This article was written by Tim Dolan (partner) and Charlotte Collins (professional support lawyer)
MiFID II is designed to build upon the framework of MiFID I,
addressing perceived gaps and dealing with market developments since MiFID I
was penned over a decade ago. Although there are only a few headline changes to
the activities and instruments to which MiFID applies, and the lists of
investment services and activities and financial instruments remain largely unchanged,
there are plenty more nuanced changes that need to be considered.
Investment services and
Some of the key changes relate to market infrastructure. One
obvious change is the addition of the new investment activity, operation of an
organised trading facility (OTF). This
is to reflect the fact that a new trading platform, the OTF, is being
introduced, to sit alongside the other MiFID trading venues: regulated markets
and multilateral trading venues. For further details on the new OTF trading platform, please see our alert on trading venues.
Further, the definition of “systematic internaliser” (essentially,
a bilateral trading venue) has been widened to include more objective criteria
than under MiFID I. It is expected that this will result in more than the
present handful of firms being caught by this definition and needing to comply
with the consequent obligations. We examine the change to this definition in our alert on trading venues.
Although at first glance other investment services and activities
do not appear to have changed, upon closer inspection it becomes evident that the
meaning of several activities has in fact been extended.
A change in the Level 2 measures means that now the MiFID
investment advice activity includes recommendations given through a
distribution channel. Although the equivalent UK regulated activity of advising
on investments is already much broader than the MiFID activity, meaning that UK
authorised firms should not need to adjust their regulatory permissions, this
extension will mean that much more investment advice is classed as MiFID
business and consequently that MiFID conduct of business rules will apply to
the provision of that advice.
A recital to the MiFID II Directive explains that issuers of
financial instruments should be within scope of the activity “execution of
orders on behalf of clients” in relation to primary issues of their own
financial instruments when distributing those instruments themselves, even when
they do not provide any advice. This means that potentially any company issuing
its own capital (whether or not already a MiFID investment firm by virtue of
its other activities) could need to be authorised to carry on this activity.
Although draft FCA guidance sensibly indicates that “it cannot be
the case that raising capital by issuing its own capital causes an ordinary
commercial company to become an investment firm”, it does not explain on what
basis companies not otherwise carrying on investment activities might successfully
exempt themselves from this activity (and regulation under MiFID II). Without
any firmer steer as to where the boundaries of this activity have been redrawn,
this expansion has potentially far-reaching consequences.
Another change, again tucked away in the recitals, is that “dealing
on own account” will capture firms engaging in “matched principal” or “back-to-back”
trading. Consequently, traders that execute orders from different clients on a
matched principal basis (where the trader acts as an intermediary between the
buyer and seller, without being exposed to market risk) will be regarded as
acting as principal.
Under MiFID II, they will need to be authorised to perform both
the activity of execution of orders on behalf of clients and the activity of
dealing on own account. Thankfully there may be little practical change here
for UK firms, which already need UK permissions to deal as agent and as
principal if trading on a matched principal basis. Although the change at an EU
level might be expected to impact firms’ regulatory capital position, draft FCA
guidance confirms that firms that do not otherwise deal on own account will not
be considered as dealing on own account for the purpose of determining their
regulatory capital requirements.
Physically settled derivatives relating to emission allowances are
now within scope (only cash settled were caught under MiFID I). Emission
allowances consisting of units recognised under the EU Emissions Trading Scheme
Directive have been added as a new category of financial instrument, fully
bringing them within scope of MiFID, in alignment with the scope of the new EU Market
Commodity derivatives that can be physically settled and that are
traded on an OTF have also been brought within scope. Wholesale energy products
that are traded on an OTF and must be physically settled remain exempt (these
are already regulated under the EU Regulation on wholesale energy market
integrity and transparency (known as REMIT)). Level 2 measures provide further
detail on the meaning of the expression “must be physically settled”, which is
intended to avoid the above exemption being exploited.
Although structured deposits are not financial instruments under
MiFID II, certain provisions of MiFID II (relating to organisational
requirements, conduct of business requirements and powers of competent
authorities) will be extended to MiFID firms when selling, or advising clients
in relation to, structured deposits. This means that firms acting as
intermediaries in relation to such products need to be mindful of the fact that
additional obligations may apply to these activities, and may need to adjust
their policies and procedures accordingly.
Steps for firms to take
Firms need to familiarise themselves with these changes to scope
and analyse whether and how these will affect both their regulatory permissions
and the way their business is regulated. Firms need to ensure that they are
prepared for these changes, and that they have the correct permissions, in time
for 3 January 2018.