Brave New World: MiFID2 and MiFIR The changes facing the Financial Markets Jason Valoti 13 July 2016
MiFID what? MiFID (Markets in Financial Instruments Directive) Sets out rules on what investment services are regulated Not banking (as the Capital Requirements Directive (CRD))but: Dealing as agent/principal, advice, DIM, RTO in financial instruments etc Financial instruments: securities, funds, derivatives etc The rules on the EU passport for investment firms The investor protection rules including conduct rules Markets rules including transparency and reporting Applies all across the EEA (so EU plus Iceland, Liechtenstein and Norway) Only in place since November 2007 1 / L_LIVE_APAC1:5232716v1
MiFID2 why and how? Result of financial crisis and unresolved issues under MiFID1 Repeals MiFID1 Applies to investment banks, broker dealers, private banks, wealth managers/advisors, exchanges/markets, certain data providers. But also direct and indirect impact on non-eu firms (third country firms) that interact with the EU market. Wide coverage will make wide sweeping reforms to market structure, transparency, investor protection, conduct of business, senior management, product governance, transaction reporting and market access for third country (non-eu) firms. Effect more will be subject to authorisation, more of everything in MIFID1 2 / L_LIVE_APAC1:5232716v1
MiFID2 Extra Territorial (ET) reach Direct impact: Branches of EEA firms (investment firms and banks) Anyone who wants to access EEA clients/investors (Third Country Rules) Regulatory and markets measures (Product Intervention) Indirect impact: Anyone who deals through EEA firms Anyone who deals on EEA markets Anyone who provides services to EEA firms Anyone who offers products to EEA investors 3 / L_LIVE_APAC1:5232716v1
Re-Cap on EU law making Level 1 (L1) Level 2 (L2) Level 3 (L3) MiFID2- Requires national implementation. MiFIR- Direct effect Implementing measures and technical standards. Guidance and recommendations. MiFID2 MiFIR Delegated & Implementing Acts Scope/ authorisation Pre & post trade transparency ESMA Guidelines Passport and third country firms Transaction reporting Organisational and conduct of business Third country firms cross-border business Regulatory/Implementing technical standards. ESMA & Commission FAQs OTFs, MTFs, regulated markets requirements Trading obligations shares/otc derivatives. Regulator enforcement 4 / L_LIVE_APAC1:5232716v1
The latest on timing 2014 2015 2016 2018 15 April 2014: Ratification of Level1 text 22 May 2014: ESMA s first CP and DP 19 Dec 2014: Final report issued to Commission; Second CP issued by ESMA April 2016: Level 2 Delegated Acts and technical standards 3 July 2017 Entry into national force 13 May 2014: adopted by Council 12 June 2014: Publication of L1 text in the OJ Sep 2015: ESMA Final Report on 75% of the RTSs Dec 2015: ESMA Final Report on remaining 25% of the RTSs FCA CP 15/43 New DATE: 3 January 2018 GO LIVE DATE (Previously 3 January 2017) 5 / L_LIVE_APAC1:5232716v1
What does this mean on a national level? Who will be on time? Very few Member States have begun any consultation process on MiFID2 (UK, Germany, and Netherlands). Many NCAs are struggling with implementation. Gold-plating? Expected Member States will Gold-Plate various requirements, including but not limited to recordkeeping, corporate governance, product governance, investor protection, algo/hft and inducements. Likely to impact non-eu firms as gold-plating may apply MiFID2 provisions to a wider scope of firms and activities. Result in lack of harmonisation 6 / L_LIVE_APAC1:5232716v1
Commodity Derivatives Conduct of Business & Senior Management Electronic Trading Arrangements Third Country Firms What are the key impacts? Product Governance & Intervention Market Structure Transaction Reporting Requirements Pre & Post Trade Transparency Regulator Interventions 7 / L_LIVE_APAC1:5232716v1
Credit Institutions Investment Banks Financial Brokers Commodity Derivatives Dealers Who are the key stakeholders? EU and non- EU operating cross-border business Operators of Regulated Markets, OTFs & MTF s Investment & Fund Managers Private Fund Managers 8 / L_LIVE_APAC1:5232716v1
Core MiFID II Content & Requirements Scope Senior Management & Controls Market Structure & Trading Venues Commodities Pre & Post Trade Transparency Requirements Transaction Reporting Electronic Trading Conduct of Business Investor protection Product Governance Third Country Firms 9 / L_LIVE_APAC1:5232716v1
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So breaking this down - impact on Third Country Firms Direct To access EEA counterparties/clients Will require registration or presence for Third Country Firms Two different types of access regimes, depending on the relevant client type. Indirect Butterfly Effect Impact on firms who trade on EU venues and/or with EU counterparties or market or distribute products into the EU but do not have an EU presence. Transparency and trading obligations. Product governance. Investor protection. Inducements. Commodity derivatives and emission allowance. 12 / L_LIVE_APAC1:5232716v1
Accessing EEA clients - Third Country Regimes CROSS- BORDER SERVICE REGISTRATION Services to eligible counterparties and per se professional ESMA registration. The EU Commission must have first adopted an equivalence decision. The Third Country firm must be authorised in the Third Country and it must be subject to effective supervision. Cooperation arrangements must be in place between ESMA and the relevant competent authorities. Question what countries will meet the test! LOCAL BRANCH SERVICE Services to retail or elective professional Option for EU Member State to require third country firms to establish and register a branch The third country firm must be authorised in the third country and it must be subject to effective supervision. Cooperation arrangements must be in place between ESMA and the relevant competent authorities of the third countries. Branch will need to comply with MiFID2 and MiFIR conduct of business rules 13 / L_LIVE_APAC1:5232716v1
Still Possible to deal on Reverse Enquiry basis Permits a Third Country firm to provide as long as the EEA client has initiated the service at its own exclusive initiative. Currently, unofficially applies in many Member States, but application is inconsistent and uncertainty remains about how regulators will interpret and apply new provision. Member States Current Regime Under MiFID2 UK Italy Netherlands Ireland Germany Limited application and subject to strict conditions Limited to transaction by transactions basis and subject to strict conditions Relationship basis rather than Transaction by Transaction Permitted provided certain conditions for permitted reverse enquiry are met. Limited to transaction by transactions basis and subject to strict conditions No indication yet on interpretation. No indication yet on interpretation. Expected that current regime will continue No indication yet on interpretation. Likely to be applied on a limited basis. 14 / L_LIVE_APAC1:5232716v1
What does it all mean for Third Country firms? Application across Member States - Currently unclear whether Member states will apply the branch regime or whether ESMA will grant equivalence decisions. Only few regulators have indicated a proposed approach: UK- FCA has decided to not elect for regime. Netherlands - Will elect for the branch regime for retail clients but not professionals. Belgium - Will likely opt in as currently operates a light touch approach. Existing national regimes to apply - In the absence of any opt-in existing Member State regimes will apply. UK - Private placement Belgium - Light touch license requirement Netherlands - Light touch for professionals Ireland - Third country cross-border exemption. Non-EU firms should monitor national implementation and interpretations closely. Should consider how they currently access EU markets and whether they will need to alter their approach or their business structure to accommodate new changes. 15 / L_LIVE_APAC1:5232716v1
New Inducement rules Delegated Directive level 2 legislation covering client funds, product governance and inducements. The issue of receipt of investment research by investment managers, and how this is paid for, has been a hot topic in the industry. Background MIFID2 states that, when providing portfolio management services, MIFID investment managers must not accept and retain fees, commissions or any monetary or nonmonetary benefits paid or provided by, or on behalf of, a third party this principle forms part of the MIFID2 inducement rules. In December 2014, ESMAs proposals on inducements proposed that the receipt of all research by an investment manager would be treated as an inducement and that such research could only be paid for either by the manager from its own resources or from a specifically established research payment account. The ESMA proposals recommended that the research payment accounts should not be capable of being funded by commissions generated from executing trades. 16 / L_LIVE_APAC1:5232716v1
New Inducement rules - continued Concerns The ESMA proposals could potentially have effectively outlawed the use of commission sharing agreements between the manager and the broker to pay for investment research (a commonly used arrangement). Position under Delegated Directive Article 12 provides: - all fees, commissions and any monetary benefits paid or provided by a third party (or person acting on the third party s behalf) to an investment firm relating to the provision of independent investment advice and portfolio management are allocated and transferred to each client - investment firms required to inform clients about the fees, commissions and monetary benefits transferred by way of periodic statements or similar - investment firms providing investment advice on an independent basis or portfolio management shall not accept non-monetary benefits that do not qualify as acceptable minor non-monetary benefits (Delegated Act sets out the criteria for minor non-monetary benefits narrowly construed. Not broad enough to cover investment research) 17 / L_LIVE_APAC1:5232716v1
New Inducement rules - continued Inducements in relation to Research Under the Delegated Directive, the provision of research is treated as an inducement. The means by which an investment firm may pay for research is covered under Article 13 and, following in principle, the ESMA proposals, provides that can only be received by an investment manager if it is paid for either: - directly by the investment manager out of its own resources; or - from a separate research payment account controlled by the investment manager and certain requirements are met. Commission Sharing Agreements not dead yet? Interestingly, the Delegated Directive diverges from the ESMA proposals by implicitly allowing transaction commissions to be used for funding the research payment account. This is provided for by way of Article 13(3) which requires the investment manager to operationally indicate a separately identifiable research charge where it is collected alongside a transaction commission. Accordingly, while certain structural adjustments to commission sharing agreements will be necessary to comply with the rules, they should conceptually still be an approach to paying for such services. 18 / L_LIVE_APAC1:5232716v1
New Inducement rules - continued Specific Conditions applicable to Research Payment Accounts To use an RPA, an investment manager must comply with the following conditions: - funded by a specific research charge: the specific research charge must be based on a research budget set by the manager for the purposes of establishing the need for third party research. It must not be linked to the volume or value of transactions executed on behalf of clients. The total amount of research charges cannot exceed the research budget - setting and agreeing a research budget: the research budget must be managed solely by the manager and be based on a reasonable assessment of the need for third party research. Appropriate controls and senior management oversight is required (including a payments audit trail). The research budget and amounts in the RPA must not be used to fund internal research - investment manager held responsible: the manager may delegate the administration of the RPA to a third party provided that the arrangement facilitates the purchase of third party research and payments to research providers in the name of the manager - assessing quality of research: the manager must establish a written policy which documents all elements of how it assesses research quality and provide it to clients (including how it benefits clients portfolios) 19 / L_LIVE_APAC1:5232716v1
New Inducement rules - continued Additional Requirements regarding Research Payment Accounts Disclosure requirement to clients: - Prior disclosure: before the provision of a service to clients, the manager must provide to clients information about the budgeted amount for research and the amount of the estimated research charge for each of them - Annual disclosure: on an annual basis, the manager must provide to each client information on the total costs that the client has incurred for third party research - Ad-hoc disclosure: if requested by clients or competent authorities, an investment manager must provide a summary of the providers paid from the RPA, the total amount they were paid over a defined period, the benefits and services received by the manager and how the total amount spent from the RPA compares with the budget set for that period Express agreement of each client to the RPA is also required covering the following (which may be set out in the IMA or general terms of business): (i) the level of the budgeted research charge and frequency of deduction from that client, (ii) increases in the research budget only permitted after provision of clear information to the client of such intended increase and (iii) if there is a surplus in the RPA after the defined period, a process for rebating the funds to the client or to offset it against the research budget for the following period. 20 / L_LIVE_APAC1:5232716v1
Brexit impact on business: Short Term Very much business as usual (albeit lack of certainty for the future) Existing EU law will continue to apply Continuation with current EU regulatory reform/implementation (e.g. PRIIPS/MIFID2): Global drivers e.g. G20 UK front runner in many areas of reform Access requires compliance Firm s footprint - Equivalence and/or new deal - Question capacity within HMT/UK regulators to deviate 21 / L_LIVE_APAC1:5232716v1
Brexit Impact on firm type Firm Type Impact Details Recommendation UK branch of third country firm UK branch of EU (non-uk) firm UK headquartered EU firm (without branches or crossborder passport) UK headquartered EU firm (without branches or crossborder passport) LOW MEDIUM to HIGH LOW HIGH HIGH UK permission intact and no freedom of service Premise of UK operations based on EU law and question whether home regulator and UK regulator will permit the continuation of the business without significant changes, whether capital, oversight, etc Based on current business model If any future plans include pan-european operations Freedom of services (crossborder and branch) will disappear Initial step is to start dialogue with home state regulator as to likely outcome. Also await UK stance on branch operations of EU firms post Brexit Confirm status of current business and seek advice for future plans Consider options including third country cross-border licences (very limited), and/or Consider alternative EU location for set-up. 22 / L_LIVE_APAC1:5232716v1
What should non-eu firms be doing now? Macro impact analysis - How does MiFID2 impact on my firm? What potential changes will we have to make to our trading strategies, IT systems, information systems and communications and agreements with EU counter-parties. Contact EU brokers and counterparties and distributors to discuss how changes may impact their relationship and what new obligations/ requirements will need to be put in place. For third party firms wishing to access EU markets consider the changes under the Third Country regime and whether any need to re-structure business or alter how the business currently accesses EU markets. Legal & Compliance teams will need stay abreast of developments of L2 and L3 legislation and guidance. Simmons & Simmons MiFID2 Manager may help.. 23 / L_LIVE_APAC1:5232716v1
Contacts Jason Valoti T +65 6831 5610 E jason.valoti@simmons-simmons.com For further information Simmons & Simmons MiFID2 website http://www.simmons-simmons.com/en/services-and-sectors/financial- Institutions/MiFID Simmons & Simmons MiFID2 Tracker http://elexica.authoring.simmons.local/en/resources/microsite/mifid-2- Tracker Simmons & Simmons Legal Headwinds http://www.elexica.com/microsites/extras/legalheadwinds/index.aspx Simmons & Simmons Brexit http://www.elexica.com/en/resources/microsite/brexit 24 / L_LIVE_APAC1:5232716v1
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