www.pwc.co.uk/fsrr 24 July 2017 Stand out for the right reasons Financial Services Risk and Regulation Hot topic FCA confirms final MiFID II rules Highlights The FCA issued final rules on MiFID II implementation in the UK. It changed its policy on research, client classification, best execution and taping. With less than six months until MiFID II goes live, the FCA issued the long-awaited MiFID II Implementation Policy Statement (PS) II (17/14) on 3 July 2017. Totalling more than 1,000 pages, the FCA responds to all five previous FCA consultation papers, outlining final rules on the majority of the provisions implementing MiFID II in PERG, CASS and COBS. This Hot Topic considers some of the key aspects of the final rules, highlighting where the FCA altered its approach. We discuss: Perimeter Guidance Manual (PERG) Client Assets Sourcebook (CASS) Inducements, including adviser charging Inducements relating to research Client categorisation Disclosure requirements Independence Suitability and appropriateness Dealing and managing Investment research Client agreements Product governance Knowledge and competence Taping.
The FCA changed its policy on research, client classification, best execution and taping. It also specifies the areas where UK requirements exceed the minimum standards in MiFID II either by maintaining current UK regulatory standards or as a consequence of new policy decisions. The regulator also applies the following MiFID II standards to non- MiFID firms: Inducements in relation to research Client classifications Disclosure requirements Independence Best execution Investment research Product governance (as guidance). CP I (15/43) PERG The FCA has opted not to make perimeter guidance on what constitutes a multilateral system at the present time. But it has instead focused its Q&A on the scope of operating an MTF or OTF with a view to enabling firms to consider what authorisation they require. The FCA remains of the view that any system that merely receives, pools, aggregates and broadcasts indications of interest, bids and offers or prices should not be considered a multilateral system. The FCA has also revisited its guidance on flexible forward contracts to reflect its position that the length of delivery periods is not relevant to whether or not an instrument is an option. In addition, it's clarified that an ordinary commercial company issuing its own securities will not fall within the MiFID perimeter and so will not come under the extended definition of executing client orders under MiFID II. CP II (16/19) CASS As the FCA already has a comprehensive CASS regime, MiFID II rules on safeguarding client assets and funds (SCAF) will have less of an impact on UK firms than for organisations based in the rest of the EU. The FCA deleted its proposals on client money liens since they are already covered in CASS 7. The FCA has also extended the application of MiFID II rules on SCAF to all designated investment firms, including those conducting non-mifid business. The FCA prohibits title transfers collateral arrangements (TTCAs) for retail clients. Firms must terminate all existing TTCAs with retail clients, which may include local authorities which MiFID II reclassifies as retail clients. Firms must take appropriate measures to prevent unauthorised use of a client's assets which exceeds the list in the CASS Handbook. This includes remedial actions where the firm is unable to deliver at settlement. The requirement that firms obtain express client consent to use a retail client's assets cannot be satisfied by mere disclosure in the firm's terms of business. The FCA relented on permitting the single SCAF officer to undertake additional responsibilities. The regulator will consult on the interaction with the Senior Managers and Certification Regime at a later date. Additional PwC thoughts on CASS impacts can be found here. Our CASS team is preparing a separate Hot Topic on the FCA s final rules. CP III 16/29 Inducements, including adviser charging The FCA confirms its approach to inducement rules for retail products and applies the current MiFID II framework for professional advice. Specifically, the FCA will extend MiFID II's ban on inducements for independent investment advice to also include restrictive advice for retail investors. Likewise, the FCA will prohibit firms from even receiving commissions (as opposed to acceptance and rebating) for retail investment advice, but will still allow such rebating for advice to professional clients. The FCA also signals that it remains concerned that firms are inappropriately categorising hospitality as a 'minor, non-monetary benefit' exempted from the inducement ban. Firms can expect renewed focus on this area since MiFID II further tightens the perimeter of what is acceptable. Inducements relating to research The FCA is extending the ban on bundling research and execution costs to investment fund managers otherwise exempted from MiFID II. But firms can operate compliant research payments accounts (RPAs) much more extensively than originally proposed. Responding to stakeholder concerns, the regulator will allow RPAs to leverage some of the characteristics of existing commission-sharing accounts. Firms will have up to 30 days (as opposed to instantly) to transfer research charges into RPAs when using a third party facilitator. The FCA also confirms that a single RPA per budget will not be necessary and that firms can use a consolidated view of multiple underlying RPAs. The FCA has imposed some additional restrictions, such as prohibiting the netting of research charges prior to transfer from the broker to the RPA. Client categorisation MiFID II re-categorises municipalities and local authorities (MLAs) as retail clients. Client classification is one of the few areas where lack of EU 2 Hot Topic Financial Services Risk and Regulation
harmonisation is permissible due to the varying legal structures of MLAs across the Member States. The FCA exercises discretion by establishing limits on an MLA's ability to opt up to elective professional status. The four-pronged test based on qualitative and quantitative criteria applies differently depending on whether the MLA's treasury function or its pension fund administration seeks to opt-up. Investment firms must test current MLAs before 3 January 2018. Professional clients must inform the investment firm of changes in the criteria affecting their status. The FCA revises its proposals in two key areas easing the standards for MLAs seeking elective professional status. First, the final rules lower the quantitative threshold from the proposed 15m down to 10m as the amount MLAs must have in their investment portfolios. Second, acknowledging the standards applicable to local government pension schemes (LGPS), the FCA adds an alternate fourth criteria for MLAs subject to the LGPS regulations. Client classification standards apply to both MiFID and non-mifid firms conducting business with local authorities. Disclosure requirements The FCA is introducing a revised disclosure framework to implement the MiFID II requirements. This includes new and more detailed costs and charges disclosure requirements for firms doing MiFID business. There are separate regimes for firms doing MiFID business, for Article 3 firms and for firms doing MiFID business in relation to professional clients and ECPs. The FCA is not currently proposing standardised format setting out how firms should calculate and disclose point-of-sale or post-sale information, including information on costs and charges. The absence of a standardised format may mean firms develop different approaches to disclosure which may make it harder for consumers to compare alternatives. But the FCA sees the practical challenges associated with developing a standardised format, and the need to consider the requirements across MiFID II, PRIIPs and the IDD, as barriers to proposing a standardised format for the time being. It plans to continue to engage with firms and industry bodies on any industry-led development of a standardised format. Independence The FCA applies the MiFID standard of independence to financial instruments, structured deposits and other non-mifid retail investment products, but only when firms are advising retail clients in the UK. The regulator believes this will avoid complexity and potential consumer confusion. This approach means that for advice that falls outside the scope of MiFID II, with certain limited exceptions, the FCA will apply as rules the provisions of the Delegated Regulation (EU) 2017/565 of 25 April 2016. Under MiFID II, individual advisers are prevented from providing both independent and restricted advice. In CP16/29, the FCA proposed that it would not apply these rules to non-mifid business more broadly, as it believes that imposing this requirement could be an issue for firms which give both types of advice and in particular for firms with only one adviser. The FCA confirms this approach. Suitability and appropriateness The FCA has no discretion on the implementation the suitability requirements in the Delegated Regulation (EU) 2017/565 of 25 April 2016. It will copy the provisions into the new COBS 9A which applies to MiFID businesses and Article 3 firms. Existing COBS rules on suitability will apply to non-mifid firms. In response to concerns about the impact of the requirement that firms analyse the costs and benefits for clients switching investments, the FCA encouraged market participants to respond to ESMA's CP on Guidelines on certain aspects of the MiFID II suitability requirements published on 13 July 2017. Firms must perform appropriateness tests to determine whether potential clients have sufficient knowledge and experience before executing client orders in complex products. MiFID II expands this rule by limiting the scope of non-complex products. Firms must assess on a case-by-case basis whether investment trusts and non-ucits retail schemes are complex or non-complex. The FCA also clarifies that distributors are responsible for conducting appropriateness tests. As with suitability, the FCA set out MiFID II appropriateness rules in a new COBS 10A applicable to MiFID firms. Current COBS rules apply to non- MiFID firms arranging or dealing in a non-readily realisable securities, derivatives or warrants for a retail client. The FCA plans to address the applicability of COBS 9A and 10A to IDD at a later date. Dealing and managing Best execution The FCA makes minor changes to the proposals to implement the revised best execution requirements under MiFID II. Industry stakeholders asked for guidance on how some of the MiFID II best execution rules apply to firms receiving and transmitting orders. In response, the FCA advises that the Delegated Regulation (EU) 2017/565 of 25 April 2016 imposes best execution requirements on portfolio managers and firms that receive and transmit orders for execution. Such firms are required to provide disclosures in relation to the entities or intermediaries to which they pass orders in the chain of execution. 3 Hot Topic Financial Services Risk and Regulation
The FCA extends the MiFID II best execution regime to Article 3 financial advisers as planned. These firms will therefore be subject to the enhanced best execution standards, but will not be required to produce an annual report on execution quality. UCITS management companies will also be required to comply with the MiFID II best execution requirements, with some modifications. Small authorised UK AIFMs and residual CIS operators will not be required to comply with the MiFID II best execution rules for the time being. The FCA says this will ensure that this set of generally smaller firms are not subject to higher standards than full-scope AIFMs. The FCA has also decided not to apply the MiFID II standards to incoming EEA AIFM branches. Client order handling MiFID II widens the scope of shares subject to limit order rules to include those traded on all trading venues, expanding coverage which was previously limited to regulated markets. It also allows additional methods for making client limit orders public and clarifies that the choice of venue must be made in line with the firm's execution policy. The FCA does not make any changes to its proposed amendments of COBS 11.3 and COBS 11.4 to implement the MiFID II changes. The FCA confirms that MiFID II transaction record keeping provisions will apply to UK branches of third country firms. Investment research While MiFID II imposes additional safeguards against conflicts of interest caused by investment research, the FCA clarifies that the UK will only apply these additional measures to true investment research as opposed to non-independent research more aligned with sales or marketing materials. Specifically, firms will only need to consider physical separation between financial analysts and traders for the provision of independent research. Likewise, the FCA concludes that producers of non-independent research will be allowed to participate in investment banking activities, such as IPO pitches, while producers of independent research will be prohibited. Also, the FCA indicates that it will be taking a proportionate approach to some of these measures. Smaller firms may not have to impose physical separation if they can manage conflicts of interest through other means. Client agreements MiFID II requires firms to enter into a basic written agreement with all types of client which contains detailed information. This must be done for each investment service and ancillary service, and applies to existing and new clients alike. These agreements must be kept for the duration of the relationship with the client, but there is no obligation to keep the record for at least five years if that is longer than the relationship with the client. The FCA will implement the more detailed client agreement requirements and simplified MiFID II record keeping requirement for firms carrying on MiFID business. It will extend the simplified MiFID II record keeping requirement (where records only need to be kept for the duration of the relationship with the client) to non-mifid business other than pension conversions, pension opt-outs or free standing voluntary contributions. Firms must keep records indefinitely for these types of business. Product governance Firms that comply with the product governance rules in the PROD rulebook do not have to apply the guidance set out in Responsibilities of Providers and Distributors for the Fair Treatment of Customers (RPPD). This is because PROD is intended to achieve the same aims as RPPD. The FCA confirmed that the MiFID II product governance requirements will be applied to UK branches of third country (non-eea) firms. Firms seeking guidance on the target market assessment have been referred to ESMA's guidelines which cover target market assessments for mass retail products. The FCA explains that the new PROD sourcebook sets out how firms should determine target market needs and that this is different to the content of RPPD which is focused on information to customers. Firms (including non-mifid firms that manufacture and distribute MiFID products) should comply with the PROD rules in a way that is proportionate and appropriate. PROD applies to firms providing portfolio management as this is within the definition of distributing under the MiFID II Delegated Directive. Knowledge and competence The FCA intends to comply with ESMA's guidelines on knowledge and competence. Firms must comply with the new rules when making a personal recommendation to a retail client. The FCA will introduce a maximum time frame of four years for individuals who provide advice or information in a MiFID context to acquire necessary qualifications under MiFID II. Such individuals will be required to be supervised by an appropriately qualified individual during that period. This is broadly consistent with the existing RDR requirements. The FCA will also introduce a minimum time period of six months for staff to be considered to have acquired appropriate experience. 4 Hot Topic Financial Services Risk and Regulation
The FCA will not update its list of retail qualifications in TC as a result of ESMA's guidelines but has instead asked firms to consider ESMA requirements and ensure that the qualifications meet ESMA's criteria set out in the guidelines. The FCA will not put in place any transitional or grandfathering arrangements in relation to the new knowledge and competency requirements. Taping The FCA is moving the taping requirements from the COBS sourcebook into the SYSC sourcebook. These taping requirements will apply to all clients and all types of MiFID financial instruments. They will also apply to third country firms. Recorded conversations will now generally be subject to MiFID II record keeping requirements. The FCA has changed its policy intention and is not applying the taping rules to all aspects of corporate finance business. But it will require conversations to be taped by corporate finance firms where they relate to the provision of client order services that relate to the reception, transmission and execution of client orders, or when dealing on own account. The FCA removed the qualified exemption for discretionary investment managers (DIMs). DIMs must comply with the taping rules from 3 January 2018. It will also apply the requirements to Article 3 firms, such as retail financial advisers but will allow such firms flexibility to take a note of conversations rather than record them. All other firms (such as UK AIFMs) will continue to be subject to taping rules that are equivalent to those currently in force, though they will be updated to align with MiFID II organisational requirements where necessary. 5 Hot Topic Financial Services Risk and Regulation
Stand out for the right reasons Financial services risk and regulation is an opportunity At PwC we work with you to embrace change in a way that delivers value to your customers, and long-term growth and profits for your business. With our help, you won't just avoid potential problems, you'll also get ahead. We support you in four key areas. By alerting you to financial and regulatory risks we help you to understand the position you're in and how to comply with regulations. You can then turn risk and regulation to your advantage. We help you to prepare for issues such as technical difficulties, operational failure or cyber attacks. By working with you to develop the systems and processes that protect your business you can become more resilient, reliable and effective. Adapting your business to achieve cultural change is right for your customers and your people. By equipping you with the insights and tools you need, we will help transform your business and turn uncertainty into opportunity. Even the best processes or products sometimes fail. We help repair any damage swiftly to build even greater levels of trust and confidence. Working with PwC brings a clearer understanding of where you are and where you want to be. Together, we can develop transparent and compelling business strategies for customers, regulators, employees and stakeholders. By adding our skills, experience and expertise to yours, your business can stand out for the right reasons. For more information on how we can help you to stand out visit www.pwc.co.uk 7 Hot Topic Financial Services Risk and Regulation