ESMA Final Report on MiFID II Guidelines on assessment of knowledge and competence

ESMA finalises its Guidelines on assessment of knowledge of competence.

On 17 December 2015, the European Securities and Markets Authority (ESMA) published itsFinal Report on Guidelines for the assessment of knowledge and competence.

The Guidelines form part of the investor protection workstream within the MiFID II framework and specify ambitious criteria for the assessment of knowledge and competence of staff in firms that provide advice or information about financial instruments, investment services or ancillary services to clients on behalf of investment firms. ESMA’s Guidelines are intended to enhance investor protection by increasing the knowledge and competence of such persons.

Following a review of the 80 responses to the earlier consultation as well as feedback from Securities and Markets Stakeholder Group’s (SMSG), ESMA amended aspects of the final Guidelines from earlier drafts (including on: a. grandfathering and assessments and requirements for existing staff; b. the relationship between and the importance of qualifications and  experience; and c. the circumstances when advice and information are given).

What do the Guidelines cover?

  • Firms
    • investment firms within Art 4(1)(1) of MiFID II;
    • credit institutions when providing investment services (Art 4(1)(27));
    • investment firms and credit institutions when selling or advising clients in relation to structured deposits;
    • UCITS management companies when they are providing the investment services of individual portfolio management or non-core services (loosely, investment advice and safekeeping and administration of units in a collective investment scheme (CIS));
    • external Alternative Investment Fund Managers when they are providing the investment services of individual portfolio management or non-core services (roughly, investment advice; safe-keeping and administration in relation to units of aCIS; reception and transmission of orders in relation to financial instruments);
  • staff – natural persons (including tied agents) – providing relevant services to clients on behalf of the investment firm; and
  • relevant services – providing investment advice or information about financial instruments, structured deposits, investment services or ancillary services to clients.

Organisations that currently provide continuous professional development or qualifications will also be interested in these Guidelines.

Criteria for knowledge and competence

The Guidelines provide the framework around which Member States should establish their assessment criteria pursuant to Article 25(1) of the recast MiFID II directive (2014/65/EU). In essence, this means the Financial Conduct Authority (in the UK) will review its rules to be certain they require investment firms to demonstrate “that natural persons giving investment advice or information … possess the necessary knowledge and competence to fulfil their [Article 24 and 25] (see Recital 79.)

Firms must ensure that staff providing relevant services possess the necessary knowledge and competence to meet legal, regulatory and  business ethics standards. In addition they should know the firm’s MiFD II policies and procedures.

What knowledge and competence means

To reach expected knowledge and competence standards, ESMA has now clarified that all in scope staff (whether existing or new) must acquire an appropriate qualification and  have appropriate experience (both of which are given limited definitions in the Guidelines). Where one or both elements is missing, that staff member should work under supervision until he/she achieves the appropriate qualification and experience, for a maximum of four years (with discretion remaining to local competent authorities to shorten this).

ESMA has dropped a proposal to allow grandfathering for those with no less than five years of experience, effectively closing a possible loophole to personnel already employed but without a qualification. From the date the Guidelines come into force, all relevant personnel will need an appropriate qualification and  an appropriate level of experience, or need to be working under supervision.

As the Final Report explains, firms must support both the supervisor and the person working under their supervision and allow them appropriate resources to move forward or fulfil a supervisory function properly (see V.IV organisational requirements Guideline 20 (d-h) and the Final Report (page 25, para 45)).

Assessment criteria

Under Art 25(1) of MiFID II, the national competent authority should require a firm to demonstrate the knowledge and competence of relevant staff. Member States will set their own standards. Firms shall be required to show how their relevant staff meet these standards.

In order for firms to determine whether someone is knowledgeable and competent, in the UK, the FCA will need to state which qualifications are appropriate for “providing investment advice” and “giving information” and, as is the case now, the content and level of these qualifications is likely to be prescribed through examination standards, linked to the assessment criteria in the Guidelines.

There are separate assessment criteria for staff giving information to clients compared with those who give investment advice. The criteria for staff giving information are set out in section V.II (Guideline 17 (a-j)) and those for staff giving investment advice are set out in section V.III (Guideline 18 (a-l).

The investment adviser standards emphasise suitability assessments (e.g. 18(c) and (d)) and both sets of standards emphasise the importance of general financial markets acumen (e.g. 17(d) and 18(e) – understand how financial markets function and how they affect the value and pricing of investment products on which they provide information to clients / offered or recommended to clients).

What staff need to know

Detail of the knowledge and competence criteria are set out in section V of the Guidelines, in section 3.6 Annex VI of the Final Report. Staff will need a detailed knowledge of a broad range of topics, including (by way of example):

  • the key characteristics, risks, complexity, and total costs of relevant products or services – including general tax implications for the client;
  • how the market functions, market structure, and the impact of economic data;
  • how to use relevant data sources and valuation principles;
  • market abuse; and
  • the relevant regulatory requirements and the firm’s internal procedures designed to ensure compliance with MiFID II.

Added to this, staff must put this knowledge in context so they:

  • understand when the firm is acting in the best interests of the client;
  • know how to meet ethical standards;
  • act in line with a firm’s internal policies and procedures (e.g., conflicts, complaints management, product governance, telephone recording, and client order handling).

It will be important for relevant staff to know whether their firm classifies them as providing investment advice or giving information as the standards they should meet will be slightly different.

What a firm must do

Linked organisational requirements (see Guidelines 19 and 20 (a-h)) for assessment, maintenance and updating of knowledge and competence are likely to fall to HR and compliance teams for implementation (e.g. job descriptions and understanding the FCA’s assessment of what amounts to an appropriate qualification for those giving advice and those providing information, annual reviews of knowledge and competence, report to the FCA if required). Tasks will include:

  • Assessing and reviewing standards;
  • Revising training programmes; and
  • Putting place any additional resources if there is a knowledge and competency “shortfall”.

Areas of note

The Guidelines set minimum standards so National Competent Authorities may set more onerous levels and standards. While this less prescriptive approach may be welcome, it may, of course, cause an additional layer of divergence and fragmentation for firms operating in several Member States. The SMSG has proposed mitigating measures to address this risk (e.g. peer reviews, supervisory convergence, and transparency, ESMA creating a database of standards adopted by each member state), which ESMA supports.

The Guidelines envisage that firms will be permitted to take a proportionate approach, reflecting the nature, scale and complexity of their business and the range of financial services and activities undertaken by the firm and specific staff.

The definition of “appropriate experience” has been clarified from earlier iterations (see commentary in para 62 on page 28 of the Final Report). Firms may find it easier to ensure their policies and expectations do not give rise to a source of indirect discrimination claims (e.g., around parental or adoption leave, part-time workers, disabilities, and using experience from “previous work” rather than only continuous experience).

Requirements vary (slightly) between those in advisory roles and those “giving information”. “Giving Information” appears to still deserve careful consideration as it has been defined to mean “directly providing information to clients about financial instruments, structured deposits, investment services or ancillary services, either upon the client’s request or at the initiative of the firm, in the context of the provision by the staff member to the client of any of the services and activities listed in sections A and B of Annex I of MiFID II”.

Back office staff with no client contact fall outside this definition and those “who merely distribute brochures” are unlikely to fall into scope, but the work of others who do have client contact may need more analysis – are they providing an investment service and giving information or advice to the client?

A starting point is to assess the definition of investment advice and its boundaries (see e.g.CESR 2010 Q&As on “Understanding the definition of advice under MiFID” as well as the examples set out in Annex VII of the Final Report) against a firm’s business model. Commentary is also given in para 49-52 on pages 25-26 of the Final Report.

Next steps

The Guidelines will come into effect on 3 January 2017 (although this may be delayed if the overall MiFID II deadline is put back). We expect the FCA to consult on how it will apply these Guidelines in its second MiFID II consultation paper, expected in the first half of 2016 and that consultation may well reveal any gold-plating on these Guidelines by the UK regulator.