ESMA published on February 2, 2022, a supervisory briefing (ESMA35-43-2900) setting out its expectations under the MiFID II framework for firms that use tied agents (the Briefing).1 The content of the briefing is likely to impact on third country firms currently using a tied agent model as part of their EU operations, including UK firms currently operating in the EU via a third party tied agent platform. In this Alert, we briefly highlight some of the key points raised in the Briefing.
The Briefing contains ESMA’s and National Competent Authorities’ supervisory expectations in relation to firms providing investment services and/or performing investment activities through the use of tied agents. More specifically, the Briefing sets out the supervisory expectations:
a) When firms appoint tied agents; and
b) On firms using tied agents in their on-going activities.
By way of reminder, per Article 4(29) of MiFID II, a tied agent is a natural or legal person who, under the full and unconditional responsibility of only one firm on whose behalf the tied agent acts, “promotes investment and/or ancillary services to clients or prospective clients, receives and transmits instructions or orders from the client in respect of investment services or financial instruments, places financial instruments or provides advice to clients or prospective clients in respect of those financial instruments or services”.
The Briefing provides general guidance on how to comply with the MiFID II provisions relating to tied agents, with specific focus on cases where these agents are legal persons and cases where they are controlled by or have close links to other entities, including third-country entities.
Requirements for Third-Country Entities
ESMA expressly states that following the UK’s withdrawal from the EU, it has been monitoring the behaviour of firms in order to understand whether their interaction with EU-based clients is done in a way that is compliant with the MiFIR and MiFID legislation (including the regimes providing the conditions for third-country firms to provide investment services and activities in the EU). ESMA adds that in this context, “some practices concerning investment firms using tied agents recently emerged as a potential source of circumvention of the abovementioned legal framework”.
Given ESMA’s view that there are instances of “circumvention” of the legal framework, it is unsurprising that the guidance in the Briefing relating to the requirements for third-country firms that wish to provide investment services and activities in the EU is emphatic.
ESMA’s view is that firms “should avoid appointing a tied agent which is a legal person and whose employees involved in the provision of the activities on behalf of the firm (e.g., sale staff) are also at the disposal or under the control of other entities, including third-country entities.”
The explanation given is that such other “entities could exercise inappropriate influence over the way in which a tied agent carries out the activities on behalf of the firm or may prevent the firm from effectively monitoring the activities of their tied agent.” ESMA cites as an example, instances where the tied agent is a legal person and is owned, controlled or has close links with a third-country entity that is itself involved in activities concerning for example establishing, managing and/or marketing investment funds.
ESMA also sees a potential exercise of inappropriate influence in instances where sales staff employed by a third country firm (without appropriate substance) are involved in the provision of the activities carried out by a tied agent as a result of arrangements with that third country firm “such as staff sharing agreements or secondment.”
ESMA goes on to say that it believes that allowing a tied agent to carry out activities on behalf of an EU-firm by mainly using the resources of another entity, especially a third-country entity, constitutes a “serious impediment to the [EU-] firm’s compliance with the duty of the firm to monitor the activities of its tied agents so as to ensure that they continue to comply with MiFID II2 when acting through tied agents”.
As a solution, and to ensure that the duty of exclusivity to which tied agents are bound (by virtue of Article 4(29) of MiFID II) is fulfilled, ESMA expects that “tied agents have sufficient substance in the EU and do not mainly rely on resources based outside of the EU in the provision of activities on behalf of the appointing firm”.
ESMA’s supervisory expectations are significant for third-country firms, and in particular UK firms, which currently use a tied agent model as part of their post-Brexit structure, and also for third-country firms that are contemplating using such a model. In the case of the former, existing tied agent entities (especially those which have been set up on a third-party tied agent platform) may find themselves being re-examined by their principal firms, particularly with regards to their current operations and substance in the EU and, if necessary, may be required to make changes. The main focus will likely be around substance requirements, given that ESMA raises questions about the viability of "dual-hatting" or secondment arrangements. For EU firms contemplating appointing a tied agent, the supervisory bodies are likely to be scrutinising these appointments going forward and EU firms will need to be able to show a clear understanding of the model and the related regulatory requirements.
In both instances, the supervisory expectation as set out in the Briefing may give firms pause for thought.