At present, there is no harmonised third country regime under MiFID. Member States have discretion as to whether and how they allow third country firms (that is, non-EU firms) to access the EU market. MiFID II aims to create a more harmonised approach, by introducing two new options for third country firms. Which option is most relevant for a firm depends on the firm’s client base:

  1. The branch model will allow third country firms to conduct regulated business with retail and elective professional clients through an EU branch. The branch will not have any passporting rights for business with retail and elective professional clients, which will mean that third country firms may have to establish a branch in each Member State where they wish to access retail markets. It remains a matter of Member State discretion for each EU state to decide whether to implement the branch model. If they do not wish to do so, Member States may continue to operate their existing national regime (which may or may not permit access and, if it does, may or may not require the establishment of a branch). Any retained national regime must not treat third country firms more favourably than firms from other Member States.
  2. The cross-border model will allow third country firms to conduct regulated business with per se professional clients and eligible counterparties on a cross-border basis from their home country. This is subject to registration with the European Securities and Markets Authority and a positive equivalence decision having been made by the European Commission in relation to the relevant third country.

The third country access provisions in MiFID II are crucial for all firms outside the EU that wish to access EU clients and investors after the implementation of MiFID II on 3 January 2018. They will also be of particular interest to UK firms following the UK's vote to leave the EU, as they are being cited as a potential solution to the possible loss of passporting rights if the UK were to be treated as a third country post-exit.

The table below provides a summary of the two options:

Requirement

Cross-border model

Branch model (subject to Member State discretion)

Permissions

Registration with ESMA.

Member State authorisation.

Initial requirements

Conditions for ESMA registration of a third country firm are:

  • the European Commission has adopted a positive equivalence decision in relation to the third country’s legal and supervisory framework;
  • the firm is authorised and subject to effective supervision and enforcement in its home country; and
  • cooperation arrangements are in place between ESMA and the third country regulator.

Various minimum conditions for authorisation, including:

  • initial capital requirements;
  • the firm must be authorised and subject to effective supervision and enforcement in its home state;
  • a cooperation agreement must be in place between the relevant Member State and third country regulators;
  • the firm must be a member of an EU-recognised investor compensation scheme;
  • the firm must comply with certain MiFID governance requirements; and
  • third country needs to have signed an OECD compliant tax information exchange agreement with the relevant Member State.

Permitted clients

Eligible counterparties and/or per se professional clients only.

All types of clients in the country of the branch – can include retail clients and/or elective professional clients.

Passporting rights

Able to “passport” and conduct MiFID business on a cross-border basis from third country into all Member States.

No passporting for regulated business with retail and elective professional clients.

May obtain a passport to carry on MiFID business with eligible counterparties and per se professional clients on a cross-border basis into all Member States without the need to establish further branches, but only if the European Commission has adopted a positive equivalence decision in relation to the third country’s legal and supervisory framework.

Ongoing requirements

Not directly supervised by any Member State regulator. A third country firm will comply with the rules in its home country rather than with MiFID but will be obliged to give warnings relating to its lack of EU authorisation and limited permitted client types.

Have to comply with the extensive requirements under MiFID, including in relation to systems and controls, conduct of business, transaction reporting and transparency.

Broadly, therefore, the ability of third country firms to conduct MiFID business with retail clients and elective professional clients (i.e. retail clients that have “opted-up” to professional status) will continue to be at the discretion of each Member State. It is only cross-border business with per se professional clients and elective counterparties that will become subject to an EU-wide access regime.

In the UK, HM Treasury has indicated that it is not minded to implement the branch model, but instead wishes to retain the status quo, whereby firms have broadly three options for accessing UK clients:

  • establish a fully authorised UK subsidiary (which can benefit from passporting rights while the UK remains in the EU, and if it subsequently negotiates equivalent arrangements);
  • establish a UK authorised branch (which is not able to benefit from passporting rights); or
  • rely on UK exemptions from authorisation, in particular the overseas persons exemption, which excludes from authorisation particular investment services and activities carried on in the context of a “legitimate approach” or carried on “with or through” an authorised or exempt UK person.

Though this means that UK authorised branches will not benefit from the limited passporting rights for authorised branches under MiFID II in relation to business with eligible counterparties and per se professional clients, in HM Treasury’s view this will maintain a more flexible regime and mean that the UK can retain its overseas persons exemption, which is broader than the MiFID “own exclusive initiative” concept.

The new regimes are relevant only for third country firms interested in establishing a branch in a Member State or providing cross-border services into a Member State without setting up an EU subsidiary. They will not affect third country firms that have or plan to set up a subsidiary in a Member State in order to obtain full authorisation and passporting rights in relation to all client types for that subsidiary.

It should also be noted that third country firms may carry on MiFID business with EU clients and counterparties without needing to use either of the models above if they only do so in response to the client’s “own exclusive initiative”. However, in practice third country firms may find this difficult to rely on, especially when advertising services through the internet or seeking to extend a relationship beyond the product or service originally requested.

The cross-border model seems an attractive option for firms conducting wholesale business, but its availability does rely on the Commission having made a positive equivalence decision. Such decisions can be highly political and are entirely within the Commission’s gift, so cannot necessarily be anticipated with any certainty.

That said, it is hard to see how the Commission could refuse to make a positive equivalence decision in respect of the UK as a third country post-Brexit, if the UK were to maintain the MiFID framework, on either a mandatory or an opt-in basis (which seems highly likely given the UK’s involvement in its design and the UK regulators’ statements since the referendum), and also continued to give EU investment firms access to the UK market. The uncertainty would instead be around when that decision could be secured, and whether it could be secured as part of the UK’s exit negotiations.

There is some scope for third country firms to conduct MiFID business with eligible counterparties and per se professional clients in Member States before the Commission makes an equivalence decision, or after such a decision is withdrawn. However, this is again a matter of Member State discretion so must be done on the basis of each Member State’s regulation of access to its market.