Structure of feedback
In PS07/2 the feedback on CP06/19 is divided into two parts. In the first part the FSA covers feedback to those proposals that it consulted on that were essential for MiFID transposition. In the second part of the feedback to CP06/19 the FSA covers those proposals that it consulted on for the implementation of other, non-COB aspects of MiFID. The next paragraphs in this Briefing cover the FSA’s feedback on the first part of the FSA’s feedback in PS07/2.
PS07/2 does not set out the FSA’s conclusions on its proposed guidance. The FSA stated that this would be covered in the NEWCOB Policy Statement that it expects to publish in Q2 2007. However, the Conduct of Business Sourcebook (MiFID Transposition) Instrument that was published with PS07/2 does include some guidance that copies out MiFID’s Recitals, where the FSA felt that this was desirable for the effective transposition of MiFID.
PS07/2 does also not provide any feedback on those areas of CP06/19 that the FSA felt was not necessary for transposition of MiFID. Feedback on these issues will be given in the NEWCOB Policy Statement.
Conduct of business obligations
Articles 19(1) and 19(3) of MiFID have been copied out in COBS 2.1.1R and 2.2.2R respectively. Article 19(1) requires a firm to act ‘honestly, fairly and professionally in accordance with the best interests of its clients’. Article 19(3) requires a firm to provide clients with information about the firm itself, financial instruments and investment strategies, which includes information on risk, execution venues, and costs and charges. The FSA reports in PS07/2 that the majority of respondents agreed with how the FSA was proposing to implement these MiFID provisions.
The FSA has decided to make some amendments to the layout of COBS 2.3.1R. The reason for doing so is to provide greater clarity and to ensure firms understand when the inducement provisions apply to them when providing services to a client. COBS 2.3.1R (2)(b) has been moved to (2)(a) on the basis that it will apply to all firms, whether they are carrying on MiFID or non-MiFID business. What is now (2)(a) will be in addition to this, and applies to MIFID business only.
In PS07/2 the FSA reports that firms were broadly content with the FSA’s proposals for copying out the MiFID provisions on client categorisation into NEWCOB and replacing the existing client classification framework for all MiFID business.
Given this, the FSA is proceeding with its proposed approach subject to certain amendments that are described on page 81 of PS07/2. Included in the amendments is that if a customer who is classified as an intermediate customer under current COB 4.1.9R (expert private customer) is grandfathered to professional client status under NEWCOB, the client will be an elective professional client under NEWCOB unless the client otherwise meets the criteria for ‘per se’ professional clients. All other intermediate customers will be grandfathered to a default status of per se professional client (COBS TP 3.2.(2)). This is relevant because some rules differentiate between per se and elective professional clients (in particular the rules on suitability at COBS 10.2.7R).
The FSA has also confirmed that COBS 3.6.6R applies only to EEA States. In COBS 3.6.6R the words ‘EEA States’ have been added and ‘different jurisdiction’ deleted. This is to clarify that under Article 24(3) of MiFID, firms are only required to defer to the relevant provisions of another jurisdiction if that jurisdiction is an EEA State.
Information about the firm, its services and remuneration
In Chapter 11 of CP06/19, the FSA explained its plans for reconciling in the short term the information requirements set out in MiFID with its Initial Disclosure Document and Menu and, in later months, for reviewing the documents.
In PS07/2 the FSA confirms that it plans to apply the new information requirements from MiFID, which are additional to the FSA’s existing requirements, to only MiFID firms. However, the FSA is considering this further and will report fully in the NEWCOB Policy Statement.
MiFID requires firms to document the terms on which they provide services to the customer. However, unlike the existing NEWCOB regime, MiFID does not prescribe the detailed content or format of this information. In PS07/2 the FSA reports that most respondents agreed with its proposals to reconcile these differences of approach and copy out the MiFID requirements into NEWCOB without adding any additional COB-based requirements for MiFID business. The FSA has therefore proceeded on this basis.
Identifying client needs and advising
In Chapter 14 of CP06/19 the FSA explained its proposals to implement the MiFID suitability obligations for personal recommendations and discretionary portfolio management. The FSA did receive some comments relating to MiFID implementation, particularly in relation to the application of MiFID to professional clients.
According to the FSA there are various considerations that may be relevant to the question of whether a firm could reasonably be understood to be providing investment advice to its professional clients, and what regulatory obligations may follow.
The FSA believes that the principal consideration is that MiFID defines investment advice as the provision of ‘personal recommendations’ to a client, which involves them being presented as suitable for the client or based on a consideration of the client’s circumstances. It is possible therefore for a firm to provide information or opinions about markets, prices and instruments to a professional client without going as far as to ‘recommend’ them or to provide a ‘personal’ recommendation to the client. In such a situation, the position of the firm will be reinforced if it makes it clear to the client that in providing the information it is not providing a recommendation (whether personal to the client or not). The context of the communication may therefore be relevant i.e. whether the information or opinion is presented as a suitable recommendation for the client and whether the client could reasonably assume that what was being said amounted to a recommendation.
According to the FSA in PS07/2, statements that clarify the status of a communication may be relevant where this would otherwise be unclear or ambiguous. But if it is clear from the circumstances that the firm is making a personal recommendation, a ‘disclaimer’ (e.g. to the effect that a recommendation is not being provided), whether in the terms of business, a notification, or otherwise, will have no effect. The FSA is of the opinion that a firm cannot contract out of the requirements applying to the provision of personal recommendations if that is what it has given. The question is whether a ‘disclaimer’ statement can change the nature of the communication. All the circumstances will have to be considered and the proximity, prominence and timeliness of such statements may have a bearing on this.
Where the suitability obligation does apply to communications between a firm and its professional clients, the FSA states in PS07/2 that the firm’s obligation to obtain information about the client is qualified in a number of ways. The formulation of the duty in COBS 10.2.2R is itself qualified by the words ‘necessary’, ‘essential’, ‘reasonable’ and ‘due consideration’. This may affect the level of intensity of the suitability obligation for professional clients.
The FSA’s proposed suitability record-keeping requirements are found at COBS 10.5.1R. Subject to any further comments from respondents the FSA is considering simplifying COBS 10.5.1R to: A firm must include in its records of business and internal organisation:
the client information it obtains to assess suitability; and
each suitability report it provides.
The FSA believes that this amendment would clarify NEWCOBS 10.5.1R interaction with the high level record-keeping requirement in SYSC 9 whilst confirming the degree of flexibility firms have in determining how to satisfy the obligations. Also, the FSA recognises that further consideration needs to be given as to what material would satisfy the MiFID record-keeping obligation in a proportionate and beneficial manner where personal recommendations are made to professional clients, including in routine trading communications. The FSA will address record-keeping further in its NEWCOB Policy Statement.
The FSA’s proposed limited extension of the MiFID requirement to non-MiFID derivatives and warrants will be covered in the NEWCOB Policy Statement.
The FSA has only made minor amendments to its draft Handbook text. Minor improvements to COBS 11.1.1R, 11.3.2R and TP 1 have been made. Also the copy-out of Article 38(a) of the MiFID Level 2 Directive has been made more transparent, at COBS 11.4.1R(3)(a), by reverting to full copy-out of the relevant MiFID language instead of using the defined term ‘warrant’.
Also, following comments received from respondents, the FSA has advised that it is intending to change the proposed guidance in COBS 11.3.3G on how a firm might be expected to react to a client who wished to proceed with a transaction after a firm had warned the client it may be inappropriate. The reason for the proposed change was because some respondents thought that the original guidance raised the standard on what compliance with the MiFID requirements involve.
The original proposed guidance stated that:
If a firm provides a warning and the client asks the firm to proceed with the transaction, the firm should consider whether it would be in the client’s best interests to proceed with the transaction. The proposed amended guidance is likely to state that: If a firm provides a warning and the client asks the firm to proceed with the transaction, it is for the firm to consider whether to do so, having regard to the circumstances.
The FSA is preceding with its intelligent copy out of the MiFID provisions as set out in CP06/19. The NEWCOB Policy Statement will, the FSA says, address whether to include as guidance in the Handbook some parts of the text of CP06/19 that explained and clarified the MiFID requirements. The FSA also confirmed that it would retain its proposed guidance on the relative importance of price for professional clients.
Limit order display
The FSA confirms in PS07/2 that ‘stop orders’ and ‘contingent orders’ are outside the MiFID definition of limit orders. It also confirms that it will use its power to waive the requirement to display client limit orders to the public in respect of limit orders larger than Normal Market Size (NMS). This is implemented through COBS 12.4.5R.
The FSA has also noted that some clients may wish to grant a general waiver to their broker not to display their limit orders.
According to the FSA in PS07/2 there is nothing in MiFID to suggest that the instruction cannot be a general one. The FSA’s interpretation continues to be that a client can instruct the firm not to publish their limit orders on a general basis, and that it does not believe that this is inconsistent with the underlying objectives of Article 22(2) of MiFID. However, a firm should not induce the client to give a general waiver where such a waiver may not be in the client’s best interests.
The FSA reports in PS07/2 that it will proceed with its proposals for intelligent copy-out of the MiFID provisions on investment research.
Feedback on the proposed guidance in COBS 13 will be covered in the NEWCOB Policy Statement. The NEWCOB Policy Statement will also cover other relevant material including the rules and guidance to implement the Market Abuse Directive.
Preparing product information
The FSA still believes that the requirement to provide a key facts disclosure document or Simplified Prospectus at the point of sale for both MiFID and non-MiFID business is appropriate.
Providing product information to clients
The FSA reports that most respondents agreed with its proposal to copy out the MiFID rules on customer understanding of risk and delete the existing rules and guidance.
In line with its approach to a more principles-based regime, the FSA does not propose to provide additional product-specific Handbook guidance.
Reporting information to clients
The FSA notes in PS07/2 that certain trade associations had asked for clarification of the reference to SUP 17 Annex 1 in COBS 17 Annex 1 R.
In response the FSA advises that Article 40.4 of the MiFID Level 2 Directive states that the notice to be sent to the retail client in respect of the execution of an order ‘shall include such of the following information as is applicable and, where relevant, in accordance with Table 1 of Annex I to the MiFID Level 2 Implementing Regulation. This Annex has been reproduced in the Handbook as SUP 17 Ann 1.
SUP 17 Ann 1 contains information which firms are required to complete when making transaction reports to the regulator. Some of the fields or field descriptions contained in SUP 17 may not be relevant either because they are not included in COBS 17 Ann 1R(1) or, where they are included, the format may not be appropriate for the purposes of reporting to retail clients. In these circumstances the information required by COBS need not be provided in the format specified by SUP 17 Ann 1.
Given this the FSA has amended the reference on the applicability of SUP 17 Ann 1 COBS 17 Ann 1R(1) to read:
The information below must be provided, where relevant for the purposes of reporting to a retail client, in accordance with SUP 17 Annex 1.
However, the FSA does state in PS07/2 that firms are free to duplicate in the field contents the information they use for the purposes of reporting to the regulator, if this meets the standard of fair, clear and not misleading communication. In either case, the information is subject to the overriding provision of being fair, clear and not misleading.
Non-COB aspects of MiFID in CP06/19
As mentioned earlier, in the second part of the feedback to CP06/19 the FSA covers those proposals that it consulted on for the implementation of other, non-NEWCOB aspects of MiFID. The remaining paragraphs in this Briefing cover the FSA’s feedback on this second part.
Organisational requirements not covered in CP06/19
CP06/19 contained the FSA’s proposals for implementing the general organisational and systems and controls aspects of MiFID and the Capital Requirements Directive. It did not cover proposals for record-keeping or outsourcing of retail portfolio management services to non-EEA service providers as they were still under discussion at European level at the time CP06/19 was published. These issues were therefore covered in CP06/19 and feedback is given in PS07/2.
In relation to its proposed record-keeping requirements the FSA received a significant level of support. Given this it has made a high level record-keeping requirement to apply to MiFID investment firms. However, the wider application of this high level requirement to other common platform firms and the provision of guidance will covered in the NEWCOB Policy Statement.
List of minimum records
In CP06/19 the FSA proposed maintaining its current practice of including a list of relevant record-keeping rules and guidance at the end of each sourcebook, rather than publishing a separate minimum list. CESR has consulted on a list of minimum records and the FSA has advised that it will consider the position once CESR has finalised its recommendations.
Outsourcing of retail portfolio management services requirements
In CP06/19 the FSA set out its proposals to implement the conditions in the Level 2 Directive for outsourcing portfolio management services to retail clients to non-EEA (third country) service providers, together with the prior notification arrangements. The Consultation Paper also contained proposals for a Policy Statement, in the form of guidance that set out examples of where the FSA would not be likely to object to an outsourcing proposal where the conditions were not met. HM Treasury has now requested the FSA to publish its guidance.
The FSA found that, in general, respondents supported its proposals for outsourcing portfolio management services to non-EEA countries. Except for minor amendments the FSA has not amended the draft Handbook text that was consulted on in CP06/19. In addition, the FSA also found that respondents agreed with its approach to the notification process and preferred it to make use of existing procedures where there is an objection to an outsourcing proposal given in a prior notification.
The FSA also makes clear in PS07/2 that MiFID does not exempt existing arrangements. Firms must ensure that their existing outsourcing arrangements for portfolio management will meet the new requirements on 1 November 2007. Firms are invited to notify the FSA, if this is required, on or after 1 July 2007.
In the first quarter of 2007 the FSA will publish a “Permissions and Notifications Guide” for firms. This document will contain the prior notification arrangements for outsourcing retail portfolio management to third country service providers.
Training and Competence: Making the sourcebook MiFID-compliant
In CP06/19 the FSA expressed its desire to make the Training and Competence sourcebook (TC) more principles-based. Some respondents have advised that they were concerned that any resulting changes to TC might conflict with industry efforts to improve training and professionalism. The FSA is considering this as part of a wider review of TC and will address the concerns by respondents in a Consultation Paper that the FSA plans to publish in February 2007.
In CP06/19 the FSA proposed to disapply all of the TC rules for inwardly passporting EEA MiFID firms. Some concerns were raised on this proposal on the basis that a competitive disadvantage could arise through inwardly passporting firms not being subject to the TC requirements (in particular the exam requirements). The FSA states that it is of the view that this is a MIFID-driven proposal, over which it has no discretion. It will determine the extent of any possible distortions as part of its wider review of TC.
In CP06/19 the FSA proposed removing the existing requirements for passing exams within specified time limits for both MiFID and non-MiFID firms. In PS07/2 the FSA confirms that it will proceed with this proposal. Also, the FSA does not intend to change its proposal in relation to record-keeping requirements in TC. The proposal was to amend the record-keeping requirements to five years for MiFID business only. The five year retention period is stipulated by MiFID and therefore the FSA has no discretion on this in relation to MiFID business. However, the FSA felt that it was not justified to apply the MiFID requirements to non-MiFID business.
Amendments to DISP
CP06/19 contained some proposed amendments to DISP (dispute resolution). In PS07/2 the FSA has only published final rules necessary for implementing the application, complaint handling and complaint record-keeping requirements of MiFID. The FSA’s feedback on proposals for non-MiFID business complaints and complaint handling requirements for participants in the Consumer Credit Jurisdiction and Voluntary Jurisdiction of the Financial Ombudsman Service will appear in the NEWCOB Policy Statement.
The FSA confirms in PS07/2 that respondents were content with its proposed approach on MiFID complaints handling. As with TC, the five year record-keeping rule for MiFID business will not be extended to apply to non-MiFID business complaints (the current retention period is three years). Obviously firms may choose, for simplicity reasons, to keep records of both types of complaint for five years.
The FSA’s proposals on other changes to DISP, in particular the requirements for resolution of complaints, will be covered in a later Policy Statement.
This publication is written as a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to a particular matter. .