In the run up to the Christmas break, the European Securities and Markets Authority (ESMA) launched its consultation paper on the MiFID 2 Directive (2014/65/EU) (MiFID II) and the MiFID (Markets in Financial Instruments) Regulation (Regulation 600/2014) (MiFIR). The consultation paper provided technical advice to assist the European Commission (Commission). The consultation paper includes at Annex B draft regulatory technical standards (RTS) and implementing technical standards (ITS) under the MiFID II Directive and MiFIR.

The consultation will run until 2 March 2015. ESMA will also hold an open hearing on the consultation on 19 February 2015.

The consultation paper runs to over 1600 pages, with Annex B running to over 500 pages and so we have given an overview of key areas of ESMA’s proposals, particularly the areas which are now more settled due to the publication of the draft RTSs and ITSs and setting out the draft Regulatory Technical Standards and similar implementing measures.

Investor Protection

The consultation paper addresses four specific aspects of investor protection. This includes: (i) the procedures for granting and refusing requests for authorisation of investment firms (RTS 1: Article 7(4) (information to be provided on application for authorisation)); (ii) the freedom to provide investment services and activities/ establishment of a branch (RTS 3: Articles 34(8) and 35(11) (information to be provided on application to exercise single market passport)); (iii) provision of services and performance of activities by third country firms following an equivalence decision (RTS 5: Article 46(6) of MiFIR, information to be provided by a third country firm applying for authorisation); and (iv) information on costs relating to execution of orders1.

The new requirements on information on costs apply to eligible counterparties, professional clients and retail clients. Eligible counterparties can agree to a “limited application” of the information requirement unless a derivative is involved, and professional clients can also do so unless they are receiving investment advice or portfolio management or a derivative is involved. As a minimum benchmark, the information requirement is to provide information about “all costs and charges” and, if a firm is “recommending or marketing financial instruments” or a key investor document (KID)/key investor information document (KIID) is required, “full point of sale disclosure” information on costs (which is set out by ESMA in detail) must be given. Third party payments are to be included as part of those costs. Costs must be expressed as both cash and percentage amounts.

There will be a new requirement for all “new” professional clients to have a written agreement in place from 3 January 2017 that sets out the “essential rights and obligations” of the parties, although this does not need to be signed.

Third country

Non-EU firms will only be able to register with ESMA and provide services into the EU from outside of it if they are based in an equivalent jurisdiction and suitability regulated in their home jurisdiction (as determined by the Commission). ESMA’s proposal is that only factual information needs to be provided by the firm, plus a written declaration by its regulator stating that it is subject to supervision and detailing the services and activities for which it is authorised. Chapter 2, RTS 3 (Article 34(8) and 35(11), MiFID) sets out the draft regulatory technical standards in relation to third country firms.

Market making and micro structural issues

Chapter 4 of Annex B includes micro-structural issues including setting out organisational requirements for investment firms (Article 17). ESMA explains in detail the issues it needed to consider, and has suggested a set of guidelines following feedback from its discussion paper. The detailed analysis in organisational requirements for trading venues (Article 48) covers matters such as governance, staffing, outsourcing and capacity. It also considers means to ensure stability and necessary controls. In relation to market making, market making agreements and market making schemes, ESMA has clarified when a market making agreement will be necessary and elaborated on the related requirements.

Commodity derivatives

The MiFID II provisions relating to commodity derivatives have been some of the most significant amendments to the existing MiFID regime. There will be an extended scope over which commodity derivatives will be regulated as financial instruments and the narrowing of available exemptions from authorisation for those entering into commodity derivatives.

Currently, many entities trading commodity derivatives rely on exemptions to avoid the need for authorisation but MiFID II will significantly amend some of the exemptions normally relied on by commodity market participants. A firm will no longer be able to rely on the dealing on own account exemption in relation to commodity derivatives.

Furthermore, MiFID 2 significantly amends the ancillary activity exemption. The draft technical standard on the criteria for establishing when an activity is considered to be ancillary to the main business is set out at RTS 28 of Annex B.

The ancillary activity exemption will only be available to entities which deal on own account other than by executing client orders in commodity derivatives; and/or provide investment services other than dealing on own account to customers or suppliers of their main business. Those entities seeking to rely on this exemption will have to satisfy the following criteria: (i) each of the two permitted activities, individually and on an aggregate basis, must be ancillary to their main business when considered on a group basis; (ii) that main business must not be the provision of investment services under MiFID, banking services nor acting as a market maker in relation to commodity derivatives; and they must not apply a high frequency algorithmic technique. The exemption in article 2(1)(k) of MiFID that was specifically designed for persons trading in commodity derivatives will no longer be available.

Therefore, the new ancillary exemption will make it difficult for a regulated group to have an unregulated commodity derivative trading subsidiary and the removal of the commodity deal exemption is likely to put an enormous pressure on the agency trading structure used by many commodities groups. If a firm is no longer able to rely on an exemption then it will need to become authorised to carry out the relevant investment services.

Admission of financial instruments to trading on regulated markets

Article 51(6) of MiFID II requires ESMA to develop regulatory technical standards which will specify and clarify a number of aspects in relation to: characteristics financial instruments shall have for being considered eligible for admission to trading on a regulated market; arrangements regulated markets shall have in place concerning certain aspects of disclosure obligations; and access to information.

Eligibility for admission

Focusing on the eligibility for admission of transferable securities, ESMA refers to Article 35 of the MiFID I Level 2 Regulation, which already applies to regulated markets in the EU. This sets out the characteristics of transferable securities that are eligible for admission to trading on a regulated market for example, securities  must be able to be traded between parties and transferred without restriction. ESMA conducted a fact-finding exercise with competent authorities to see how these rules were working and found the provisions have proven to be appropriate and no specific problems in supervisory practice have been reported. Therefore, ESMA proposes to use these standards as the basis for its regulatory technical standards under MiFID II.

Disclosure obligations

Article 51(3)(1) of MiFID II requires regulated markets to establish and maintain effective arrangements to verify that issuers of transferable securities comply with obligations of initial, on-going and ad hoc disclosure under EU Law. The obligations stem from the Prospectus, the Transparency and the Market Abuse Directive. ESMA states that although practice varies significantly across regulated markets the respondents to the discussion paper reported that arrangements in place are adequate and that the details should be left to the discretion of each regulated market. As a result ESMA proposes to require regulated markets to adopt a policy to verify compliance by issuers which shall be published on the website of the relevant regulated market.

Major issues still to be developed

The majority of the issues which have not yet been turned into draft RTSs relate to different aspects of calibrating pre and post-trade transparency and other important aspects relating to trading of financial instruments, particularly in relation to non-equity instruments. There are a large number of these issues where further draft RTSs will be produced.

Next steps

The draft RTSs in Annex B will now be reviewed by the European Commission which may redraft them in whole or in part. There is little prospect of ESMA making changes to Annex B. ESMA will absorb comments on the other matters which are more open and then draft RTSs which are likely to be published in Q2 of 2015.