Previous articles in our series on MiFID 2 have considered specific publications and drilled into its effects on particular aspects of business. During 2015, there have been many important consultations, responses, policy papers and final versions of standards. But the always-ambitious implementation timeline is beginning to slip. In this article, Emma Radmore of Dentons looks at what has happened so far, what remains to be finalised, and whether there will be a delay in implementation.
The Level 1 legislation
It now seems a long time ago that the Level 1 legislation – the revised Markets in Financial Instruments Directive and the Markets in Financial Instruments Regulation (referred to collectively as MiFID 2) was adopted. But adoption was in May 2014, and the measures were published in the Official Journal of the EU in June 2014.
The MiFID 2 Directive required Member States to adopt and publish by 3 July 2016 all necessary laws, regulations and implementing measures to comply with the Directive and to apply them from 3 January 2017, with the exception only of one provision (relating to consolidated tape providers) that would not apply until 3 September 2018 and a provision amending the Alternative Investment Fund Managers Directive which had to take effect earlier, from 3 July 2015. Transitional provisions would apply in order to give a staggered application of the clearing provision stemming from the European Market Infrastructure Regulation (EMIR) to certain derivatives contracts.
MiFIR, as a Regulation, does not need to be implemented, and is stated to apply from 3 January 2017 (with provisions allowing the European Supervisory Authorities (ESAs) and others to develop required standards taking effect immediately and provisions relating to access to and licensing of benchmarks not taking effect until 3 January 2019.
The Level 2 legislation and technical standards
But, as is increasingly the case with EU legislation, the Level 1 measures are only the tip of a very large iceberg, and the devil is in the detail. A swathe of delegated and implementing legislation needs also to be finalised before the MiFID 2 package can take effect – and without these measures, national regulators cannot finalise their measures, and affected firms cannot finalise their preparations.
The timetable was always ambitious, but the European Commission had anticipated this, and had already sent ESMA a mandate to provide it with advice on the content of these measures, in April 2014. The request included the implementation timeline – specifically that ESMA was to provide its advice to the Commission within six months of the legislation coming into force (which we now know to be December 2014) with the Commission to adopt measures based on ESMA's advice no later than six months after that.
Various articles of the MiFID 2 package also required ESMA to develop and submit regulatory and implementing technical standards (RTS and ITS) to the Commission by 3 July 2015.
Where are we now?
ESMA published consultation and discussion papers on its advice to the Commission and technical standards in May 2014 and followed these up with public hearings over the summer. These resulted in a further set of papers in December 2014, comprising ESMA's final technical advice to the Commission and consultation drafts of around 40 technical standards.
Over the early part of 2015, ESMA issued further papers on specific aspects of MiFID 2. At the end of June, it submitted to the Commission its first five technical standards, covering aspects of authorisation of investment firms.
In July, it updated the European Parliament's Economic and Monetary Affairs Committee (ECON) on its progress. At that time, it still needed to publish a few more technical standards for consultation, which it did in August.
Then, in September, ESMA published the bulk of its final RTS and ITS.
So, ESMA met its timescales in sending its technical advice to the Commission, but the Commission did not meet its timescale to adopt measures based on the advice. We are currently expecting the advice in mid-December – so around six months late.
ESMA did not meet its timescales to publish the RTS and ITS by 3 July – it was nearly three months late in publishing most of them, and is still due to publish the final version of those for which consultation was delayed. The Commission has not commented on the standards ESMA published in June.
What did the technical advice cover?
The technical advice to the Commission covers the detail of many important issues. Without the technical advice, we cannot be sure of the Commission's final position and guidance on matters such as:
- the interpretation of what is providing an investment service "in an ancillary manner";
- any adjustments to the definition of "investment advice" for assessing how investor protection rules apply;
- organisational and compliance requirements on firms;
- expectations on product governance;
- recording of communications;
- governance and organisational requirements around protection of client money and assets;
- changes to the current framework on conflicts of interest;
- appropriate requirements for remuneration policies;
- format of information firms must provide to clients on advice, instruments, costs and charges;
- interpretation of suitability and appropriateness requirements;
- expectations on reporting, best execution and client order handling;
- criteria and factors regulators should apply when considering using their new product intervention powers;
- interpretation of several provisions relating to transparency, including on what is a liquid instrument or market, how to delineate between products, and pricing;
- interpretation of provisions relating to data publication and access to quotes;
- advice on what falls within the scope of algorithmic and high frequency trading and Direct Electronic Access;
- conditions affecting trading and trading venues, including when instruments can be suspended or removed from trading;
- the scope of key definitions of derivatives contracts caught by MiFID 2, and position reporting thresholds and management powers; and
- portfolio compression.
ESMA's advice to the Commission will result in a mixture of revisions and updates to Level 2 measure that exist under MiFID 1 and are, at least in part, still fit for purpose, and new measures, to address the many aspects of MiFID 2 and the advice that are not currently addressed adequately or at all.
Moreover, many of these measures will inform, and affect, how Member States put in place their own implementing legislation – so without them, the ability of Member States to progress their implementing timetables and of firms to prepare for the changes MiFID 2 will bring are limited, and any preparations made will be subject to change.
What do the RTS and ITS cover
Confusingly, ESMA has carried out renumbering of its standards, and there is now some duplication of numbering, which makes referencing hard.
The June Standards
In June, ESMA submitted to the Commission standards on:
- authorisation: RTS 1 and ITS 2 on information applicant must provide and formalities for applications;
- passporting and tied agents: RTS 3 and ITS 4 on notifications of intentions to provide services, directly or through tied agents, in other Member State; and
- third-country firms: RTS 5 on the information a third-country firm applying for authorisation must submit to ESMA and how these firms must notify clients of the limitations on their activities that MiFIR mandates.
The September Standards
- transparency: RTS 1 to 5 on transparency requirements in respect specific instruments, the volume cap mechanism, criteria for determining whether derivatives should be subject to the trading obligation and whether derivatives have a direct, substantial and foreseeable effect within the EU;
- microstructural issues: RTS 6 to 12 on organisational issues for algorithmic traders, direct electronic access providers, trading venues when allowing algorithmic trading, market making agreements, co-location structure, tick sizes and material markets in terms of liquidity relating to trading halt notifications;
- data publication and access: RTS 13 to 15 on organisational requirements for data reporting services providers, data disaggregation and clearing access;
- requirements applying on or to trading venues: RTS 17 and 19 and ITS 19 on admission, suspension and removal of financial instruments to trading and description of the functioning of multilateral and organised trading facilities;
- commodity derivatives: RTS 20 and 21 on the criteria for establishing when an activity is to be considered to be ancillary to the main business and the methodology for calculating and applying position limits for commodity derivatives traded on trading venues and economically equivalent OTC contracts;
- market data reporting: RTS 22 to 25 on reporting obligations, supply of financial instrument reference data, maintenance of relevant data and accuracy of business clocks;
- post-trading issues: RTS 26 to 28 on the obligation to clear derivatives traded on regulated markets and timing of acceptance for clearing, information on execution data and publication by investment firms of information on the identity of execution venues and on the quality of execution.
The Standards still under consultation
The remaining standards, in relation to which consultation closed on 312 October, relate to:
- the timing and format of publications and communications where there is a suspension or removal of financial instruments from trading on a trading venue;
- standard forms, templates and procedures for the notification and provision of information for data reporting services providers (DRSPs) covering applications for authorisation of DRSPs, the notification of members of the management body of a DRSP and of any changes to its membership; and
- weekly aggregated position reports for commodity derivatives, emission allowances and derivatives of these.
ESMA intends to submit these to the Commission by 3 January 2016.
A case for delay?
The popular belief was that despite the slippage in the Commission's timetable, delaying the effects of MiFID 2 was not an option. Indeed, ESMA wrote to the Commission setting out areas of MiFID 2 that it thinks will in practice be challenging or impossible to have in place by the current “go-live” date. It noted several requirements that will involve IT development by both regulators and market participants, many of which are dependent on others. The requirements, on (i) reference data, (ii) transaction reporting, (iii) transparency parameters and publication and (iv) position reporting, are contained in the Level 1 text, to be embellished in Level 2. ESMA noted that, according to the current timetable, the earliest the MiFID Level 2 measures that ESMA sent to the Commission at the end of September will appear in the OJEU, after Commission, European Parliament (EP) and Council approval, is March 2016 – and this assumes the fastest possible timetable, assuming that the Commission does indeed publish the measures in December and that EP and Council take the minimum permitted time of three months to approve them. This would leave only nine months before 3 January 2017, when the majority of MiFID 2 is to be implemented into and operational in the laws of Member States. ESMA advised the Commission that this period is way too short. In the course of the last couple of months, it has become evident to ESMA and national regulators that it will not be feasible to have those systems ready for 3 January 2017. Market participants, who will need to feed into those systems, are facing similar implementation challenges. ESMA said that some provisions could operate in the absence of all the market players and all authorities being ready. However, some others, because of their very nature, require a high degree of synchronicity. ESMA explained the problems and suggests some alternative methods for dealing with them, listing the pros and cons of each. It suggested:
- a Level 1 “fix” by delaying the application date of certain requirements;
- a Level 2 “fix” by fixing the implementation date of relevant requirements as later than the Level 1 date; or
- a Level 3 “fix” whereby ESMA and national regulators agree an implementation date that is later than the one in the law.
Its letter explained how each fix has been used in the past and expressed its strong preference for a Level 1 fix.
But now, the EP has written two letters to the Commission. It refers to a Commission "non-paper" it received in late November, and says it is open to considering a wholesale delay in the application of the MiFID 2 package, but only on condition that the Commission adopts the Level 2 measures as soon as possible, and that, if there is a delay, the Commission reports regularly to EP on progress towards implementation. The accompanying press release suggests a delay of one year. The second letter criticises ESMA for its failure to address EP's concerns on position limits, non-equity transparency and the ancillary activity exemption.
So it seems as if ESMA's complicated solution may not be needed after all.
The UK implementation status
In the meantime, the UK, mainly in the form of the Financial Conduct Authority (FCA) has been doing what it can to progress towards MiFID 2. In March, both it and HM Treasury (which will have to make the necessary changes to UK legislation to implement MiFID 2) issued lengthy papers.
Treasury consulted on the principles it will use when implementing MiFID 2 into UK law. Overall, it will:
- make changes to existing legislation to maintain consistency;
- use the copy-out approach wherever possible; and
- consult on changes as early as possible.
It is consulted on a set of secondary legislation to:
- designate the relevant UK regulators as competent authorities for the purposes of MiFID 2, provides for the article 3 exemptions the UK will implement; creates the position limit regime; imposes obligations on unauthorised persons in respect of algorithmic trading, provision of direct electronic access services, acting as a general clearing member and synchronising business clocks; provides for necessary changes in the recognition requirements; and makes other consequential amendments;
- set the UK regime for regulating data reporting services operators;
- make operating an organised trading facility (OTF) a regulated activity, bring structured deposits within the scope of certain activities; make emission allowances a specified investment; make options and futures specified investments in certain circumstances involving Alternative Investment Fund Managers (AIFMs); and transpose the Article 2 exemptions.
The consultation also covered:
- third countries: Treasury's view is that the UK is not minded to apply the option MiFID 2 allows to require third country firms that wish to provide investment services to retail or elective professional clients to do so by setting up a branch;
- data reporting services: as well as publishing the draft legislation, Treasury consulted on the key definitions of the entities that will fall within them and the requirements the regulations will place on them;
- position limits and reporting: Treasury believes this is best treated as a standalone regime applicable equally to authorised and non-authorised persons;
- unauthorised persons: Treasury is consulting on its plans to apply certain aspects of MiFID 2, such as those on algorithmic trading, to firms that are otherwise exempt from MiFID under article 2. It also looks at whether FCA has adequate powers over those involved in benchmarks to satisfy MiFID 2;
- structured deposits: Treasury proposes to introduce a definition for structured deposit into the RAO and provide that the regulated activities of dealing as agent in, arranging deals in, making arrangements with a view to transactions in, managing and advising on investments will catch activities related to structured deposits;
- power to remove board members: Treasury sought views on whether PRA and FCA's existing powers over approved persons are enough to meet MiFID 2 requirements or whether to introduce a standalone power to apply to MiFID investment firms and operators of recognised investment exchanges (RIEs);
- OTFs: Treasury proposed relevant amendments to existing legislation to allow appropriate credit institutions, investment firms and RIEs to operate OTFs. It says FCA will look at how to identify firms with an OTF permission that conduct matched principal trading and principal trading in illiquid sovereign bonds. Inviting or inducing a person to participate in an OTF will also be subject to the financial promotion restriction; and
- binary options: the UK currently treats these options, which pay a fixed sum if the option is exercised or expires in the money, and nothing at all otherwise, as bets rather than financial instruments. Member States diverge on whether these would better be treated as financial instruments and Treasury now proposes to do so where the binary option is a derivative in relation to which an investment firm or credit institution is providing or performing investment services and activities on a professional basis.
Treasury asked for comments by 18 June.
FCA published a Discussion Paper to gauge views on how it might implement certain conduct of business (COB) and operational requirements of MiFID 2. The paper looked at:
- applying MiFID 2 rules to insurance-based investment products and pensions;
- treatment of structured products and which part of its rules should cover the MiFID 2 requirements on these;
- receipt of commissions and other benefits for discretionary investment managers: MiFID 2 will effectively apply requirements similar to the Retail Distribution Review (RDR) adviser charging rules to discretionary investment management (DIM). FCA asked whether it should include the MiFID 2 concession to DIM of allowing firms to accept commissions and benefits, provided they rebate them back to the client, or apply the RDR restrictions and ban it. It suspects many DIM firms already apply RDR standards and wants to ensure regulatory consistency;
- client categorisation: FCA sought views on the way in which local authorities can opt up to professional client status following MiFID 2;
- adviser independence: FCA seeks views on how different the MIFID 2 standard is from its current standard. There is some, but not a complete, overlap between its "retail investment products" (RIPs) to which the RDR rules apply and the set of products to which the MiFID independence standard will apply;
- applying remuneration requirements to non-MiFID firms: FCA considers its current rules that aim to ensure a firm's remuneration policies do not encourage individuals to act in a way that is not in the customer's interests. It also looks at approaches under various Directives. It thinks the best way forward is to introduce common and consistent provisions and in principle would favour applying MiFID 2 requirements to non-MiFID firms;
- recording of communications: FCA proposes to introduce a regime on recording of telephone conversations and electronic communications that is the same for firms that benefit from the "article 3" option as for those that do not. It also thinks it should remove the current exemptions for investment managers;
- costs and charges disclosures: FCA asked for views on what technical challenges firms may meet in implementing these requirements, with which FCA might help (although it hopes the Commission will address many of them) and on whether it might develop a standardised format for certain disclosures;
- inducement standards: FCA proposes to apply MiFID 2 inducement standards to both independent and restricted advice, as well as to DIM and to both retail and professional clients; and
- complex and non-complex products and application of the appropriateness test: FCA's understanding the Commission is taking a strict interpretation of the criteria for establishing whether a product is complex or non-complex, which will significantly reduce what is considered non-complex. It is aware of firms' concerns, and wants to work with firms to assess how to apply the necessary tests in different product contexts.
Alongside the paper, FCA has published an indicative timeline for MiFID 2 implementation. Its main consultation in implementation is due in December this year. FCA asked for comments by 26 May.
Since then, FCA has both held a conference on MiFID 2, focussing on its application to wholesale markets and firms, and has regularly published the minutes of its monthly round table discussions with key industry associations and other stakeholders.
It still plans to publish its major consultation paper on changes to its rules during December, but it now proposes a separate consultation paper in around March 2016 on retail aspects of implementation. It also noted at its most recent round table that further consultation is dependent on the delegated legislation, so it will have to wait for the Commission to publish it before it can consult on the effects of the legislation. Additionally it reported a transposition workshop for Member States had been postponed from 22 September, and is now expected to take place by the end of the year.
So what next?
As at 3 December, we do not know whether the Commission will publish the expected delegated legislation in December. Neither do we know when it plans to approve the ESMA measures submitted to it.
From the correspondence between EU institutions, however, it seems likely that we can expect a wholesale delay in MiFID implementation, and it is possible that the application of specific provisions may be delayed still further.
But if there is a delay, it is critical to remember that the reason for it is because there is not enough time to prepare, not least given various dependencies within some of the technical provisions. This means that the Commission cannot slip further, and the national regulators must still be prepared to act as quickly as they can once final EU measures are published. Affected firms should carry on their preparations, as if they take a rest and wait for further measures, the risk of running out of time will soon reignite.