Structure of feedback
The feedback on CP06/14 is divided into three parts:
- Scope, authorisation, passporting and enforcement
- Client assets and prudential issues
The following paragraphs pick out those areas where the FSA has made changes to its proposals or given further guidance on what is envisaged. Annex 3 contains the final Handbook text showing the amendments the FSA has made.
MiFID scope for firms — Perimeter guidance
In May 2006 the FSA consulted on draft perimeter guidance relating to the scope of MiFID and the recast Capital Adequacy Directive (as part of CP06/9). CP06/14 included further draft perimeter text indicating the effect of MiFID on the domestic scope of regulation in the form of changes to the Regulated Activities Order (RAO). The FSA comments that the statutory instrument making changes to the RAO differs in some material respects from the draft order consulted upon by the Treasury in December 2005. It therefore says it wants to “consider the final version of the order carefully”. The FSA intends to publish the final version of all the perimeter guidance in the first quarter of 2007.
In CP06/14 the FSA stated that, as the authorisation provisions in the Investment Services Directive (ISD) had for the most part been imported directly into MiFID and the Handbook already reflects the ISD requirements, there were very few amendments required to the Handbook in this area. Respondents to the consultation agreed with this approach. The FSA says it will revise the application packs and related guidance where necessary and will make them available on the FSA website shortly.
Cross-border services and establishment of branches
In relation to cross border services, there will be no significant change to the draft Handbook text published in CP06/14. The FSA’s proposals replicated the provisions of MiFID and the FSA also proposed retaining guidance (not found in MiFID) that sets out the structure, format and confirmation of notifications. There may be some operational changes to this guidance following further Level 3 discussions. Any changes will likely be included in the Permissions and Notifications Guide to be published in the first quarter of 2007.
In relation to establishing a branch, many respondents to CP06/14 suggested that further guidance was needed to clarify how responsibility for conduct of business will be divided between Home and Host State regulators. This is obviously an important issue, both for firms and regulators. CESR issued a consultation paper on passporting in December 2006 as part of its MiFID Level 3 work. The consultation ended on 9 February 2007 and the FSA says it will consider what further clarification may be appropriate when the CESR process is complete.
Appointment of tied agents
CP06/14 contained the FSA’s proposals for implementation of MiFID’s provisions on the use of tied agents. As you know, the tied agents regime for MiFID business will be implemented through changes to the Appointed Representative (AR) framework. The FSA says most respondents to the consultation paper were supportive of the proposed changes and the only changes made to the Handbook text that was consulted on are those necessary to align the FSA rules with the statutory instrument making the changes to the AR Regulations.
The FSA intends to provide further information to firms on the practicalities of entering a tied agent on a public register and notifications where a MiFID principal intends to use a tied agent to undertake MiFID business in or into another Member State.
Under MiFID, a tied agent cannot act for more than one principal in relation to MiFID business. The FSA proposed that the prohibition on multiple principals for certain activities should be reflected in the written contract between a firm and its tied agent. This is currently a requirement for written contracts with ARs and therefore this proposal aligns the MiFID restriction to the current regime. Most respondents supported this proposal.
The other changes that the FSA has made to the draft Handbook text relate to:
- the treatment of tied agents that do not act in the UK;
- the position of tied agents of third country investment firms; and
- other drafting changes necessary for consistency with the AR Regulations (including, for example, a new contract term regarding entry on the relevant public register) and for effective operation of the new framework.
Tied agents not acting in the UK
Under the AR Regulations, tied agents of UK MiFID firms that do not act in the UK will not be regarded as ARs under FSMA. This is different from the FSA’s understanding as set out in CP06/14. The section of the Handbook on ARs will now include in each section a separate provision specifying the application of the relevant requirements to categories of tied agent not acting in the UK. To make the distinctions between various types of tied agents clearer, the FSA has created three separate definitions: FSA registered tied agent, EEA registered tied agent and EEA tied agent. For further detail on these concepts, please refer to chapter 5 of Section A, Part I of PS07/2.
The position of tied agents of third country investment firms
The AR Regulations treat tied agents of third country investment firms in the same way as the tied agents of MiFID investment firms. In the interests of consistency, the FSA has decided to follow this approach in the Handbook. It has therefore extended its definition of a tied agent to include a tied agent of a third country investment firm.
Enforcement and regulatory cooperation
CP06/14 set out the relatively minor changes the FSA envisaged to the Enforcement Manual (ENF) and the Decision Making Manual (DEC) to take account of the Treasury’s proposed amendments to FSMA, which implement the relevant provisions of MiFID. Respondents to the consultation paper generally indicated their support for the proposed amendments, noting that they appeared consistent with the relevant provisions of MiFID and did not place any unintentional additional obligations on firms.
The current MiFID-led changes are primarily focused on amending the description in ENF and DEC of the FSA’s powers under FSMA. These changes will also be considered in the current separate review of ENF and DEC.
Principles for Businesses
In CP06/14 the FSA proposed to keep the text of the 11 Principles for Businesses unchanged and to implement the detailed MiFID requirements through changes to other areas of the Handbook. It proposed a general application provision to say that the Principles would not apply where this would result in the UK being in breach of a European obligation. It also proposed the introduction of guidance to explain how this general provision would affect the application of the Principles.
Respondents agreed that the 11 Principles should be retained but did not agree with the proposed high-level dis-application provision (referring to circumstances where the Principles conflicted with European law). Instead respondents wanted detailed amendments to the application provisions to make clear where MiFID cut back, extended or otherwise altered the nature or scope of the Principles. The FSA says it considered the feedback it received but has decided not to amend its approach. PRIN is a key element in the move to more principles-based regulation, the FSA argues, and to amend PRIN in the way respondents suggested would result in extensive and detailed requirements which could undermine PRIN’s status as a high-level set of principles which focus on outcomes and not specific measures or means. The FSA has, it says, improved the clarity of PRIN 4 (guidance on the general application provision).
The FSA says it plans to consult on a centralised piece of guidance to deal with the implications of MiFID on the territorial application of the Handbook – including the Principles.
The FSA has made a few drafting changes to its draft text. It discusses these and various other issues in this section though in respect of certain of the issues raised by respondents, it has declined to provide further guidance and suggested that firms direct queries to their supervisors.
The FSA has reiterated that it would be concerned if firms tried to use the flexibility in the MiFID recital on title transfer to avoid providing client money protection to retail clients and that it expects any arrangements to be properly documented and involve good faith collateral or other arrangements.
The FSA has amended the guidance to make it clear that the conduct of business rules will govern the investment in a qualifying money market fund.
The FSA has confirmed its understanding that the new prohibition on depositing client financial instruments with unregulated third parties in jurisdictions where safekeeping is supervised and the restriction on depositing them with third parties in unregulated third countries also applies to sub-custodians appointed by a third party.
Capital/professional indemnity insurance requirements
The FSA sets out its responses to comments it received to its proposals on capital adequacy for exempt CAD firms (ECFs). The FSA has confirmed that it will not provide a more sophisticated capital and PII trade off than a simple interpretation as set out in the CP. For ECFs that are not personal investment firms (PIFs), it will not specify the excess limits on a PII policy. It will not apply a PII requirement for ECFs that have at least EUR 50,000 capital.
Firms that conduct activities within Article 67(3) of MiFID and other non-MiFID scope activities will still need to meet the financial resources requirements of applicable chapters that reflect their non-MiFID business. The FSA is revising its permissions framework so that a firm's permissions will more accurately reflect its MiFID activities, and continuing to write to firms with details of the new requirement for ECFs.
The FSA remains of the view that ECFs that choose to hold PII should be subject to a minimum solvency requirement of £5,000. While this goes beyond the MiFID requirements, the FSA thinks firms should hold adequate capital to cover the excess payments on upheld claims.
In this section, the FSA addresses many detailed interpretation issues raised by respondents on the three new chapters of the Market Conduct sourcebook.
The FSA has concluded that exchange traded funds (ETFs) do not fall within the MiFID definition of shares and should not therefore be subject to the transparency regime. However, it notes that many regulated markets and Multilateral Trading Facilities (MTFs) demand pre- and post-trade transparency of ETFs and says it would welcome the continuance of this practice.
It has confirmed that regulated markets should notify the FSA when they intend to provide arrangements which facilitate remote access from another member state and be prepared to provide information about participants based in other member states.
Multilateral trading facilities
The FSA has provided some limited guidance about the types of firm that would not be covered by the definition of MTF operator, while emphasising that each system needs to be considered individually.
The FSA has also defended its proposal to retain its existing guidance on transparency for financial instruments other than shares admitted to trading on a regulated market, although it has agreed to be flexible in its expectations of MTF operators and acknowledges that it expects different transparency in different markets. It has also assured firms that it will amend the rules to take account of the European Commission’s review of transparency in the bond and derivatives markets.
Investment firms trading OTC — Post trade transparency
The FSA has confirmed, in response to various requests for clarity, that responsibility for transparency resides with whichever party agrees to publish the trade or, where there is no agreement, the party determined by the default list. It has confirmed that there are circumstances where investment managers conclude transactions and also that where there is a chain of intermediaries relating to the same transaction, only the transaction interacting with the regulated market or MTF or an investment firm dealing on own account should trigger a post-trade publication.
The FSA’s proposed guidance on minimum standards for transparency arrangements to be put in place by regulated markets, MTFs and firms correlated with the equivalent CESR guidance and the FSA intends to incorporate the relevant elements of the latter once it has been finalised. It has omitted this guidance from the final text in the meantime.
Trade Data Monitor framework
The FSA will implement the Trade Data Monitor (TDM) model on a voluntary basis in the form outlined in the draft text but it has amended its guidance to make clear that using an approved TDM will satisfy a firm’s obligations to ensure its arrangements for making information public satisfy the necessary conditions. It has also said that it will monitor closely any firm which chooses not to use an approved TDM. The FSA will assess the success of the framework within two years of MiFID implementation.
The FSA has also made some minor changes to the TDM service criteria. It has decided to address concerns about the self-regulatory nature of the framework by incorporating high level quarterly reporting criteria under which TDMs will be required to provide the FSA with information about trade queries, amendments made and time lags. TDMs will not be required to put complaints procedures in place although the FSA has suggested that this would be desirable: firms will be able to raise performance issues with the FSA in any event. Regulated markets and MTFs acting as TDMs will be permitted to use their own platforms as a benchmark but only insofar as the trade they are checking is traded on their platform on a regular basis.
The FSA has also decided to require TDMs to provide an independently verified statement of compliance with the service criteria when they apply for approval, make a significant and material change and at the FSA’s request. TDMs should also provide annually a statement confirming that they have met all the service criteria in the previous 12 months.
The FSA will welcome applications to be admitted to its list of approved TDMs as early as possible. The application process should not take longer than three months from the date of receipt of a complete application but applications will need to be received no later than 1 August in order to be processed by 1 November.
According to the FSA, this was one of the two main issues arising from CP06/14. The FSA has modified some of its draft rules but may make further changes once the CESR Level 3 work on transaction reporting has been finalised. In particular, the FSA has not given detailed guidance on scenarios in which a firm may or may not be “executing” a transaction as this is being addressed by CESR, although it believes firms that are caught by the existing transaction reporting obligations will continue to be within scope. However, it has included some further specific guidance for investment managers, having received a number of responses from them on various matters. There are also several areas where the FSA has promised that further guidance will follow in its Transaction Reporting Users Pack due to be published shortly (the FSA has said in the course of 2007).
The new guidance for investment managers is intended to allow them to continue to rely on an exemption from the transaction reporting obligation by relying on the authorised counterparty to report on their behalf. When entering into a transaction in the course of providing a service of portfolio management, or having specifically recommended a transaction to a client, the investment manager need not transaction report provided it has reasonable grounds to believe that the other party will do so and that their report will contain as such information as would have been included in the investment manager’s report. This exemption will also be available to operators of collective investment undertakings and occupational pension schemes, which the FSA does not intend to release from the transaction reporting obligation. Investment managers that do not rely on the exemption should note that they will be required to make reports electronically rather than by fax or email from 1 November.
The FSA has also confirmed various matters including:
that it will continue to require that OTC equity and debt derivatives which are priced or valued by reference to debt or equity instruments admitted to trading on a prescribed or regulated market or to indices constituted by such instruments are reported;
- that it is continuing to explore arrangements with LME, LiFFE, the ICE Futures Exchange and NYMEX Europe for the reporting of transactions on those exchanges but that it will not have similar arrangements with commodity, interest rate or foreign exchange derivatives in other member states;
- its super-equivalent separate classification for credit default swaps is warranted;
- MTFs will be assigned a market identifier code (MIC) to identify transactions executed on an MTF;
- it will continue with its requirement for firms to identify the client on whose behalf they have executed a transaction but will grant temporary waivers from the requirement to use a consistent unique identifier code to EEA passported branches coming into the regime for the first time where they will face difficulty in doing so by 1 November.
The FSA has decided not to proceed with its proposal to indicate whether transactions have been conducted on a principal or agency basis or whether principal transactions have been executed for proprietary purposes or client facilitation.