Firms have had over a year to comply with FSA’s rules that implemented MiFID. It was clear some rules would cause more trouble than others. FSA has recently reviewed MiFID compliance by wholesale firms. Its concerns are no surprise. Firms are struggling to meet standards on execution and conflicts policies.
Robert Finney and Chris Borg look at what firms should have done, why they have not, and the shortcomings to address now.
MiFID’s best execution requirements forced firms to redraft order execution policies, or draft new policies from scratch.
The main changes MiFID brought to FSA rules were to:
- apply the best execution obligation to all executions of client orders;
- oblige firms to get the best possible result; and
- require firms to make the right disclosures and get the right consents.
The rules challenged firms in several ways, in particular:
- execution policy contents: many firms were confused about how to apply the rules in the context of their businesses and whether their policies had to consider everything MiFID and FSA rules referred to;
- disclosures: firms were unclear how much leeway they had to apply practicality to the prescriptive rules;
- consents: firms did not understand what consents they had to get and how to get them. In particular, they misinterpreted the need for “prior express consent” and did not know what to do if they did not get the required consents; and
- safe harbours: again, firms misinterpreted the subtle distinctions to be made in applying (or disapplying) best execution to dealing on quotes and specific instructions.
FSA was unimpressed with the execution policies it reviewed. It described them as “terse”, “vague” and “defensive”. It also found firms were uncertain about monitoring requirements and wanted guidance.
FSA gives few concrete answers on best execution. Although FSA expects firms to apply the rules to their business, firms’ execution policies cannot merely copy out rules with little indication of how they apply them. Similarly, FSA will not issue specific guidance on monitoring the frequency, and detail required will “depend on all the circumstances”, including, for example, transaction volumes and values. Firms must work it out for themselves and document the factors.
COBS requires firms to review execution policies and order execution arrangements annually and assess execution venues and arrangements “on a regular basis”. FSA’s report reinforces the need for a critical reappraisal.
Conflicts of interest
Similarly, MiFID requires firms to have written conflicts of interest policies. Even more onerous, firms must embed conflicts management in their systems and controls in such a way that they control and address conflicts wherever feasible, so reliance on disclosure alone is a last resort.
MiFID made firms focus more on identification and management of conflicts and less on general disclosure.
What FSA found
FSA was disappointed some firms had made very few changes to their policies, systems and controls. FSA emphasises the importance of record-keeping and monitoring. Policies were often too high level lacking detail and not reflected in practical systems and controls.
As with best execution, FSA recognises that how firms deal with their conflicts management is specific to the firm and its group, so FSA rules cannot be too prescriptive. However, it noted some areas of good practice and expects firms to review their policies in light of its findings.
Other areas of review
Many areas of MiFID implementation required firms to make major changes. Best execution and conflicts were obvious areas of difficulty, and firms should certainly review these.
However, other conduct of business rules were also important. FSA’s post-MiFID review should spur firms on to carry out their own reviews in areas such as:
- customer categorisation (for pre- and post-MiFID customers): firms need to review this;
- other KYC/client due diligence (CDD) issues;
- suitability and appropriateness;
- customer documentation, including provision of information;
- permissions, passports and approved persons: check that permissions truly reconcile with passports, that these and controlled functions reflect the current business and, given the major changes happening in many firms, that management of controlled function approvals is working effectively (international firms will be concerned at FSA’s proposals to change the approved persons regime);
- inducements: a particularly problematic area;
- systems and controls: governance issues are especially topical.
FSA will expect firms to check they have met MiFID requirements with the benefit of hindsight and market developments over the past year.