MiFID II and APAC: How Far Does the Legislation Reach?
MiFID II, the EU's revised Markets in Financial Instruments Directive and new Markets in Financial Instruments Regulation (MiFIR), comes into effect on 3 January 2018 with the objective of improving the working of EU financial markets and strengthening investor protection. MiFID II will make major changes to the way in which European firms and markets operate. Given the international reach and inter-connectedness of global financial markets, it comes as no surprise that the legislation's impact extends beyond the EU (including the EEA) to other regions, such as Asia-pacific ("APAC"), where firms either provide or receive services from EU financial counterparties. Firms in those regions will need to evaluate the impact of MiFID II on their businesses as a matter of priority based on whether they provide investment services to EU-based clients or whether they have EU counterparties. In some cases, even if those firms are not directly subject to MiFID II, it is likely that APAC firms will have to comply or facilitate compliance with the new regime by EU-based investment firms if they wish to continue doing business.
MiFID II creates new licensed activities and cuts back on existing exemptions. As a result, firms whose
business has a nexus to the EU should consider whether they need to apply for any new permissions or variations to existing licences. As regulators have six months to assess applications for authorisation (or variations of permission), the deadline to ensure
It comes as no surprise that the legislation's impact extends beyond the EU (including the EEA) to other regions, such as Asia-pacific.
that the UK Financial Conduct Authority (the "FCA") deals with them by 3 January 2018 passed on 3 July 2017. To the extent that any remain outstanding, and not forgetting passporting notifications and waiver requests (where different time limits apply), they should now be made as a matter of urgency. This briefing looks at some of the areas where MiFID II may impact APAC firms and what steps they should take as a result.
Quick Reference: MiFID II Rules Impacting APAC Firms
New thirdcountry access
Product governance & classification
Inducements and research
Share trading obligation
Underwriting and placing
Third-country firm access to retail and professional clients
Rules for manufacturers and distributors to enhance investor protection
Unbundling execution costs from research; commission ban for investment advice
Impact on third-country trading venues where an instrument is also traded on an EU venue
Impact of enhanced and expanded trade reporting
Scaled back exemptions for trading firms and increased reporting requirements
More prescriptive conflicts rules over underwriting, pricing and placing
Position under MiFID I
Currently, each EU Member State decides whether, and on what basis, third-country firms may access their national markets, provided that this is not on more favourable terms than those available to EU firms. APAC firms may use a mixture of treaty rights, non-solicitation models and, of course, employment of regulated agents and distributors specific to each EU market.
Under MiFID II, Member States may opt into a new third-country regime under which each Member State decides whether a third-country firm needs to establish a branch in their jurisdiction to provide investment services and activities to retail or professional clients. Where a branch is established under the regime, it brings the advantage of allowing that firm to provide cross-border services to professional clients and eligible market counterparties in other EU Member States. A thirdcountry firm may also provide cross-border services to more sophisticated clients (e.g. per se professional clients and eligible market counterparties) without establishing an EU branch, provided it is from a thirdcountry assessed to be equivalent and is registered with the European Securities and Markets Authority ("ESMA"). Brexit aside, the UK has chosen not to opt in, but to keep the benefits of its Overseas Persons Exclusion, most notably by means of the exclusions for activities carried on "with or through" an authorised or exempt UK person - note that MiFID II also allows for a limited form of access to clients on their "own exclusive initiative", dispensing with the need to open a branch or register with ESMA. Nonetheless, despite
the UK's decision not
to participate, the
will still be relevant for
APAC firms accessing
other EU markets
and whose home
countries' legal and
must be assessed as
assessments to date
have been time consuming and influenced by
technical criteria, so there may be a long lead time,
for example, for those undertaken for EMIR central
counterparties. The existing national regimes for
third-country firms will, however, continue to apply
in the absence of an equivalence determination and
for a transitional period thereafter.
Changing Client Classification
APAC firms should also be mindful of changes to client classification rules and, in particular, those concerning which clients may be treated as "professional." One example concerns the mis-selling of complex derivative products to municipal authorities in the run up to the financial crisis, which has initially led to municipalities being treated as retail clients to give them better investor protection. All this may impact the ability of APAC investment firms to sell complex products, whether through the new third-country access regime, or when distributing products locally using EU-based investment firms.
Inducements and Research
Rules around inducements form a major part of the independent advice are prohibited entirely from
innovations introduced under MiFID II, having the receiving inducements, except minor benefits (e.g.
objective of better protecting
participating in conferences or
the end-client and increasing
seminars) that are capable of
clarity over the quality of the
Although the MiFID II
enhancing the quality of service
services provided. In what
restrictions will not be directly
and which are disclosed to clients.
amounts to an extension of the UK's Retail Distribution Review regime, MiFID II tightens the rules generally regarding the
applicable to APAC firms, they will have an indirect effect on
Potentially, this could affect distribution models where APAC firms rely on EU intermediaries in return for providing remuneration
receipt of fees, commissions and
or other forms of sales support.
non-monetary benefits provided by third parties. One of the most significant changes that is likely to
Portfolio managers and investment firms offering impact APAC firms is that on inducements relating
to research. The intention is to increase transparency and accountability on costs to investors, as well as to increase competition in the market for research. In a significant strengthening of the rules, MiFID II provides that in order for third party research not to be regarded as an inducement for an investment firm, it must be received in return for a direct payment by a buy-side firm out of its own resources, or payments from a separate research payment account controlled by that firm.
Although the MiFID II restrictions will not be directly applicable to APAC firms, they will have an indirect effect on their business. APAC brokers will no longer
be able to provide EU-based investment managers which are subject to MiFID II (including fund managers, e.g. AIFMs subject to national gold-plating provisions) with research bundled up with the cost of dealing and execution. In theory, APAC firms will still be able to receive bundled research from EU-based brokers (according to the FCA's interpretation of the rules), but EU-based brokers may have changed their business model and started charging for research. This rule has the capacity to cause, at the very least, administrative and compliance issues where research is either received or provided in respect of a variety of jurisdictions each with their own rules.
One of MiFID II's key drivers is the financial crisis which market (including identifying a "negative" market of
revealed mis-selling in both retail and wholesale excluded recipients), the method of distribution and
markets. The introduction of product governance ensure that the contractual documentation provides
requirements is intended to
for an adequate flow of product
reinforce obligations on supply
side firms to ensure the suitability
Firms must take steps to see
Although an APAC manufacturer
of products "manufactured"
that they analyse their
would not be directly subject
and "distributed" by them.
to MiFID II product governance
ESMA's Guidelines interpret
rules, an EU-based distributor
these terms broadly, referring to
or placement agent would in
a manufacturer as "a firm that
practice be unable to distribute APAC products unless
manufactures an investment product, including the
the information and marketing requirements in MiFID
creation, development, issuance or design ... including
II and the ESMA Guidelines were met. Moreover, EU-
when advising corporate issuers on the launch of a
based investment firms (that are manufacturers)
new product" and a distributor as "a firm that offers,
which collaborate with third-country firms to develop
recommends or sells an investment product and
or issue products are required to outline their mutual
service to a client investment." This means that firms
responsibilities in a written agreement.
must take steps to see that they analyse their target
ESMA's Guidelines on MiFID II Product Governance Requirements require firms to:
ensure that the products are designed to meet the needs of an identified target market of end clients within the relevant category of clients;
ensure that the distribution strategy is compatible with the identified target market; and
take reasonable steps to ensure that the products concerned are in fact distributed to the identified target market.
Unsurprisingly, there is concern among some manufacturers about the difficulties of complying, especially where there is no relationship with the end-client, and that the requirements favour larger firms with more sophisticated distribution models or which sell direct. This is an issue for EU-based investment firms and third-country firms alike,
although the challenges are more acute for the latter due to geographical distance. On the positive side, to the extent that good information flows are achievable, the receipt of more detailed information about customers may benefit manufacturers in terms of product development and the better identification of customers and market segments.
The trading obligation introduced by MiFIR seeks to trade as opposed to
return liquidity to trading venues and improve price placing or transmitting
discovery. As a general rule, EU-based investment an order to an APAC
firms will not be able to execute a trade in shares broker-dealer which
admitted to trading on an EU regulated market (or is a member of the
other EU trading venue) unless it takes place on such local exchange. Even
a venue, a Systematic Internaliser, or an equivalent so, AFME concede this
third-country trading venue. Where, for instance, interpretation would
an EU-based investment firm wishes to buy Hong not apply when used
Kong equities and those equities are also traded on to evade the policy
an EU regulated market (having the same ISIN ), i.e. behind the trading
they are "dual-listed", as a general rule the trading obligation.
obligation will apply. If trading is
Similarly, for derivatives subject
to take place on an APAC trading
to the EMIR clearing obligation
venue, for example that venue is the primary market, an EU-based
APAC markets face, potentially,
under MiFIR, ESMA can declare these instruments as subject to a
investment firm must ensure that
a loss of order flow and
trading obligation that is binding
it is "equivalent" to an EU venue
liquidity to EU venues
on an EU entity, irrespective of
(e.g. in respect of transparency
whether there is a financial or
rules). Such assessments over
non-financial counterparty based
equivalence can be a lengthy
inside or outside the EU. There are also anti-avoidance
process. Therefore, notwithstanding any conflicts
provisions which can apply to third-country entities
over best execution, APAC markets face, potentially,
where a contract has "a direct, substantial and
a loss of order flow and liquidity to EU venues.
foreseeable effect" within the EU or where it is
Industry association AFME argue that MIFIR, properly
"necessary or appropriate" to prevent evasion.
interpreted, imposes a trading obligation only where
it is the EU-based investment firm that executes the
Measures in MiFIR that improve market transparency will also affect APAC firms and financial instruments. Pre- and post-trade reporting will be extended from equities to equity-like instruments (e.g. exchange traded funds and depository receipts) and nonequities (e.g. bonds, structured finance products, emission allowances and derivatives) and will apply to non-EU instruments traded on EU exchanges. An APAC firm providing quotes and undertaking
transactions to the extent they take place in the EU will also be caught. Such is the increase in the burden of these obligations (for example, more data is required for post-trade reporting and within T+1 under MiFID II), that some investment managers in the EU are dispensing with their MiFID authorisations in favour of the relatively easier burden imposed by the Alternative Investment Fund Managers Directive.
There are also issues with respect to market surveillance. An APAC firm sending orders to
Will APAC firms and their clients have obtained an LEI
by next January?
Identifier code or that of its clients, prior to any transaction. Will APAC firms and their clients
an EU-based investment firm
have obtained an LEI by next
(including its EU subsidiary based
January? Many Asian markets have
in a third-country) subject to transaction reporting their own system of identification and this may only
requirements, will need to provide its Legal Entity complicate matters.
EU-based investment firms, subject to best execution, placing or transmitting orders with a APAC firm, will likely require the latter to raise standards and have an order execution policy, and to show that "all sufficient steps" (previously "reasonable") were taken. This will include
providing information on the quality of execution. APAC firms should review their booking models to identify where MiFID II obligations are relevant and whether their policies, procedures and practices require updating.
Commodity Derivatives Trading
In future, more APAC businesses may have to apply management controls and regulators have the
for MiFID II authorisation to trade commodity power to require any person to reduce the size of a
derivatives and emission allowances (or derivatives position or their exposure to a commodity derivative
of such) on EU markets. Businesses that deal in listed or traded in the EU. To this end, members and
commodities as principal but which also buy and sell participants (e.g. commercial firms) on EU trading
MiFID financial instruments for
venues will have to report details
their business, will find that the
of positions on a daily basis,
existing "commodities dealer"
More APAC businesses may
including those corresponding
exemption is to be abolished
have to apply for MiFID
to non EU-based end clients.
(although exemptions may be available for certain hedging purposes) and a second "ancillary
II authorisation to trade commodity derivatives and
Applications for waivers must be made at least 21 days before 3 January 2018.
activity" exemption will be
If they have not done so already, it
significantly cut back. In addition,
is essential that firms review their
EU regulators will have to be
trading activities and decide whether they need to
notified (by 3 January 2018) of the exemption's use
apply to EU regulators for permissions to carry on
and the basis upon which it is relied; nor will the
doing business after 3 January 2018. In this regard,
exemption be available for high frequency trading.
the FCA has published a MiFID II application and
MiFID II introduces new position limits under which notification user guide.
operators of trading venues can apply position
To improve transparency and competitiveness, MiFID II introduces more prescriptive conflicts rules relating to underwriting, pricing and the placing of securities. Corporate finance firms will need to provide issuers with more information on their arrangements to prevent and manage conflicts when providing advice. On pricing an offer, firms must ensure that they do
not promote the interests of other clients or indeed the firm's own interests. In practice, this means that the corporate finance arm of an APAC subsidiary of an EU-based bank should review the impact of MiFID II on its business, processes, disclosures and whether any re-papering is required.
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