition. Exit charges cannot defeat a perceived liquidity. The FCA advises (see CP16/29 at para. 8.16) that when firms apply these criteria, they should adopt a cautious approach if there is any doubt as to whether a financial instrument is non-complex. Implications for firms of widening of scope of complex products: Firms will need to carry out the appropriateness test for a wider range of products than at present, and as a result will need to review their distribution model to ensure they conduct an appropriateness test when distributing a complex product without advice. Two areas that will be particularly impacted by the widening of scope of complex products are: Firms offering products through direct offer financial promotions. The FCA considers it unlikely that such firms will be able to meet the appropriateness test because the obligation to conduct the test is on the firm, and not the client or potential client. In particular, the FCA envisages this will impact firms distributing non-ucits collective investment schemes in the UK (see DP15/3 at para ). Firms using online distribution models. Simply collecting information as to a client s knowledge and experience is not enough in itself. Firms are required to make an assessment of this information before a complex product can be sold. Such firms need to develop a method and operational process to collect the relevant information to complete the appropriateness test before selling complex products through online channels. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

13 Topic: Suitability Impact severity: amber Key changes: MiFID II places enhanced requirements on investment firms to review and report on suitability on a continuing basis, in particular: MiFID II project timetable: Intermediate workstream: MiFID II introduces more specific requirements than before to ensure suitability of personal recommendations or decisions to trade. Some material business change required. Priority impact areas: Client documentation FCA current proposal regarding implementation: The existing suitability provisions will remain in place in an amended COBS 9 and will apply only to firms advising on, or managing portfolios in relation to non-mifid products. The new MiFID II suitability requirements, which will apply to a firm carrying on MiFID or equivalent third country business and to an Article 3 firm carrying on MiFID-scope business will be contained in new COBS 9A. Key sources: HR MiFID II: Recital 82 and Article 25(2). SYSC MiFID II Delegated Regulation C(2016) 2398: Recitals and Articles 54 and Periodic suitability assessments: firms providing investment advice should draw a retail clients attention to whether the recommended services or instruments require the client to seek a periodic suitability review of their investments and the suitability of recommendations made. Before providing investment advice, firms should inform clients whether it will provide such an assessment. This periodic assessment should be completed at least annually and its frequency should be increased to take account of the risk profile of the relevant client and the types of financial instruments recommended. Periodic suitability reports: where a firm provides a portfolio management service or has informed the client it will carry out a periodic suitability assessment, it must provide the client with a periodic suitability report, which contains an updated statement of how the investments meet the preferences, objectives and other characteristics of the client. Other changes are broadly procedural in nature aimed at reducing the likelihood that unsuitable personal recommendations or decisions to trade will be made and should to some extent formalise existing industry best practice. Key contact Peter Wilson Senior Associate, Financial Services Regulatory +44 (0) p.wilson@taylorwessing.com ESMA Papers: ESMA Q&A on MiFID II Investor Protection Topics (2016/1444) and ESMA Guidelines for assessment of knowledge and competence (ESMA EN(Rev)). Draft FCA Rules: Chapter 7 and Appendix 1, Annex H of CP16/29.

14 Comments and observations on suitability MiFID II does not fundamentally change the FCA s current approach to its suitability requirements, and the MiFID suitability test remains broadly unchanged under MiFID II. There are however some new requirements, which will require firms to make changes to their existing suitability policies and procedures and roll out associated staff training. Bundled products or services: where an investment firm provides investment advice recommending a package of services or products that are considered to be bundled for the purposes of Article 25(2), firms must ensure the overall bundled package is suitable for the client. Client information: firms will need to have procedures in place to ensure that information collected about their clients or potential clients is reliable and does not include information that is manifestly out of date, inaccurate or incomplete (Article 55(3) of the MiFID II Delegated Regulation). This means that there is now a specific obligation to the effect firms will need to ensure that client information is kept up-to-date if the firm is providing ongoing advice or portfolio management services to a client (Article 54(7) of the MiFID II Delegated Regulation). Automated advisory and management services: the MiFID II regime takes account of industry developments in automated advisory and management services. It makes clear that a firm offering an advisory or management service to a client remains responsible for the suitability assessment and that its responsibility is not reduced by the fact it uses an automated system to assist it make recommendations or decisions to trade (Article 54(1) of the MiFID II Delegated Regulation). Switching investments: if a firm s advice or portfolio management involves switching investments (whether a buy/sell or the exercise of a right to change an existing investment), MiFID II places a requirement on the firm to collect information on the client s existing investments and the recommended new investments. The firm should then analyse the costs and benefits of switching investments so that it can reasonably demonstrate to the client the benefits of switching are greater than the costs (Article 54(11) of the MiFID II Delegated Regulation). Who is subject to the suitability assessment? Firms must have a policy for deciding who the suitability assessment should relate to: where a client is a legal person; or where a client is a group of two or more natural persons; or where one or more natural persons are represented by another natural person. This policy should set out how to determine who should be subject to the suitability assessment and how this assessment will be done in practice, including who to obtain information about and their knowledge and experience, financial situation and investment objectives (Article 54(6) of the MiFID II Delegated Regulation). Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

15 Topic: Best execution Impact severity: amber MiFID II project timetable: Intermediate workstream: changes are incremental rather than fundamental but firms will need to act in good time to be able to demonstrate that they have assessed best execution against the revised standards, adjusted their systems and controls and prepared deeper disclosure statements and additional reporting processes. Priority impact areas: Key changes: MiFID II raises the bar from taking all reasonable steps to taking all sufficient steps. FCA comment: this will likely require an execution venue reassessment and stronger systems and controls. The degree of disclosure to clients will become more forensic as to execution performance and need to address additional information fields. Execution venues and their clients will need to publish additional reports on best execution performance, meaning both will need to devise systems for capturing and using this data Key sources: MiFID II: Article 24(1) and Article 27. Draft RTS 27 and 28. MiFID II Delegated Regulation C(2016) 2398: Recitals Articles 59 and IT/Ops Client documentation Reporting Draft FCA Rules: Chapter 9 of CP16/29, Appendix 1 Annex H. FCA current proposal regarding best execution implementation: MiFID II standards will apply to non-mifid firms, including Article 3 exempt firms. RTS 28 reporting (on top 5 venues) will not however apply to Article 3 firms. MiFID II will apply to UCITS management firms (including RTS 28 reporting). MiFID II standards will apply to AIFMs in line with the current allocation set out in COBS A. RTS 28 will apply to full scope AIFMs. Further FCA proposals expected for full and small authorised and residual CIS operators. Key contact Jonathan Rogers Partner, Financial Services Regulatory +44 (0) jonathan.rogers@taylorwessing.com

16 Comment and observation on best execution Overall standard: the obligation to obtain best execution has moved from a must take all reasonable steps standard to a must take all sufficient steps standard. It has been generally accepted that this represents a higher standard, with the comparative comfort blanket of reasonableness replaced with a more objective standard of sufficiency. We suggest that firms should ensure that this shift in emphasis is demonstrably acknowledged in their internal processes and assessments. The FCA s comment is that this change will likely require an execution venue reassessment and stronger systems and controls. RTS 28: firms that execute client orders will need to make an annual public statement as to the quality of execution they receive and their top five execution venues in terms of volumes across each class of investment instrument. The disclosure will also need to include information on the quality of the execution actually obtained and be split across professional and retail trades. RTS 28, proposed to be copied out in COBS 11, sets out the detail of how firms should comply. The standards are prescriptive as to the categories of investment instrument, how relative volumes should be assessed and presented and as to the factors to be taken into account when assessing effectiveness. The information on effectiveness will also need to address any arrangements with venues as to monetary or other non-monetary benefits. There are additional rules and/or guidance: On use of single execution venues, whether for those executing order or placing orders. Essentially firms need to be able to demonstrate, including with reference to published data, that they are obtaining execution that is at least as good as the results they could achieve elsewhere at least as good may sound benign but it is a high standard. On the need to apply the best execution rules to matchprincipal dealing (back-to-back trading). On the distinctions that can legitimately be drawn between OTC and other trading venues, although the obligation is still there for firms to take sufficient steps to ensure that an OTC price is fair and delivers on the best execution obligation. Against applying different spreads or commissions depending on which venue a transaction is being executed on, unless arising from the difference in the cost of those venues. On the need for market makers or liquidity providers to make execution quality data available without charge and at least annually. These firms will need to comply with RTS 27 in terms of the data they need to make available. Disclosure to retail clients: additional disclosure is required for retail clients, with firms needing to provide a summary of their execution policy, focussed on the costs that will be incurred by the retail client. Furthermore, the firm must provide links to the most recent execution quality data published by each relevant platform. Payment for order flow: consistent with the FCA s guidance on payment for order flow (FG12/13) and its thematic review (TR14/13), a firm must not receive any remuneration, discount or non-monetary benefit for routing orders to a particular venue which would infringe the rules on inducements or conflicts. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

17 Topic: Conflicts of interest Impact severity: amber MiFID II project timetable: Intermediate workstream: while the changes are not elemental, it is not that firms can simply insert a footnote to their existing conflict controls. Instead firms will need to allow time to go back over previous work with a focus on conflict prevention (not just management) and ensure that links between particular conflicts and their corresponding controls are captured in detail. Priority impact areas: Key changes: The core test has been upgraded from one of taking all reasonable steps to all appropriate steps and the objective has shifted from one of identifying conflicts, to one of prevention. Disclosure is an option of last resort and (if it is to be used) must contain a clear statement that the firm s controls are insufficient to prevent a risk of damage to the client, as well as details of the conflict in question and the risks of damage that arise. Firms must review their conflicts of interest policies and report to senior managers on identified conflicts at least once a year. Key sources: MiFID II: Articles 16(3) and 23. MiFID II Delegated Regulation C(2016) 2398: Recitals and Articles ESMA Papers: ESMA Q&A on MiFID II and MiFIR investor protection (2016/1444). SYSC Reporting Client documentation FCA current proposals regarding implementation: The FCA proposes to extend the core rule on identification, management and prevention, and the revised rules on disclosure, to all firms, including non-scope firms. However, the rules on annual review and assessment, will only apply as guidance to non-scope firms Article 3 firms and third country equivalents will be subject to the same requirements as MiFID firms. Draft FCA Rules: Chapter 5 from para of CP 16/19 and CP16/29. Draft PRA Rules: Annex F, para 3.2 of CP43/16. Key contact Caroline Bystrom Professional Support Lawyer, Financial Services Regulatory +44 (0) c.bystrom@taylorwessing.com

18 Comments and observations on conflicts of interest Re-run conflicts assessment: MiFID II extends and strengthens certain key conflicts requirements rather than introducing fundamentally new concepts. However, in order to meet the new standards, firms will need to re-run their conflicts assessment across their business, to ensure they have a clear and detailed map of their conflicts and corresponding preventative measures. It is only by doing this that firms will be in a position to meet the enhanced internal reporting and disclosure requirements. Materiality: MiFID II tends against allowing firms to set levels of materiality when deciding whether a conflict should be addressed. The FCA s MiFID II derived changes proposed to SYSC R reflect this, with the deletion of a materiality test in terms of whether there is a risk that a conflict could cause a client damage (CP16/19). Disclosure to be of last resort and more detailed: it is clear under MiFID II that disclosure is a solution of last resort prevention is the primary objective. A key change also arises in terms of the detail to be disclosed where a firm does not have reasonable confidence that the risk of damage to a client arising from a conflict has been prevented. The legislation moves away from general disclosure, and requires: a clear statement that the steps taken by the firm to prevent the conflict are not sufficient to manage the risk of damage; specific description of the conflicts that arise from that service; and an explanation of the risks that arise. Annual review: while it may already have been good practice, MiFID II makes it a rule that firms should at least annually review their conflicts policy and report to senior management on the situations contained in the firm s record of conflicts. Given the focus on prevention rather than management, it seems a safe assumption that senior management will be expected to take appropriate steps to eradicate conflicts identified on the record, rather than allow them to rest there. ESMA examples: illustrations given by ESMA in its MiFID II Q&A on investor protection topics (16 December 2016) emphasise how disciplined firms will need to be in order to avoid a presumption of an unmanaged conflict of interest. Independent advice firms will have to have controls in place to detect any routine or systematic bias to their own products and be able to demonstrate why this is consistent with independence. Firms offering execution only services will need to be able to retrace client interactions, particularly where there is a doubt as to appropriateness for a client, and demonstrate the client s initiative. The bar is raised where other factors point to a more complex client interaction, for example where prior to a transaction, a client profile is changed, or a service moves from advisory to execution only. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17

19 Topic: Client assets and client money Impact severity: amber MiFID II project timetable: Intermediate workstream: changes may require operational variations to satisfy new requirements. Minor changes to client contracts can be implemented at a later stage, but changes to B2B contracts (to the extent required by a firm) may require more time. Priority impact areas: IT/Ops 1 Client documentation FCA current proposal regarding implementation: 1 1 Governance The FCA s Client Asset Sourcebook (CASS) currently applies to all designated investment business (i.e. MiFID and non-mifid). The FCA intends to maintain a single rulebook for client assets and apply MiFID II changes to all designated investment business. Key changes: Firms must appoint a single officer of sufficient skill and authority with specific responsibility for safeguarding client money and assets. Title Transfer Collateral Arrangements (TTCAs) are prohibited with retail clients. TTCAs with other clients subject to appropriateness and risk disclosure requirements. Firms may not grant to third parties general liens, security interests or rights of set-off over client money or assets unless required by applicable law. Firms must ensure that their sub-custodians also comply with certain requirements on delegating custody to third parties. Before placing client money in a money market fund, firms must carry out an internal credit quality check and not just rely on ratings from CRAs. New proportionality exemption from the restriction against holding more than 20% of client money with a group entity. Firms arranging securities financing transactions in respect of client assets must take collateral and monitor its appropriateness. Key sources: MiFID II: Recitals 51 and 52, Article 16(8) to 16(11). MiFID II Delegated Directive C(2016) 2031: Articles 2 to 8. Draft FCA Rules: Chapter 7 and Appendix 1, Annex F of CP16/19. Key contact Christopher Ratcliffe Senior Associate, Financial Services Regulatory +44 (0) c.ratcliffe@taylorwessing.com

20 Comments and observations on transaction reporting Governance arrangements: the requirement to have a single director or senior manager responsible for custody is not new to FCA regulated firms, who must already maintain a CASS oversight function. However, proposed FCA guidance goes further than MiFID II requirements by stating that, with the exception of small and non-complex firms, the CASS oversight function should not have any additional responsibilities. As FCA guidance becomes finalised, firms should look at their CASS oversight function and decide whether a dedicated resource is required. TTCAs: existing restrictions against entering TTCAs with retail clients will become an outright prohibition under MiFID II. However, the FCA already views these arrangements negatively and it is unlikely the changes will mark a significant departure from market practice. There are new requirements on firms entering into TTCAs with non-retail clients to consider and document the appropriateness of the TTCA. This requires consideration of whether there is only a low or negligible risk of the client owing a liability to the firm and whether the TTCA assets or funds are proportionate to any liabilities. This will prevent the blanket use of TTCAs and firms may need to revisit their client contracts to ensure that any TTCA passes the appropriateness threshold and that the risks and effect of a TTCA are explicitly disclosed. Custody liens: CASS already restricts firms that enter into custody agreements from granting broad security interests over client assets. These restrictions do not apply if security interests are required by local law, or are necessary to access a local market MiFID II is stricter and the only exemption will now be as required by local law. The new requirements also apply to both client assets and client money whereas current rules only cover client assets or money derived from those assets. Firms must disclose the granting of security interests in their client contracts and keep a record of assets over which security interests have been granted. The MiFID II Delegated Directive only permits security interests over a client s assets for debts that relate to the client or services for the client. FCA proposals subtly adapt this wording to debts/services for one or more clients, presumably to clarify that security can be granted over omnibus accounts rather than on a client by client basis. The new FCA rules will need to be assessed carefully to determine how exactly they apply to omnibus and multiple client accounts. On the face of it, the draft rules are potentially broader than existing wording. Delegation of custody to third parties: currently, firms that delegate safekeeping duties to a third party must ensure that: custody assets are held by a third party in a jurisdiction that regulates and supervises their safekeeping; and are not held by a third party in a non-eea country unless required by a professional client or by the nature of the assets. MiFID II requires firms that appoint sub-custodians to impose the same restrictions on any delegation by the subcustodian. Qualifying money market funds: under MiFID II, firms that deposit client money into Qualifying Money Market Funds (QMMF) cannot just rely on credit rating agency ratings, but must carry out their own documented internal assessment. Firms also may need to change their client agreements from opt out to opt in. Group deposits: MiFID II brings a proportionality exemption to the current prohibition on depositing more than 20% of client money with a group entity. Securities financing transactions: firms arranging securities financing transactions in respect of client assets must take collateral and monitor the appropriateness of that collateral. Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices offer clients integrated international solutions. Though our offices are established as distinct legal entities and registered as separate law practices, we are able to help our clients succeed by providing clear and precise solutions with high-level legal and commercial insights. For further information about our offices and the regulatory regimes that apply to them, please refer to taylorwessing.com/regulatory.html and rhtlawtaylorwessing.com. TW_001886_01.17