On 29 September, FCA published its long-awaited third (but apparently not final) consultation paper on how it plans to amend its rules to take account of MiFID 2. The consultation complements its August consultation (see our separate summary), and is the paper most firms have most eagerly awaited as it contains, among other things, FCA's proposed changes to its Conduct of Business rules (COBS).
What does the paper cover?
The wide ranging paper covers key conduct of business issues, many of which were controversial in the negotiating stage, and several related matters. In brief, it deals with:
- Inducements, including adviser charging
- Inducements and research
- Client categorisation
- Disclosure requirements
- Dealing and managing
- Underwriting and placing
- Investment research
- Other conduct issues
- Product governance
- Knowledge and competence requirements
- Recording of communications
- The Supervision Manual (SUP), authorisation and approved persons
- Perimeter Guidance (PERG)
- Consequential Handbook changes.
A couple of policy decisions underpin the structure of many of the changes. Most importantly, FCA has taken at least a temporary decision on whether to apply the MiFID 2 conduct rules to (a) insurance-based investment products and (b) structured deposits. FCA has decided:
- For the moment, not to apply MiFID 2 conduct rules to insurance-based investment products, pending finalisation of the implementing measures for the Insurance Distribution Directive (IDD). However, in principle it is keen to have consistency across measures, and will return to this when consulting on implementing the IDD next year;
- To apply relevant conduct rules to activities relating to structured deposits, but not to include those activities within the definition of "designated investment business". The rules that apply will also apply to Article 3 firms (firms that have opted-out of MiFID 2 because of the limited nature of their business);
- In relation generally to non-MiFID business – which includes Article 3 firms, branches of third-country firms and some of the specialist regimes mainly covered in Chapter 18 of COBS, FCA will in principle mainly apply MiFID rules, but has discretion. Its proposals need to take account of the MiFID 2 requirement that, in some areas, rules for Article 3 firms must be "at least analogous" to MiFID 2 rules, and that third-country firms should not be treated more favourably than branches of EEA firms;
- That, once the rules are adopted, it hopes firms that carry on a mixture of MiFID and non-MiFID business will be able to apply a single, higher, set of standards across all business so they can comply with a single set of rules.
Contrary to the now normal approach of not copying-out text from EU Regulations into the rules, FCA has decided that because of the links relevant to COBS between MiFID 2's mix of Directives (which need to be implemented) and Regulations (which do not), and the high use firms make of COBS, it will copy out various conduct provisions from the MiFID 2 Delegated Regulation in particular. It says it will also take this opportunity to "translate" some of the phrases in that legislation.
FCA is currently assessing the effects of MiFID 2 on its notifications to the European Commission of gold-plating of MiFID 2 provisions.
The consultation proposes 20 pages of new or amended definitions. Key among these are:
- A new definition of "distribute" and "distributor" referring to offering, recommending or selling an investment or providing an investment service to a client, and a definition of "manufacture/r" referring to creating, developing and issuing or designing an investment, including advising corporate issuers on the launch of new investments;
- A new definition of "investment advice" based on Treasury's latest consultation, and referring to the provision of personal recommendations to a client, either on the client's request or at the firm's initiative, in respect of one or more transactions relating to designated investments – but also retaining the definition of "advising on investments" by reference to the Regulated Activities Order and including structured deposits within its scope. The definition of "structured deposit" is also amended to bring it into line with MiFID 2;
- A new definition of "research" including that it explicitly or implicitly recommends or suggests and investment strategy and provides a substantiated opinion as to investments' value, or otherwise contains analysis and original insights and reaches conclusions that could be used to inform an investment strategy and be "relevant and capable of adding value to the firm's decisions on behalf of clients being charged for that research". FCA will also replace the definition of "investment research" with a reference to the definition in what FCA rules will define as the "MiFID Org Regulation" (that is, the EU MiFID 2 Delegated Regulation on organisational requirements), and "non-independent research" to say it is an investment recommendation that does not meet the conditions set out in the MiFID Org Regulation; and
- Extending the definitions of the "arranging (bringing about)", "dealing as agent", and "making arrangements" to include structured deposits.
Other changes include new references, significant changes to all defined terms relating to commodities, and specification of different meanings of terms for the purposes of some rules only (in particular, what "senior management" means and the application of the rules on remuneration.
Amendments to SYSC
The key changes to the Senior Management Arrangements Systems and Controls Sourcebook (SYSC) are to introduce a new rule in Chapter for common platform firms on the assessment of knowledge and competence, and a new chapter 10A on recording telephone calls and electronic communications. This new chapter is one example of a rule that specifically states that where it applies to a third country firm, it must not have the effect of meaning the firm is treated more favourably than an EEA firm. Other changes to SYSC include the deletion of rules that will now be contained elsewhere in the Handbook.
Amendments to APER
The Statements of Principle and Code of Practice for Approved Persons (APER) is amended to include within Principle 7 reference to the relevant provisions of the MiFID Org Regulation.
Amendments to TC
The Training and Competence Sourcebook (TC) includes a new Chapter 4 for MiFID investment firms and third country investment firms, in respect of personal recommendations to retail clients and information to retail clients about financial instruments, investment services or ancillary services.
Amendments to COBS
COBS is potentially the module of the Handbook that will be most significantly affected. The proposed amendments to it include:
Chapter 1: to extend the application of certain rules to apply to activities relating to structured deposits and to include a new section on the interface with the MiFID Org Regulation.
Chapter 2: to impose the duty to act honestly, fairly and professionally on firms carrying on eligible counterparty (ECP) business, and to separate the requirements for information disclosure and inducements so there are different requirements for MiFID business than for non-MiFID, equivalent third country or optional exemption business. There will be a new part in this chapter to address the MiFID 2 inducement requirements, while retaining the existing requirements for other business. These provisions will replace the existing COBS 11.6. FCA also plans to extend the application of the MiFID 2 ban for services to retail clients to bring restricted advice within its scope and to extend it to mere acceptance of commission and benefits rather than acceptance and retention, FCA wants to amend the adviser charging rules to apply the ban also to the business of providing restricted advice and banning rebating for firms providing these services to retail clients.
Chapter 3: to reflect the MiFID 2 requirement that local authorities will be retail clients, unless they elect to be a professional client, and the conditions for opting up. FCA proposes a qualitative and a re-calibrated quantitative test for permitting the opt-up.
Chapter 4: to reflect the different requirements for communicating with retail clients, depending on whether the business is MiFID, third country or optional exemption business or not. It asks whether firms foresee difficulties with the way in which it proposes to split the requirements for MiFID and non-MiFID business. FCA proposes new rules on disclosures to professional clients and eligible counterparties (ECPs).
Chapter 6: again, to introduce a distinction between MiFID (and equivalent) and non-MiFID business in terms of information about firms that a firm must provide, including introducing a new chapter 6.2B on describing advice services. FCA recognises the distinction between the RDR adviser charging rules and the MiFID 2 rules, and notes that retail investment products (RIPs) that fall within MiFID 2 will be subject to both the RDR and MiFID 2 requirements.
Chapter 8: to introduce new provisions for client agreements subject to MiFID, or relating to equivalent third country or optional exemption business. FCA notes the MiFID 2 requirement that firms provide client agreements to professional clients as well as retail, and the greater content requirement that MiFID 2 imposes. However, it expects this will mean little practical change from what firms currently do.
Chapter 9 and 10: again, to separate the suitability and appropriateness requirements for MiFID (and equivalent) and non-MiFID business, to remove references to the existing MiFID. The main difference for firms carrying on MiFID business is the need to carry out the appropriateness test on a wider range of products than at present. FCA notes that MiFID 2 does not require the application of broadly analogous rules on appropriateness to Article 3 firms, and therefore it does not propose to do so – leaving these firms on the "non-MiFID" rules, the current COBS 10.
Chapter 11: to delete the entire sections on best execution and record keeping and replace them with the MiFID 2 provisions, to add MiFID 2 requirements in the sections on client order handling, client limit orders, to delete COBS 11.6 (use of dealing commission), to add a new chapter on personal account dealing in relation to MiFID or equivalent business, and to delete the COBS 11.8 (recording telephone conversations). FCA also proposes to add the European Commission's Regulatory Technical Standard. In principle, FCA will extend the MiFID 2 rules to non-MiFID business and "level up" best execution rules for fund managers. However, it intends to continue to disapply the best execution requirements for corporate finance business and non-MiFID energy and oil market activities. The full requirements will apply to Article 3 firms and third country branches.
Chapter 11A: to insert a new chapter setting out requirements on underwriting and placing. This will copy out relevant parts of the MiFID 2 delegated Regulation, to replace current SYSC requirements.
Chapter 12: to update the rules on investment research to take account of MiFID 2 and to introduce within the same chapter provisions on non-independent research.
Chapter 14: again, separating the product information requirements depending on whether the products are MiFID products.
Chapter 16: again, to include a new part addressing reporting information to clients in relation to MiFID or equivalent business.
Chapter 18: amending relevant provisions within specialist regimes to reflect the MiFID 2 changes and, in particular including a new section for full scope AIFMs and incoming EEA AIFM branches and UCITS management companies.
Amendments to CASS
The main amendments to CASS focus on reporting.
Amendments to SUP
FCA proposes to amend parts of SUP 10A and C to reflect the provisions of the MiFID Org Regulation. It has also proposed a new Form A for MiFID firms that will include information MiFID 2 requires.
Product Intervention and Product Governance Sourcebook
There will be a new Sourcebook called PROD, which will interact with the RPPD insofar as firms need not comply with the RPPD if they have complied with Chapter 3 of PROD, on product governance.
Amendments to PERG
FCA will need to update its Perimeter Guidance, mainly in Chapters 2 and 13.
Firms should consider FCA's proposals carefully, and note, in particular how FCA proposes to amend its rules where it will treat MiFID and non-MiFID business separately. Consultation closes on 4 January 2017, but FCA asks for comments on its proposals for change to the Supervision manual and approved persons by 31 October 2016. This should form an important part of any firm's planning for the necessary change to its policies and procedures for being compliant with MiFID 2. There will be a further consultation before the rules are finalised, but this is likely to focus on consequential changes rather than major structural change to the rules.
This article was first published in BNA's World Securities Law Report.