Firms dealing with clients need to be aware of various changes under MiFID II, many of which will require careful reviews of policies and procedures. This alert covers some of the key changes in relation to client obligations, many of which are designed to increase client protection and therefore will result in more onerous obligations for firms.
Changes in relation to the suitability and appropriateness requirements, and best execution, will be covered in separate alerts.
Firms will need to review their current client base and processes for classifying clients. Protections are being strengthened under MiFID II so that firms dealing with public authorities will need to treat them as retail clients by default, although it will be possible for them to opt-up to professional status (firms will not be able to treat them as eligible counterparties).
In this regard, there is discretion for Member States to apply their own opt-up criteria, and the FCA is proposing to do so. It proposes to strengthen the criteria to ensure that local authorities are not inappropriately opted-up, introducing a new quantitative test and requiring that local authorities are assessed separately by firms depending on the capacity in which they are acting (that is, whether they are acting as treasury managers or pension fund administrators). The FCA also proposes to make the same changes for firms dealing with public authorities in respect of non-MiFID business.
Further, it will no longer be possible to treat an elective professional client (i.e. a retail client who has opted-up to professional status) as an eligible counterparty. Again, the FCA proposes to extend this change to non-MiFID business.
MiFID II also mandates slightly more formal procedures for changing client classifications – eligible counterparties requesting a greater level of protection must make a written request, and professional clients wishing to opt-up to eligible counterparty status must receive a written warning from the firm, following which they must confirm in writing both their request and the fact that they are aware of the consequences of the protection they may lose.
Firms dealing with eligible counterparties also need to be aware that additional obligations will apply when dealing with these clients under MiFID II. For example, certain rules on reporting to clients and the provision of information to clients will apply when dealing with eligible counterparties. Also, firms will be required to ensure that they act honestly, fairly and professionally and communicate in a way which is fair, clear and not misleading when dealing with any type of client, not just retail and professional clients.
These changes mean that firms will not only need to review their client classification procedures, but will also need to review the existing classification of current clients (in particular elective professional clients who have opted up to eligible counterparty status, and public authorities) to ensure that they are categorised appropriately under MiFID II. This will also require a wider review of the impact re-categorisation has on the treatment of relevant clients, and may require firms to check they have the appropriate permissions to deal with the relevant types of client.
Client agreements will need to be reviewed and potentially revised to comply with MiFID II.
MiFID II is more prescriptive about the contents of client agreements. Whilst MiFID I simply requires that an agreement sets out the essential rights and obligations of the parties, MiFID II specifies that this means an agreement should include at least:
- a description of the services to be provided (plus a description of the nature and extent of any investment advice to be provided, where relevant);
- for portfolio management services, the types of financial instruments that may be purchased or sold, and the types of transactions that may be undertaken, on behalf of the client; and
- a description of the main features of any custody services to be provided.
Although most firms will be in compliance with these enhanced standards already, firms will need to check that the contents of their agreements comply with the MiFID II standard.
Further, although many firms already enter into written agreements with professional clients as a matter of good practice, under MiFID II they will be required to enter into written agreements with professional clients, as well as retail, when providing investment services and custody services (with the concession that, when investment advice is provided a written agreement is only required where periodic suitability reports are provided to the client). Under MiFID I, firms are only obliged to enter into written agreements when providing investment services (other than investment advice) to new retail clients.
Reporting to clients
This is an area where there are a number of important changes for firms; a careful review of policies and procedures will be required to pick these up.
The basic requirement relating to the provision of reports to clients on services provided contains additional detail under MiFID II, specifying that reports should include periodic communications that take into account the type and complexity of the financial instruments involved and the services provided.
There are various tweaks and modifications to the detail of the existing MiFID I standards. An important change is that the detailed requirements will apply in respect of both professional and retail clients; under MiFID I many of the more detailed requirements only apply in respect of retail clients. However, firms may be able to lighten the burden as MiFID II does permit them to enter into agreements with eligible counterparties setting out tailored reporting requirements in respect of the execution of orders if they wish.
The frequency with which reports in respect of portfolio management services and statements of client financial instruments and funds must be provided will increase. Although MiFID II introduces a concession that reports will not be required where statements are made available online, in order to make use of this the firm will have to show that a client has accessed the statement within the relevant period and so this may be difficult for firms to rely on in practice.
Much more prescriptive requirements are being introduced in relation to the additional reporting obligations for portfolio management or contingent liability transactions (which require the reporting of certain losses or depreciation to clients), which are complex and may be challenging for firms to implement.
MiFID II will introduce a requirement to record all calls leading up to the execution of an order, rather than just, as is the case under MiFID I, the call in which the order is executed. This will present practical challenges for firms. In addition, records of calls will need to be stored for a period of five years. The FCA proposes to go further than what is required under MiFID II by extending the telephone taping regime to all portfolio management services (including removing the exemption for discretionary investment managers where calls are recorded by their broker), corporate finance business, activities of collective portfolio management firms (such as AIFMs), and potentially also financial advisers who are Article 3 firms.