Introduction

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 with which those providing such services should comply.

Following technical advice received from the European Securities and Markets Authority (ESMA) and a public consultation, the European Commission published legislative proposals in 2011 to amend MiFID by recasting it as a new Directive (MiFID II)1 and a new Regulation (MiFIR)2. The legislative proposals were the subject of intense political debate between the European Parliament, the Council of the EU (the Council), and the Commission. However, informal agreement between the EU institutions was finally reached in February 2014. On 15 April 2014, the texts were approved by the European Parliament in plenary session which enabled the Council to adopt them on May 13, 2014.

The texts will soon be published in the Official Journal of the EU (OJ). The Commission’s request to ESMA for technical advice on implementing measures anticipates the entry into force of MiFID II and MiFIR to be in June 2014. Application will then follow 30 months later. The implementing measures that will supplement MiFID II and MiFIR will take the form of delegated acts and technical standards. ESMA has indicated that a discussion paper on the technical standards will be published shortly after the European Parliament approves the final texts. Following the responses to the discussion paper, ESMA will publish a consultation paper on draft technical standards later in 2014 or early in 2015.

Third country provisions: changes under MiFID II

Of all the provisions of the MiFID II texts, the third country provisions have been subject to some of the most heated – and high profile – debate and lobbying. Articles have dropped in and out of different drafts at a confusing rate, and it has been difficult to keep track of the latest developments.

The term “third country” refers to jurisdictions outside the EU and “third country firms” refers to entities incorporated outside the EU, whether they do, or seek to do, business by way of a branch established in the EU, or on a cross-border basis – i.e. providing services to persons in one jurisdiction from a place of business in another jurisdiction without any establishment in the client´s jurisdiction.

With the review of MiFID, the Commission has attempted to create a harmonised regime for granting access to EU markets for firms in third countries. However, the regime is limited in scope to the cross-border provision of investment services and activities provided to per se professional clients and eligible counterparties.

As regards the third country regimes for retail clients and opted-up professional clients, full EU harmonisation could not be achieved, as Member States are free to continue to apply national rules. However, where Member States choose not to maintain their respective national regimes, MiFID II provides for a detailed set of rules that are designed to harmonise the requirements with which the branch of the third country firm will have to comply in order to be authorised by the national competent authority of the Member State. To put it in the EU Commission´s words “third country firms should see this as a positive step forward as it reduces divergences across EU Member States and therefore the legal and regulatory costs for third-country operators.” Where a Member State makes use of this option, third country firms may not provide services to these clients other than through a branch authorised pursuant to the harmonised procedure set out in MiFID II by the respective Member State.

Third country firms dealing with per se professional clients or eligible counterparties will, on the other hand, be permitted to operate on a cross border basis either from outside the EU or (if provided for in the respective Member State and then subject to further conditions) from a branch in a Member State.

In each case, there will be a greater, formalised focus on agreements between the EU and third country regulators and the assessment of third country regimes. There is also an exclusion in the form of the client's exclusive initiative - see further below.

Through an authorised branch

An EU Member State may require third country firms to provide investment services or perform investment activities to retail or opted-up professional clients in its territory through a branch authorised in that Member State.

However, such branch authorisation may only be given by the Member State’s national competent authority:

  • where the firm is authorised and supervised in respect of the provision of the relevant services in its home third country jurisdiction;
  • having regard to the Financial Action Task Force (FATF) recommendations relating to anti-money laundering and counter terrorist financing;
  • where co-operation arrangements exist between the relevant Member State and third country regulators, also relating to the exchange of information for the purposes of preserving the integrity of the market and protecting investors;
  • where the branch has sufficient initial capital at its free disposal;
  • where branch management consisting of one or more persons is appointed in accordance with, and complies with, the governance requirements of MiFID II and the Capital Requirements Directive3 (CRD IV);
  • where a tax information sharing agreement (complying with the standards in Article 26 of the OECD Model Tax Convention) has been entered into between the relevant Member State and the home third country jurisdiction, ensuring an effective exchange of information in tax matters; and
  • where the firm belongs to an EU investor compensation scheme.

Such branches must comply with various organisational, conduct of business, trading and other MiFID II requirements and will be subject to the supervision of the national competent authority in the respective Member State where the authorisation was granted. It is interesting to note that Member States will not be permitted, save in limited circumstances, to impose any additional requirements on the organisation and operation of the branch in respect of matters covered by MiFID II and that such branches may not be treated more favourably than EU investment services firms. In these respects, MiFID II amounts to maximum harmonisation.

An important point to note is that the relevant Member State national competent authority may only authorise a branch where the applicant is authorised and supervised in its home third country to provide all of the services for which it is requesting branch authorisation. This will not only exclude branches of unregulated firms, but will also restrict the scope of activities that a regulated third country firm can perform through a branch, to the extent that any such services are not regulated in the home third country. This may cause problems given the complexity of the definitional scope of different services and activities in and outside the EU.

Different types of client

On the face of it, this provision in MiFID II applies to firms providing services specifically to retail clients and opted-up professional clients. However, MiFIR provides that branches authorised pursuant to MiFID II may provide investment services to eligible counterparties and per se professional clients across the EU, provided their third country legal and supervisory framework has been recognised by the Commission as equivalent (see below). From this, it can be concluded that such branches can provide their services to per se professional clients and eligible counterparties throughout the EU on a cross border basis (with appropriate equivalence decisions). However, where such a third country firm wishes to provide services to retail clients and opted-up professional clients in other Member States, it would either need to:

  • apply for separate authorisation in each Member State in which it wishes to provide services and establish a branch in each one (where the Member State´s regime provides for this possibility); or
  • comply with the local regime governing market access in case of retail or opted-up professional clients.

Where a Member State has implemented the MiFID II provisions on the establishment of third country branches, a third country firm that has not established a branch in that Member State will not be able to provide investment services with or without any ancillary services to retail clients or opted-up professional clients (except on such client´s exclusive initiative, see below). Where a Member State's regime does not require the establishment of a branch, the provision of services to retail clients and opted-up professional clients will be subject to the respective Member State's national requirements.

Cross border

However, a third country firm may provide investment services to eligible counterparties and per se professional clients on a cross border basis where such firm is registered with ESMA.

ESMA will only register such third country firms where:

  • the Commission has adopted a decision that the prudential and business conduct requirements in the firm’s home third country have equivalent effect to MiFID II and CRD IV;
  • the Commission’s decision also concludes that such third country also has an effective and equivalent system for the recognition of investment firms authorised under the third country's legal regime;
  • the firm is authorised and effectively supervised in its home third country in respect of the provision of the relevant services (as with the requirements for branch authorisation, this would restrict the scope of cross border services that a regulated third country firm can perform to the extent that any such services are not regulated in the home third country); and
  • co-operation arrangements exist between ESMA and the firm’s third country national competent authority which, among other things, relate to the exchange of information and co-ordination of supervisory activities.

An ESMA registered third country firm will have to inform prospective EU clients that it cannot provide services to EU clients other than per se professional clients and eligible counterparties and is not supervised in the EU. It must also offer to submit any disputes relating to its services or activities to a court or tribunal in the EU.

Transitional provisions

Where there is no currently effective Commission equivalence decision in respect of any particular third country, Member States may allow firms from such third country to continue to provide investment services to eligible counterparties and per se professional clients, if permitted by (and in accordance with) the relevant national regimes. There is also a transitional provision in MiFIR under which firms will be able to continue to provide services and activities in accordance with national regimes until three years after the adoption of a Commission equivalence decision in respect of the relevant third country. It is not clear whether this transitional provision is intended to apply to services provided to all client types or whether it is limited to cross border business.

Exclusive initiative of client

A third country firm may, however, provide investment services and activities to clients on the exclusive initiative of such client, without requiring authorisation or registration in the EU.

Such “exclusive initiative” rules are likely to be interpreted strictly and a number of points in particular must be considered:

  • there is a clear indicator that a bullish approach to “reverse solicitation”, where firms raise their profile through various forms of marketing and seek to claim that any prospective clients that subsequently get in touch have not been solicited, should not be tolerated;
  • once a third country firm that is not authorised in a Member State has established a relationship with a client (following the exclusive initiative of such client), it cannot subsequently provide such client with other services (unless such additional services have also expressly been sought at the exclusive initiative of the client). In other words, the “exclusive initiative” test applies on a service by service basis, not on a relationship basis; and
  • that said, there is some ambiguity as to whether, having been approached by the client (on the client’s exclusive initiative) to provide a service, the third country firm may subsequently provide repeat instances of the same services/product type to the client. In theory this may be possible, but in practice it is likely to be a risky approach to take.

Implications for the German market

Currently, access to the German market from third countries is subject to a very strict approach by the German regulator (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). The provision of investment services (and banking business) in Germany requires a licence. BaFin not only assumes that there is such (licensable) provision of investment services in Germany where the provider of the service has a permanent establishment in Germany but also in cross-border cases where the service provider targets the German market in order to provide services repeatedly or on a commercial basis to clients in Germany.

Such targeting of the German market can be done at a very early stage, e.g. in case of marketing in Germany or offering via internet, visits of distributors etc. This means that a licence pursuant to German banking law may also be necessary in case of cross-border market access from third countries. However, as such licence can only be obtained if there is a permanent establishment in Germany, service providers from third countries which are deemed by BaFin as targeting the German market have no possibility to obtain such licence and run the risk of committing the criminal offence of providing regulated business without the necessary licence. This may also entail a certain litigation risk.

In order to avoid such consequence, third country service providers currently have either the possibility

  • to establish a subsidiary or branch in Germany, or a subsidiary in another Member State of the EU which then provides the services in Germany under the so-called European passport; or
  • to apply for an exemption from the licensing requirement with BaFin; or
  • to limit their activities to cases which are covered by the freedom to provide the requested services (passive Dienstleistungsfreiheit) as interpreted by BaFin.

This understanding of market access by the German regulator, its interpretation of the concept of freedom to provide the requested services, and the requirements for an exemption from the licensing requirement are set out in detail in a BaFin Notice of 2005.4

In this context, two points are worthy of note:

For once, the German regulatory regime already generally provides for the possibility that third country firms establish a third country branch in Germany (cf. Sec. 53 and Sec. 53c of the KWG). However, other than under MiFID II, such branches are in principle not restricted to the provision of investment services (they may also provide banking business) or to the provision of such services to a specific type of client. Furthermore, the authorisation procedure and the requirements to be fulfilled by such third country branches differ from the provisions in MiFID II.

Secondly, the concept of “freedom to provide the requested services” is comparable to the concept of “exclusive initiative of the client” under MiFID II and MiFIR. However, BaFin´s interpretation of the freedom to provide the requested services is, in our opinion, far less restrictive than the concept of exclusive initiative of the client. For example, maintaining existing client relationships is considered as not giving rise to a licensing requirement but as falling under the freedom to provide the requested services.

In view of this, MiFID II and MiFIR can have a deep impact on the current regime in Germany regulating market access from third countries:

  • If the German regulator chooses to make use of the optional provisions in MiFID II to require that investment services to retail clients and opted-up professional clients may only be provided by third country firms after establishment of a branch, the current regime of Sec. 53 et seqq. of the KWG should be subject to a thorough review. In this context, it has yet to be seen whether the German legislator will differentiate between the provision of investment services and banking business and as to the type of client to which such services are provided.
  • If the German regulator chooses not to transpose these optional provisions in MiFID II, the question arises whether BaFin´s administrative practice on the cross-border provision of regulated business can be upheld. In particular, the question would arise whether the concept of the freedom to provide the requested service can be maintained in view of the MiFID II / MiFIR definition of “exclusive initiative of the client”.
  • In any case, the question arises how the use of transitional provisions, e.g. in the case of per se professional clients and eligible counterparties until the EU Commission´s equivalence decision, will affect the current national approach in Germany.

In our opinion, it is of crucial importance that the ramifications of MiFID II are analysed prior to any implementing measures by the German legislator and that affected players quickly find a common approach in order to address their issues and thoughts with the German legislator as soon as possible.

The financial services team of Norton Rose Fulbright LLP is happy to assist you with further information and analysis of MiFID II and market access questions.