The Markets in Financial Instruments Directive (MiFID) is one of the cornerstones of EU financial services law, setting out which investment services and activities should be licensed across the EU and the organisational and conduct standards that those providing such services should comply with.

Following technical advice received from the European Securities and Markets Authority (ESMA) and a public consultation, the European Commission (the Commission) published legislative proposals in 2011 to amend MiFID by recasting it as a new Directive (MiFID II1) and a new Regulation (MiFIR2). The legislative proposals were the subject of intense political debate between the European Parliament, the Council of the EU, and the Commission. However, informal agreement between the EU institutions was finally reached in February 2014. The final MiFID II and MiFIR texts were published in the Official Journal of the EU on 12 July 2014 and entered into force 20 days later on 2 July 2014. Entry into application will follow 30 months after entry into force on 3 January 2017.

The implementing measures that will supplement MiFID II and MiFIR will take the form of delegated acts and technical standards. On 22 May 2014, ESMA released a consultation paper (the CP) setting out ESMA’s proposed advice to the Commission regarding delegated acts and a discussion paper (the DP) setting out ESMA’s proposals for technical standards. The deadline for responses to the CP and DP has now closed. ESMA is expected to provide advice on the delegated acts to the Commission by the end of 2014 and drafts of the technical standards by the middle of 2015.

While the headline changes to the MiFID regime center on market infrastructure, there are many changes being made to investor protection requirements. The overall theme is one of a small number of macro changes but a large number of micro changes which, together, will represent very significant regulatory reform in this area. What is developing is a thick layer of additional EU requirements applicable to investment firms, some of which is clearly post-crisis reaction (for example, new product intervention powers, full prohibitions on some inducements, a tougher stance on execution-only business and a tighter client categorisation regime).

Conflicts of interest

What are the current requirements?

MiFID currently requires firms to:

  • consider and identify where conflicts may arise in the course of their business between: (a) the firm (including its managers, employees and tied agents) or any person directly/indirectly linked to the firm, and its clients; and (b) between different clients;
  • keep and regularly update a record of these actual and potential conflicts;
  • put in place organisational and administrative structures to prevent such conflicts from adversely affecting the interests of clients, and document this in a conflict of interest policy; and
  • where these organisational / administrative measures do not allow a firm to have reasonable confidence that risks of damage to clients’ interests will be prevented, to make adequate disclosure to clients. The disclosure must be in a durable medium and contain sufficient detail of the general nature and/or sources of the conflicts that may arise and the steps taken to mitigate/manage them so clients can make an informed decision before conducting business with the firm.

What is new in MiFID II Level 1?

There are no substantive changes being made to these requirements in the Level 1 text of MiFID II.

What is ESMA proposing in Level 2?

Despite the lack of substantive changes being made by Level 1 of MiFID II, ESMA is proposing to recommend significant changes as follows (these changes will apply in addition to the current requirements):

  • due to a perception that firms over-rely on disclosure, ESMA is proposing that disclosure is to be a ‘last resort’. By this ESMA means that disclosure can only be used where a firm’s organisational / administrative measures are not sufficient to ensure, with reasonable confidence, that the risks of damage to clients’ interests will be prevented;
  • coupled with the perception that firms over-rely on disclosure (discussed above), there is also a perception that the disclosures that are currently made are too generic. ESMA is proposing that disclosure to a client should be tailored to a client – i.e. disclosure should mention the specific conflict(s) that arises for that client/category of service, as opposed to listing all conflicts that generally arise from the firm’s business across all client categories and in respect of all services;
  • in the disclosure, ESMA is proposing that it must clearly state that the firm’s organisational / administrative arrangements established by the firm to prevent or manage that conflict are not sufficient to ensure, with reasonable confidence, that there will not be a risk of damage to the interests of the client;
  • conflicts of interest policies must be reviewed and updated frequently (at least annually); and
  • over reliance on disclosing conflicts of interest must be considered to be a deficiency in the firm’s conflict of interest policy.


What are the current requirements?

There are no specific restrictions under MiFID in relation to remuneration although, as noted above, there are general requirements in relation to managing conflicts of interest. In 2013 ESMA did, however, under the ESMA Regulation publish Guidelines on remuneration policies and practices for investment firms.

What is new in MiFID II Level 1?

As there are a number of other EU measures which place restrictions on remuneration (for example, those applicable to AIFMs in AIFMD, credit institutions in CRD IV and UCITS managers in UCITS V), MiFID II proposes to mirror (in principle) these restrictions so that they apply to investment firms.

MiFID II proposes restrictions on incentive schemes, internal rewards and sales targets for those firms operating in both the retail and professional markets as follows:

  • a formal remuneration policy implemented and overseen by senior management;
  • the alignment of remuneration structures to encourage responsible business conduct, fair treatment of clients and to avoid conflicts of interest;
  • not to remunerate or assess the performance of staff in a way that conflicts with the clients’ best interest rule or which incentivises staff to sell particular products or services.

What is ESMA proposing in Level 2?

Following ESMA’s principles in its Guidelines on remuneration (mentioned above), ESMA proposes:

  • to use the same definition of ‘remuneration’ as contained in those Guidelines which includes as remuneration, non-financial remuneration such as in-kind benefits and career progression;
  • to require management bodies to seek advice from compliance before approving remuneration policies and for senior management to be responsible for the day-to-day implementation of the policies;
  • to specify the design criteria for the remuneration policies, in particular to tackle the risk of staff being incentivised to favour their own interests or the firm’s to the potential detriment of clients; and
  • for there to be an appropriate balance between fixed and variable remuneration at all times with variable remuneration principally based on criteria reflecting compliance with applicable regulations, fair treatment of clients and the quality of client service (and not solely on commercial criteria).

Communications – fair, clear and not misleading

What are the current requirements?

MiFID requires all information addressed to clients or potential clients to be fair, clear and not misleading and for marketing communications to be addressed as such. There are specific conditions that communications need to meet in order to be fair, clear and not misleading, which currently only apply to retail clients.

What is new in MiFID II Level 1?

MiFID II is not proposing any direct changes to the current regime. However, it does reinforce in the recitals that eligible counterparties are clients. Consistent with this, MiFID II is proposing a new obligation on firms to communicate with eligible counterparties in a way that is fair, clear and not misleading.

What is ESMA proposing in Level 2?

Bearing in mind that one of the objectives of MiFID II is to improve, where appropriate, the treatment of non-retail clients, ESMA is proposing: (1) some targeted improvements to the current regime applicable to retail clients; and (2) an extension of some aspects of the retail client regime to professional clients. ESMA is not making any additional proposals in relation to the extension of the fair, clear and not misleading rule to eligible counterparties.

Retail clients

ESMA proposes strengthening the conditions with which information must comply in order to be fair, clear and not misleading as follows:

  • information should be consistently presented in the same language throughout all forms of information and marketing material;
  • to always include a fair and prominent indication of any risks, including where potential benefits are referenced, which must be in a font size at least equivalent to the predominant font size used throughout the communication;
  • information should always be up-to-date bearing the communication method in mind (e.g. online information should always be up-to-date, printed material should be updated when next printed); and
  • information based on future performance, should include performance scenarios in different market conditions and should reflect the nature and risks of the specific types of instruments.

Professional clients

ESMA is proposing to extend some of the detailed requirements on communications to retail clients (both from the existing regime under MiFID and ESMA’s proposals as discussed above) to also apply to communications with professional clients.

Dealings with eligible counterparties

What are the current requirements?

Under MiFID, “eligible counterparty business” is essentially excluded from the majority of investor protection requirements. Eligible counterparties are, broadly speaking, financial institutions, pension funds and governments. Eligible counterparty business refers to arranging and dealing activities when carried out by eligible counterparties.

What is new in MiFID II Level 1?

MiFID II extends some existing investor protection requirements to eligible counterparties. The recitals note that “the financial crisis has shown limits in the ability of non-retail clients to appreciate the risk of their investments. While it should be confirmed that conduct of business rules should be enforced in respect of those investors most in need of protection, it is appropriate to better calibrate the requirements applicable to different categories of clients. To that extent, it is appropriate to extend some information and reporting requirements to the relationship with eligible counterparties. In particular, the relevant requirements should relate to the safeguarding of client financial instruments and funds as well as information and reporting requirements concerning more complex financial instruments and transactions.”

“New” obligations

MiFID II introduces the following express obligations on firms when dealing with eligible counterparties:

  • to act honestly, fairly and professionally in their dealings with eligible counterparties;
  • to communicate in a way which is fair, clear and not misleading;
  • to provide certain information to eligible counterparties (see ‘Information to clients’ discussed in this note); and
  • certain reporting obligations have been extended to eligible counterparties (see ‘Reporting to clients’ discussed in this note).

While these obligations are not new concepts for firms generally (i.e. they currently apply to their dealings with retail and professional clients), they have not been applied to eligible counterparties before.

What is ESMA proposing in Level 2?

ESMA is not proposing any additional requirements in relation to the obligation to act honestly, fairly and professionally, or to communicate in a manner that is fair, clear and not misleading with eligible counterparties. In relation to the information to be provided to eligible counterparties, ESMA is proposing that eligible counterparties can ‘opt-out’ of receiving certain disclosures (for instance, post-sales periodic disclosures) in certain circumstances.


What are the current requirements?

MiFID currently prohibits the payment of fees or commissions and receipt of other non-monetary benefits between firms and persons other than their clients (e.g. advisory firms and distributors), unless certain criteria are met. This prohibition is intended to ensure such payments and benefits are not inducements and, as such, do not introduce conflicts with clients’ interests.

Payments and non-monetary benefits are required to be assessed to ensure that they do not impair the firm’s duty to act in the best interests of the client, that they are designed to “enhance the quality” of the service being provided to the client and that they are disclosed to the client.

What is new in MiFID II Level 1?

With the introduction at an EU level of the new concept of ‘independent advice’ (discussed later in this note) and with historic concerns about potential conflicts of interest with firms receiving third party payments, MiFID II strengthens the current inducement rules and introduces the following changes:

  • firms providing independent investment advice or portfolio management are prohibited from receiving and retaining any fees, commission, or monetary or non-monetary benefits from third parties – these payments / benefits can be received but they must be passed on in full to clients;
  • after much negotiation, minor non-monetary benefits are excluded from the prohibition but they must not impair a firm’s duty to act in the best interests of its clients;
  • firms not providing independent investment advice or portfolio management must comply with the existing inducement rules from MiFID 1 for all types of third party payments (there is no exclusion for minor non-monetary benefits like there is for independent advisers/managers above);
  • firms are unable to set off any payments from fees owed to them;
  • clients need to be accurately and, where relevant, periodically informed about all the fees, commissions and benefits the firm has received in connection with the investment services provided; and
  • where applicable, firms must inform clients on how the fee/commission/non-monetary benefit can be transferred to them.

Member States are also given the ability to impose greater restrictions (i.e. gold plate the MiFID II requirements) in exceptional circumstances.

What is ESMA proposing in Level 2?

ESMA proposes the following additional clarity.

Independent advisers/portfolio managers considering financial instruments that pay commission

  • Any monetary payments received in relation to financial instruments that pay commission need to be paid over to clients as soon as possible – no strict timelines are proposed to be introduced but ESMA is proposing that the transfer occur ‘as soon as reasonably possible’.
  • Client can be informed about what payments have been received and paid over to them as part of their regular periodic reporting statements.

Interpretation of minor non-monetary benefits

  • The ability for independent advisers and portfolio managers to receive minor non-monetary benefits should be strictly interpreted – i.e. the benefits should be reasonable and proportionate and should not be likely to influence the behaviour of the adviser/manager.
  • ESMA is proposing to recommend to the Commission that it adopt an exhaustive list of minor non-monetary benefits and that this list should include: (1) information or documentation relating to financial instruments (including research, but see further discussion below); (2) participation at conferences / seminars / training on specific financial instruments / services; and (3) reasonable hospitality of a de minimis value.

Treatment of research

  • In order for research to be accepted as a minor non-monetary benefit:
    • it cannot impair a firm’s duty to act in the best interests of its clients;
    • it needs to be intended for wide distribution (i.e. to a number of firms or to the public generally);
    • it cannot amount to a third party allocating a lot of resource to produce research for one particular firm;
    • the amount of research received (or its quality) cannot be linked to the volume of transactions placed by an adviser/manager through that firm; and
    • its content cannot be tailored or bespoke nor can its distribution or access be restricted (i.e. privileged access to research analysts; face-to-face meetings or conference calls; bespoke reports; analytical models; investor field trips; services linked to research such as corporate access and market data services).
  • Firms can still contract for, and buy, research on a distinct and separate basis if it is required. However, the receipt of such paid-for research: (1) should be for a reasonable price (this is likely to mean market value); (2) should not be linked to volume/value of transactions placed by the firm through the entity providing the research; and (3) should not be linked to the firm’s purchase of other services from such entity.
  • ESMA also advises the Commission to align the restrictions on research (outlined above) with those applying to UCITS managers and AIF managers.

Quality enhancement and disclosure requirements

  • Improvement to the rules to require clients to be accurately informed about all fees, commissions and benefits the firm receives from third parties including what must be disclosed and on what basis, when it must be disclosed and how often it should be disclosed.
  • Clarification of the requirement to enhance the quality of the service being provided including a non-exhaustive list of the circumstances and situations to determine when the quality enhancement test is not met. For example, ESMA proposes that further ESMA Guidelines and Recommendations should be developed, but in the meantime that the following are not quality enhancements:
    • fees used to pay for or provide goods or services which are essential for the recipient firm in the ordinary course of its business;
    • it does not result in an additional or higher quality service to the end user (above regulatory requirements);
    • it directly benefits the firm/shareholders/employees without tangible benefit/value to the end user; and
    • if it is an ongoing inducement, there is no ongoing service to which it is related.
  • ESMA also proposes an additional obligation on firms to prove that the services enhance quality by requiring them to record each payment and note how it is used to enhance the quality of the service.

Investment advice – definition and independence

What are the current requirements?

Under MiFID, investment advice is given when a personal recommendation is made to an investor. However, a personal recommendation is not made when it is given exclusively through distribution channels or to the public. Under MiFID, there is no distinction between different types of advice (e.g. independent or restricted).

What is new in MiFID II Level 1?

MiFID II makes no changes to the definition of ‘investment advice’ from that contained in MiFID 1.

It does, however, introduce the concept of ‘independent advice’ (as opposed to restricted advice although the term ‘restricted advice’ is not used in MiFID II). MiFID II requires the following to be satisfied in order for advice to be considered to be ‘independent’:

  • a sufficiently wide range of financial instruments available on the market must be considered;
  • a sufficiently diverse range of financial instruments must be considered (e.g. by type, issuer, product provider);
  • the financial instruments considered should not be provided solely by the firm or other entities that have close links with the firm or entities with close legal/economic relationships (such as contractual relationships) such that independence is at risk of being impaired; and
  • the firm should not receive and keep any inducements/commission/monetary or non-monetary benefits from the product provider (minor non-monetary benefits are permitted to be received/kept – see ‘Inducements’ discussed in this note).

What is ESMA proposing in Level 2?

Definition of investment advice

ESMA has, since 2010, considered that there was a risk that firms would misinterpret the exclusion, set out in Article 52 of the MiFID 1 Implementing Directive, that a personal recommendation is not made when it is given exclusively through distribution channels or to the public to mean that advice could never be given when made through distribution channels. In addition, ESMA has found that intermediaries do provide personal recommendations through the use of distribution channels (e.g. the internet). As a result, ESMA is now consulting on its recommendation to delete the reference to ‘through distribution channels’ from the exclusion as currently drafted. This still leaves the exclusion for advice addressed ‘to the public’ generally, but it may mean that where firms may have viewed that they do not give advice if they use particular distribution channels, they may now need to accept that they could be giving investment advice (i.e. through a restricted-access website, not available to the public generally).

Independent advice

ESMA makes a number of additional proposals to those contained in MiFID II.

ESMA proposes that firms providing independent advice should define and implement a selection process to assess and compare a sufficient range of sufficiently diverse financial instruments, which process must contain the following elements:

  • a diversified selection of instruments (by type, issuer or product provider), and which is not limited to instruments provided by the firm or entities closely linked to it, should be considered;
  • the number and variety of instruments considered should be proportionate to the scope of services offered and should comprise a substantial part of those available in the market;
  • the quantity of financial instruments issued by the firm or entities closely linked to it should be proportionate to the total amount of instruments considered; and
  • the criteria for comparing various financial instruments should include all relevant aspects, and should ensure that neither the selection of instruments that may be recommended nor the recommendations are biased.

For firms that provide independent advice, but who focus on certain classes or a specified range of financial instruments, ESMA proposes additional restrictions (e.g. marketing restrictions to ensure only relevant investors are attracted; to allow investors to easily identify a preference for the specified classes/specified range of financial instruments; clients must indicate that they only want these specified classes/specified range of financial instruments; the firm must be able to easily confirm whether its service is appropriate for each new client).

For firms providing both independent and non-independent advice, ESMA proposes the following requirements:

  • to inform retail clients, in good time before providing services, and in a durable medium, whether advice will be independent or non-independent;
  • not to describe the business as a whole as ‘independent’; and
  • to have organisational controls so that both types of advisory service and advisers are separated (including that the same adviser does not provide both types of advice), and to ensure that clients are not confused about which type of advice they are receiving.

ESMA is proposing to conduct additional work at a later stage to further clarify the concept of ‘independent’ advice.

Product intervention

What are the current requirements?

MiFID does not currently contain any EU-wide specific product intervention powers, although different Member States have their own national measures.

What is new in MiFID II Level 1?

In a clear post-crisis reaction, MiFIR sees the introduction of formal product intervention powers at an EU level, which complement the new product governance regime. The intervention powers appear to be based on the UK’s existing product intervention regime although there are some differences. MiFIR gives these powers to ESMA (in relation to financial instruments), to the EBA (in relation to structured deposits) and to the national regulator of each Member State.

National powers

The national regulator of a Member State may prohibit or restrict: (1) marketing or distribution of a particular instrument; or (2) any type of financial practice in or from that Member State. The Member State national regulator may only take action if it is satisfied on reasonable grounds:

  • that there is a significant investor protection concern or a threat to the orderly functioning and integrity of financial or commodity markets or stability of the whole or part of the financial system in at least one Member State or a derivative has a detrimental effect on price formation in the underlying market;
  • existing regulatory requirements do not sufficiently address the risks and the issue would not be better addressed by improved supervision or enforcement of existing requirements; and
  • the action is proportionate given the risk, sophistication of investors or market participants and the effect of the action on investors and the market participants.

Before exercising such power, the Member State national regulator must consult with the national regulators in other Member States that might be affected by the intervention and take into account whether any action will have a discriminatory effect on the services or activities provided from another Member State.

The temporarily ban / restriction can only last for a maximum of three (3) months.

This represents a major impact in those Member States that do not already have national measures that permit their local regulator to ban products. All Member State national regulators, regardless of whether they are a principles-based, light touch regulator, will now have a relatively heavy-handed power to supplement their enforcement tools.

Powers to ESMA and the EBA

Both the EBA and ESMA have similar powers to those described above for Member State national regulators. Any product ban / restriction can be exercised on an EU-wide basis or can be exercised in relation to a particular Member State. This power can only be used in certain circumstances, namely:

  • where there is a significant investor protection concern (or a threat to the orderly functioning of the market or stability of the financial system generally);
  • where existing regulatory requirements are not sufficient to address the issue;
  • where Member State national regulators have failed to address the issue; and
  • where ESMA/EBA ensures that the action will not detrimentally affect the efficiency of the market or detrimentally affect investors in a disproportionate manner to the benefits of exercising the power or create a risk of regulatory arbitrage.

Each ban / restriction lasts for a maximum of three (3) months but can be renewed (if it is not renewed, it expires) and will be published on the website of ESMA or the EBA (as the case may be).

Any action taken by ESMA/EBA will apply instead of action taken by a Member State national regulator.

Additional product intervention introduced by other measures

While these powers apply to instruments caught by MiFID, they mirror product intervention powers being introduced in relation to insurance-backed investments under the Insurance Mediation Directive (IMD) as contained in the new EU Regulation for a key investor document in relation to packaged retail and insurance-backed investment products.

What is ESMA proposing in Level 2?

ESMA and the EBA are working together to set out the factors which Member State national regulators should consider when determining if there are circumstances which require the use of product intervention powers. While acknowledging that these factors are intended to limit the otherwise relatively wide discretion of Member State national regulators to use the powers, ESMA also notes that the factors need to be sufficiently flexible so as not to restrict a regime that needs to remain relatively dynamic.

Therefore, ESMA has proposed a list of factors for each of the items below but, for flexibility, intends the list to be general in nature, non-exhaustive and to not include quantitative thresholds. In addition, ESMA re-emphasises that the primary focus should be on using the powers in a proportionate way:

  • the degree of complexity of the financial instrument or type of financial activity or practice;
  • the size of the potential problem or detriment;
  • the type of clients involved in an activity or practice or to whom a financial instrument is marketed or sold;
  • the degree of transparency of the financial instrument or type of financial activity or practice;
  • the particular features or underlying components of the financial instrument or transaction including any leverage a product or practice provides;
  • the degree of disparity between expected return or benefit for investors and risk of loss in relation to the financial instrument, activity or practice;
  • the ease and cost for investors to switch or sell an instrument;
  • the pricing and associated costs;
  • the degree of innovation of a financial instrument, activity or practice;
  • the selling practices associated with the financial instrument;
  • the situation of the issuer of a financial instrument.

As these powers are new, it remains to be seen how Member State national regulators will use them (if at all) and whether there may be inconsistent use of the powers in relation to the same or similar products (i.e. whether it may be banned in one Member State but not in another due to the different views of the Member State national regulators). Conscious of this, ESMA proposes to undertake further work (including sharing information across Member State national regulators) to encourage a common understanding on the use of the powers.

Product governance and sales processes

What are the current requirements?

There are no existing detailed provisions addressing product governance or sales processes in MiFID, although there do exist high level organisational requirements.

What is new in MiFID II Level 1?

MiFID II introduces a new EU-wide product governance regime which applies to both sides of the product development and sales process, namely to (1) product manufacturers; and (2) product distributors (if different).

For product manufacturers, there are new requirements to maintain appropriate product governance policies and procedures as part of their organisational arrangements, including product approval processes, to ensure investment products are designed appropriately, ‘consistent with the needs’ of identified target markets, distributed appropriately to the target market, the relevant risks are assessed, appropriate information is made available to distributors, and investment products are regularly reviewed to ensure that they are being sold appropriately and remains consistent with the identified target market.

For product distributors, there are new requirements to ensure that the firm’s knowledge and understanding of the products allows them to match these to the needs of their clients which are primarily linked to training from product manufacturers on products and access to all information (including from product manufacturers) necessary to enable the distributor to sell the product appropriately. Product distributors must also regularly review the products they market to assess whether they remain consistent with the needs of the identified target market and whether the distribution strategy remains appropriate.

What is ESMA proposing in Level 2?

ESMA is proposing a quite detailed extension of the Level 1 requirements as follows:

  1. more prescriptive requirements aimed at reducing the risks of mis-selling risks at an early stage;
  2. applying the new regime should not only apply to products but also to investment services;
  3. ensuring the measures can be applied to Member State legal/economic models so that they are proportionate.

In order to address the above, ESMA is proposing to split the policy proposals into two different sets, namely those that apply specifically to product manufacturers and those that apply specifically to distributors (firms that both manufacture and distribute will be required to comply with both sets of proposals).

The proposed obligations on manufacturers and, separately, on distributors are relatively extensive and detailed and relate to: (i) governance and oversight of the product design and manufacturing process; (ii) managing conflicts of interest; (iii) identifying the target market; (iv) risk assessment; (v) charging structures; (vi) information to distributors; and (vii) regular review of products.

Some interesting unusual items are being proposed:

  • that firms be proactive in checking that their products function as intended, rather than being reactive and waiting for detriment to occur;
  • firms who both manufacture and distribute products will only be required to conduct a single assessment of the needs and characteristics of the target market for whom relevant products will be manufactured, and to whom they will be distributed; and
  • that the obligations on distributors should apply to all distributors in a chain albeit that the distributor with the client relationship will have the ultimate responsibility to comply with the obligations. ESMA proposes lesser requirements (but still some requirements) on intermediate distributors in a distribution chain.

Best execution

What are the current requirements?

Investment firms must already comply with an obligation of ‘best execution’ under MiFID, namely to take all reasonable steps to obtain the best possible result for their clients (taking account of factors such as price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order).

Where retail clients are concerned, best execution is considered in terms of the ‘total consideration’ (being the price paid for the instrument and all associated costs including costs/commission charged by the firm).

What is new in MiFID II Level 1?

MiFID II imposes new requirements on firms and trading venues to produce public data about executed transactions. Firms must summarise and publish annually their top five execution venues by trading volume for each class of financial instrument, as well as information on the quality of execution obtained. Trading venues and systematic internalisers must also publish annually information on quality of execution for certain types of financial instrument.

MiFID II also strengthens the current requirements in a number of ways:

  • whereas before firms had to take ‘all reasonable steps’ to obtain best execution, firms must now adhere to a stricter standard – i.e. take ‘all sufficient steps’ to obtain best execution;
  • the requirement to notify clients of material changes to a firm’s execution policy expressly applies only in respect of clients with whom a firm has an ongoing client relationship;
  • firms must be able to demonstrate best execution not only (as is currently the case) to their clients, but also to their Member State national regulator on request; and
  • following concerns about the generic and standardised nature of firm’s order execution policies, firm’s order execution policies must now be clear, easily comprehensible and sufficiently detailed so that clients can easily understand how firm’s will execute client orders.

What is ESMA proposing in Level 2?

ESMA is proposing a number of additional requirements and clarifications to contribute to improving investor protection and the transparency of firms’ policies and procedures.

ESMA’s proposals include:

  • additional obligations in relation to the detail of execution policies and policies for firms that receive and transmit orders or place them with other firms to execute – the overriding obligation is that these policies need to be customised depending on the class of instrument and the service provided, as opposed to being generic. In addition, all the venues or entities used for execution are proposed to be listed in the policies;
  • for retail clients, a separate sheet that summarises the best execution policy, focusing on the total known costs for execution, should be provided;
  • additional disclosure obligations on firms namely: (i) to provide clients with additional information about a firm’s policy when requested; (ii) to clearly indicate in the policy if the client’s order may be executed outside a regulated market, multi-lateral trading facility or an organised trading facility; (iii) to include information in the policies about any third party payments received by firms in connection with the execution of orders; (iv) to present the costs of any execution venues alongside other features of those venues so that the focus of the client is not solely on the cheapest venue;
  • for the review of policies (annually or where there has been a material change), ESMA is proposing to clarify what constitutes a ‘material change’ to ensure consistent interpretation by Member State national regulators, namely a significant event of internal or exchange change that could impact the parameters of best execution; and
  • to clarity how firms can satisfy best execution requirements when using a single venue or entity for execution.

Client order handling

What are the current requirements?

MiFID currently requires firms authorised to execute client orders to implement procedures and arrangements which provide for the prompt, fair and expeditious execution of client orders, relative to other client orders or the trading interests of the firm. There are also general principles that firms have to satisfy when carrying out client orders, on aggregation and allocation of client orders.

What is new in MiFID II Level 1?

MiFID II has not introduced major changes to the client order handling rules. The existing requirement to disclose unexecuted client limit orders to the public is being extended to capture additional trading venues (e.g. OTFs) but this is being consulted upon by ESMA under data publication requirements which are covered in a separate note.

What is ESMA proposing in Level 2?

ESMA is not proposing to recommend any changes to the current requirements.

Client categorisation

What are the current requirements?

Under MiFID, clients can be categorised as eligible counterparties, professional clients or retail clients. The category of retail clients captures every client that is not a professional client or eligible counterparty.

What is new in MiFID II Level 1?

MiFID II does not change the categories of clients, nor the various monetary thresholds and experience levels that eligible counterparties and professional clients are required to meet.

However, a few bespoke changes are being made.

Municipalities and local public authorities

Due to a number of mis-selling concerns in connection with the sale of complex products to local authorities, some changes have been made to how municipalities and local public authorities are able to be classified. They are no longer permitted to be eligible counterparties or per se professional clients, so they are, in effect, deemed to be retail clients. They are still able to elect to be treated as elective professional clients and ‘opted up’ from retail client status.

MiFID II also allows Member States the discretion to adopt specific criteria for the assessment of the knowledge and expertise of municipalities and local public authorities requesting to be treated as professional clients. These criteria can be alternative or additional to the criteria normally required to be satisfied by firms when opting up clients to elective professional client status. In principle, a Member State could adopt less strict criteria for the opting up of municipalities and local authorities.

Elective eligible counterparties

MiFID II is proposing no changes to the various categories of clients that can elect to be eligible counterparties, but the Commission did ask if ESMA agreed with this.

What is ESMA proposing in Level 2?

Municipalities and local public authorities

ESMA was not requested to provide any technical advice or recommend any delegated acts in relation to this point.

Elective eligible counterparties

Bearing in mind that the objective of MiFID II is to increase the protection of investors and reduce the areas of exemption, including strengthening the treatment of eligible counterparties ESMA is proposing to restrict, the types of investors who can qualify as an elective eligible counterparty. ESMA is recommending that the ability to allow investors who have elected to be professional clients to then also elect to be eligible counterparties is removed.


What are the current requirements?

Firms providing advice (whether independent or not) or providing portfolio management services to clients must obtain the necessary information regarding the client's knowledge and experience, their financial situation and investment objectives so as to enable the firm to (in the case of advice) provide suitable personal recommendations to clients or potential clients or (in the case of portfolio management) to make suitable investment decisions on their behalf.

What is new in MiFID II Level 1?

MiFID II does not introduce any major changes to the current regime but enhances the obligation requiring firms to also obtain information about the client’s ability to bear losses and their risk tolerance and makes explicit that, where products are packaged or bundled, the overall package or bundle is suitable.
MiFID II introduces a new requirement that firms must provide retail clients with a suitability report specifying how the advice given meets the client’s circumstances.

What is ESMA proposing in Level 2?

ESMA proposes to enhance both the suitability assessment and suitability report requirements.  

Suitability assessment

ESMA proposes to expand the requirements in a number of key areas including:

  • confirming that the responsibility to undertake the suitability assessment lies with the firm and that firms should not create any ambiguity about this;
  • confirming that the suitability assessment does not just relate to recommendations to buy investments but also whether or not to hold or sell an investment;
  • requiring firms to adopt policies and procedures to ensure that they understand the nature, features (including costs and risks) of instruments selected for clients and that they assess whether alternative financial instruments, less complex or with lower costs, could meet the client’s profile;
  • for non-independent advisory firms, requiring that they should not make a recommendation in relation to their non-independent financial instruments if they are not suitable for clients;
  • requiring firms to assess any switching of products to ensure that the benefits of switching outweigh the costs;
  • in on-going advisory relationships or in portfolio management, requiring firms to have procedures to demonstrate so they maintain up-to-date information about the client (so that they can continually assess suitability);
  • clarifying that it is up to firms to determine the extent of the information obtained from clients and to ensure the information is reliable; and
  • guidance on determining who should be subject to the suitability framework if the client is a legal person or a group of persons.

Suitability reports

ESMA proposes to:

  • prescribe the content of suitability reports namely: (i) to outline the advice; (ii) to set out how the recommendation is suitable for the retail client; and (iii) disadvantages of acting on the advice;
  • ensure they are personalised; and
  • bring to a retail client’s attention if a periodic review is needed. Any subsequent report needs to only address what has changed (in either the client’s circumstances or the financial instruments) since the last report.

Appropriateness and execution-only business

What are the current requirements?

MiFID currently requires firms, when providing investment services other than investment advice or portfolio management, to obtain information regarding their existing or potential clients’ knowledge and experience relevant to a specific service or product, to enable the firm to assess whether it is appropriate for the client. (Professional clients are assumed to have sufficient knowledge and experience.)

Firms are not required to carry out this appropriateness assessment where the service being provided is ‘execution only’ and the financial instruments are either listed shares, money market instruments, bonds or other forms of securitised debt, UCITS funds and other non-complex financial instruments.

The MiFID Implementing Directive set out four criteria for assessing when a financial instrument is non-complex, and ESMA’s predecessor (CESR) provided guidance in a Q&A in 2009 on the distinction between complex and non-complex products.

What is new in MiFID II Level 1?

MiFID II modifies the existing list of financial instruments where no appropriateness analysis is required as follows (which narrows the scope of execution-only business):

  • shares admitted to trading on a regulated market, an equivalent third country market or a multi-lateral trading facility, where these are shares in companies (except shares in non-UCITS collective investment undertakings and shares that embed a derivative);
  • bonds and other forms of securitised debt admitted to trading on a regulated market, an equivalent third country market or an multi-lateral trading facility and money market instruments (except those that embed a derivative or incorporate a structure which makes it difficult for the client to understand the risk involved);
  • shares or units in UCITS (except structured UCITS);
  • structured deposits (except those that incorporate a structure which makes it difficult for the client to understand the risk of return or the cost of exiting the product before term); and
  • other non-complex financial instruments.

In addition, it clarifies that where credit is provided (i.e. discussions on existing credit facilities, overdrafts and current accounts), an appropriateness analysis will always be required.

Further, where a package of services or products is provided and a suitability assessment is not required, the overall bundled package must be assessed as appropriate.

What is ESMA proposing in Level 2?

ESMA is proposing to confirm the four criteria set out in the existing MiFID Implementing Directive as being appropriate to determine when a financial instrument is non-complex and add an additional two criteria, namely:

  1. the instrument does not incorporate a clause, condition or trigger that could fundamentally alter the nature or risk of the investment or pay out profile (i.e. investments that incorporate a right to convert the instrument into a different investment); and
  2. the instrument does not include any explicit or implicit exit charges that have the effect of making the investment illiquid.

ESMA also proposes to confirm that instruments not falling within the above bullet point list of non-complex products are considered to be complex.

ESMA has not made any proposals in relation to what information needs to be obtained in order to carry out the appropriateness assessment.

Reporting to clients

What are the current requirements?

MiFID requires various reports to be provided to clients in a durable medium, namely:

  • occasional reporting (other than for portfolio managers);
  • reporting obligations in respect of portfolio management;
  • additional reporting obligations for portfolio management or contingent liability transactions; and
  • statements of client financial instruments or client funds.

What is new in MiFID II Level 1?

MiFID II does not propose any significant changes to the current regime. It confirms the above but extends the reporting requirement to also include ‘periodic communications (taking into account the type and complexity of financial instruments involved and the nature of the service provided to the client).’

What is new is that these reports may also now need to go to eligible counterparties.

What is ESMA proposing in Level 2?

ESMA’s proposals include the following:

Reporting to eligible counterparties

  • it is for the firm and the eligible counterparty to contractually decide what information will be provided and by whom – it could be all of the above or (potentially) none of the above;

Reporting to professional clients

  • a trade confirmation will need to be sent to professional clients on T+1 (the same as it is currently for retail clients);
  • professional clients should get the same confirmations (in terms of content) as retail clients receive;

Content of reports re: portfolio management

  • the reports should be quarterly at a minimum (not bi-annually – to align the timing with reports to retail clients) and cover the activities undertaken and the performance of the portfolio during that period (this harmonises the requirements under AIFMD to report on the performance of the AIF, which ESMA views as no different to a managed account);

Reporting obligations re: portfolio management or contingent liability transactions

  • firms to agree with retail clients that have portfolio management services or a client account that includes / is likely to include leveraged financial instruments or other contingent liability transactions, bespoke loss thresholds which will trigger a reporting threshold. (ESMA has mentioned 10% or multiples of 10% of the initial value of the investment at the beginning of each year);

Content of reports in relation to investment advice

  • there is now the requirement for a suitability report to be provided when advice is being provided to retail clients and additional suitability reports where an ongoing advisory service is being provided – see ‘Suitability’ discussed in this note;

Statements in respect of client assets and funds

  • statements to be provided at a minimum of quarterly intervals (not annually) and can be requested more frequently;
  • statements to include: (i) clear indication of which assets are subject to client asset protection and which are not; (ii) clear indication of which assets are affected by peculiarities in their ownership status (e.g. if they have a security interest over them); and (iii) the market or estimated value of the instruments together with a clear indication that “a lack of a market price is likely to be indicative of a lack of liquidity”; and

Reporting on costs and charges

  • see ‘Information to clients’ discussed in this note.

Information to clients

What are the current requirements?

MiFID requires investment firms to provide certain information to clients or potential clients, such as information on its services, on financial instruments, on costs and charges, and its terms of business (in a client agreement).

What is new in MiFID II Level 1?

MiFID II retains the existing measures but given that it introduces new measures (e.g. the new concept of ‘independent’ investment advice), the information requirements imposed also need to be extended.

Information on investment advice

Before advice can be given (see ‘investment advice’ discussed in this note), firms must inform clients of the following:

  • whether the advice to be provided is independent or non-independent;
  • whether advice is based on a broad or restricted range of financial instruments (and whether those instruments are issued by entities linked or tied in some way to the firm); and
  • whether it will provide the client with a periodic assessment of the suitability of the financial instruments recommended to that client.

Information on financial instruments

Information on financial instruments which, from existing measures, must contain appropriate guidance on, and warnings of, the risks associated with investment in the instruments, must now take account of whether the instrument is intended for retail or professional clients and any target market identified in accordance with the new product governance requirements on product manufacturers (see ‘product governance’ discussed in this note).

Information on costs and charges

MiFID II reinforces the existing requirements but clarifies them in places and sets additional requirements. Information on all costs and associated charges, including charges related to investment and ancillary services, the cost of advice and the cost of financial instruments must be disclosed; the method of payment stated, and details of any third-party payments. All costs and charges should be aggregated so the client understands the overall cost as well as the cumulative effect on the return of the investment (with an itemised breakdown should a client request it). Information about costs and charges is to be provided “in good time” and, where applicable, at least annually post-sale.

Information in client agreements

MiFID II mirrors the existing requirement for a client agreement to be provided.

Information on client assets

MiFID II does not include any specific information requirements in relation to the safeguarding of client assets.

What is ESMA proposing in Level 2?

Information on investment advice

ESMA is proposing greater information disclosure requirements by requiring a substantial amount of detail so that firms properly explain the scope and the features of the advice given, including requirements to:

  • explain whether or not, and why, investment advice qualifies as independent in a clear and concise way - and the type and nature of any restrictions that apply;
  • the proportion of the total number of financial instruments analysed that is issued by the firm itself or related parties. Independent firms should also confirm the selection process they adopt in relation to financial instruments and the aspects they take into consideration;
  • if a firm provides a periodic assessment of suitability, the firm must explain to its client:
  • the frequency and extent of such assessment;
  • the extent to which previously disclosed information will be subject to reassessment; and
  • the way in which the updated recommendation(s) will be communicated.

Information on financial instruments

ESMA proposes the following information to be disclosed on financial instruments:

  • how the instruments function and perform in both positive and negative market conditions;
  • the extent of any restrictions or impediments on disinvestment (e.g. illiquid assets);
  • the legal nature and status of financial instruments which are comprised of two or more different financial instruments, their components and how their interaction affects their risks; and
  • the scope and nature of any guarantee or capital protection incorporated in financial instruments.

This information may be provided in a standardised ‘fact sheet’ format.

Information on costs and charges

ESMA considers that cost disclosure, together with the disclosure about risk, is an important element to improve the ability of investors to assess the products that are offered to them. Due to concerns that the current MiFID II requirements could still result in different application by investment firms due to certain ambiguities in the drafting, ESMA is proposing significant detail on information on costs and charges including the following:

  • extending the disclosure requirements to professional clients and eligible counterparties with the ability for them to opt-out of receiving some information (e.g. post-sale periodic disclosure). The ability to opt-out should not apply when investment advice or portfolio management services are being provided or where the financial instrument concerned embeds a derivative;
  • full ‘point of sale’ disclosures must be provided when: (i) the firm recommends or markets financial instruments to clients (which shall be interpreted broadly and include distribution arrangements); or (ii) if the firm is required to provide a key investor document (KID) under PRIIPS or a key investor information document (KIID) under UCITS. If a firm is not required to provide a KID/KIID, for instance because it is acting in a passive execution-only role, then it only needs to provide information about the costs and charges relating to its service (and not the underlying financial instruments). Importantly, however, ESMA considers that the ‘point of sale’ costs disclosures may be ‘generic’, provided they are representative of the costs the client would incur; all instances where a client ‘indirectly’ pays for a product should also be included – e.g. rebates of a management fee collected from the product and paid over to an advisory firm;
  • ‘aggregated’ costs must include the costs and associated charges of other parties to whom the firm directs the client, for the investment services / ancillary services provided to the client, as well as all costs associated with manufacturing and/or managing the financial instruments for the client. The ‘aggregated amounts’ must be presented as one, single figure both as a cash amount and a percentage;
  • ‘aggregated information’ must be provided to the client in sufficient time so that the client can consider material information when they make their investment decision;
  • the types of costs that need to be disclosed are set out in an Annex to the CP; and
  • periodic post-sale disclosure does not apply to firms that provide a ‘one-off’ service.

ESMA has set out various examples of how it considers disclosures might be made in the CP.

Information in client agreements

ESMA is proposing to significantly expand the scope of this requirement as follows:

  • the requirement for client agreements should be extended from retail clients to also include ‘new’ professional clients where there is intended to be an on-going relationship (i.e. relationships with professional clients entered into after MiFID II comes into force);
  • the current exclusion from needing to provide a client agreement for advisory services is removed, however the exclusion will still apply when ‘one-off’ advice is provided;
  • the requirement to provide a client agreement will be extended to where custody is being provided; and
  • the scope of the client agreement is proposed to be expanded beyond merely recording the ‘essential rights and obligations’ of the parties, to: (i) the ‘nature and extent of investment advice services’ to be provided; (ii) the types of financial instruments which may be bought or sold, and transactions undertaken on behalf of the client, as well as any which are prohibited (in the context of portfolio management); and (iii) an explanation of the key features of any custody services to be provided by the firm, including setting out the firm’s role in relation to corporate actions.

Information on client assets

See ‘Safeguarding of client assets’ in this note.

Record keeping

What are the current requirements?

Firms (where applicable) are currently required to keep records in a significant number of areas, including in relation to:

  • client orders;
  • decisions to deal;
  • transactions (both where executed by a firm or passed to another to execute); and
  • client files (including client agreements, information to assess suitability).

The records are required to be kept for a period of 5 years or for the duration of the client relationship (if longer) and there are requirements in relation to the medium, the form and the manner in which they should be retained. Member State national regulators were given the discretion to draw up a list of minimum records that should be retained, and ESMA’s predecessor, CESR, provided recommendations in 2007 about what those minimum records should be.

What is new in MiFID II Level 1?

MiFID II does not make any substantive changes to the existing requirements. It does emphasise that Member State regulators must be able to use records to fulfill their supervisory tasks and there is an express reference to records being used to assist with ‘market integrity’.

What is ESMA proposing in Level 2?

ESMA is not proposing to alter the existing requirements but is seeking to codify its previous Level 3 recommendations, published by CESR in 2007. It is proposing to prescribe a non-exhaustive list of minimum records that firms should be required to keep and what they should cover, to harmonise practices across Europe. In addition, it is proposing that all policies that firms are required to maintain under MiFID II and other European directives need to be kept in writing.

Recording of telephone conversations and electronic communications

What are the current requirements?

There are currently no mandatory existing requirements under MiFID to record telephone conversations or electronic communications, although Member States had the discretion to require it.

What is new in MiFID II Level 1?

To increase certainty, investor protection and deterrence of market abuse, MiFID II has introduced organisational requirements which require firms to record telephone conversations or electronic communications when they:

  • receive and transmit orders;
  • executive orders on behalf of clients; and
  • deal on own account.

The requirements includes all telephone conversations and electronic communications that relate to activities that are intended to result in the conclusion of a transaction or the provision of client order services, even if they in fact do not.

What is ESMA proposing in Level 2?

ESMA is proposing the following additional requirements, amongst others:

  • firms should have effective organisational arrangements to ensure compliance with the rules on recording telephone conversations and electronic communications, and should have an effective and appropriate written policy in this area;
  • ESMA is proposing that internal conversations and communications within firms are caught by the recording requirement where they relate to or are intended to result in transactions; and
  • the content of face-to-face conversations with clients should be documented (by a file note) and ESMA prescribes the minimum content to be documented.

ESMA also proposes that these requirements should relate to firms caught by MiFID and to branches of third country firms.

For storage, ESMA is proposing that records be stored in a durable medium for seven (7) years.

Complaints handling

What are the current requirements?

MiFID introduced high level requirements in relation to the organisation of firms and the handling of complaints raised by retail clients, their record-keeping and resolution.

What is new in MiFID II Level 1?

MiFID II continues the current regime.

What is ESMA proposing in Level 2?

ESMA is proposing to significantly extend the requirements in relation to complaints handling.

The measures contain strict (albeit still high-level) requirements with the aim that this will implement harmonised complaints-handling across the EU and, currently, apply to both retail and professional clients. There are new requirements in relation to the governance of complaints. The additional requirements include:

  • a written complaints procedure for handling complaints;
  • the ability for clients to be able to make a complaint without charge;
  • communication requirements with client (i.e. in plain language);
  • responding without unnecessary delay;
  • providing the firm’s response to a complaint and the client’s options should they wish to refer the complaint elsewhere (or take civil action);
  • complaint data reporting requirements to a firm’s regulator; and
  • meaningful analysis of complaints data by compliance to identify issues.

ESMA has stated that it may set out more specific guidelines in the future.

Safeguarding of client assets

What are the current requirements?

In relation to client assets, MiFID put in place the following requirements:

  • organisational arrangements – including requirements to make arrangements to safeguard the client’s ownership rights, and to minimise the risk of loss or diminution of client assets;
  • requirements relating to the registration of title to custody assets;
  • requirements to keep accurate records and perform reconciliations;
  • requirements for firms to perform due diligence on third parties with whom custody assets are deposited;
  • restrictions on the use of client assets; and
  • requirements for auditor confirmation that firm’s arrangements for compliance with the custody rules are adequate.

What is new in MiFID II Level 1?

MiFID II continues the current regime.

What is ESMA proposing in Level 2?

ESMA is proposing a significant number of additional requirements, including the following:

Governance arrangements in firms concerning custody

  • a new requirement for a dedicated officer (who may, where appropriate, be the compliance officer) to take overall responsibility for client assets;

Title transfer collateral arrangements (TTCA)

  • while TTCAs are not permitted to be used with retail clients, ESMA proposes that there be restrictions in relation to the use of TTCAs with professional clients and eligible counterparties – specifically, TTCAs should not be used where: (i) there is a weak argument for doing so (so no real connection between the TTCA and the client’s liability to the firm); (ii) the amount of client funds or assets subject to the TTCA far exceeds the client’s liability; and (iii) firms insist all clients’ assets are subject to TTCAs without considering what obligations each client has to the firm;
  • requiring firms to be able to demonstrate the appropriateness of any TTCAs used;
  • requiring disclosure to clients of the risks of TTCAs;

Securities financing transactions and collateralisation

  • requiring that firms monitor those who borrow client asset’s (e.g. stock lending activities) to ensure they provide the appropriate collateral and take necessary steps to maintain the balance with the value of client assets;
  • that this should apply not only to retail clients but also to professional clients and eligible counterparties;
  • that the express consent of non-retail clients for firms to enter into arrangements for securities financing transactions should be clear, recorded in writing and affirmatively executed by the client;

Considering diversification of firms’ holding of client funds

  • a requirement on firms depositing client funds with third parties to consider diversification as part of their due diligence in the appointment of those third parties;

Intra-group deposits of client funds

  • imposition of a 20% limit on intra-group deposits, unless the firm can demonstrate that this is disproportionate;

Custody liens

  • a ban on custody liens enabling third parties to recover debts unrelated to clients or the provision of services to clients, except where this is required in jurisdictions where assets are held;
  • disclosure requirements where firms are obliged to enter into these types of liens;
  • record-keeping requirements, to make clear the ownership status of client assets, in respect of liens, security interests or other encumbrances granted by firms;

Segregation of client assets in third countries

  • limitations on the ability of investment firms to rely on “other equivalent measures” when they are unable to comply with segregation requirements in third countries as a result of applicable law or market practice;

Availability of information to insolvency practitioners and others

  • requirements on investment firms to make information easily available to Member State national regulators, insolvency practitioners and those responsible for the resolution of failed institutions.