At long last, it feels as if the end is in sight. July 3, the date by which national regulators needed to have in place all necessary measures to transpose the MiFID 2 package into their domestic laws, has passed, and the gradually increasing drip-feed of final legislation and rules from the UK regulators included a deluge of over 1,000 pages of feedback and rules from FCA on most of the key changes to its rulebook.
There are still a few outstanding pieces of tidying up, but the jigsaw pieces have at least now almost all been shaped, and many put together.
In terms of the UK regulatory package, there are three legislative measures, and significant PRA and, to a far greater extent, FCA, rule amendments.
The nature of the changes, including the fact that the majority of the trading-related parts of MiFID 2 are in EU Regulations, which are therefore directly applicable in the UK without the need for implementation, mean that the amount of legislative change is fairly minimal, especially to FSMA and other relevant primary legislation. There are three statutory instruments:
- The FSMA (Regulated Activities) Amendment Order 2017: this was made by Treasury in March, and partly came into force early to allow for applications to be made to the regulators to vary their permissions because of changes to the regulatory perimeter. Mainly, it:
- brings operation of OTFs within the scope of regulated activities
- includes emission allowances as specified investments
- allows for binary options to be treated as financial instruments
- makes consequential changes to the definitions of derivative instruments
- requires firms to have regulatory permission to deal as agent, arrange deals in, or advise on structured deposits, without making structured deposits financial instruments in themselves
- disapplies the "overseas persons" exclusion to third-country firms that operate under the MiFID 2 equivalence regime and
- makes consequential changes to the Financial Promotion Order and the Appointed Representatives Regulations
- The FSMA (Markets in Financial Instruments) Regulations 2017: this was made by Treasury in June and makes changes to FSMA and other primary and secondary legislation to make the legislative amendments necessary to implement MiFID 2 that are not separately addressed by the Regulations amending the RAO and putting in place the authorisation and supervision process for DSRPs (see below). The key elements of the Regulations address:
- “exempt investment firms” and the process for application
- third country investment firms
- position limits and position management controls in commodity derivatives
- requirements on unauthorised algorithmic trading by members of trading venues, direct electronic access providers, general clearing members and business clocks
- removal of members of the management board of an investment firm, credit institution or RIE by FCA and PRA
- miscellaneous FCA functions, including investigation and enforcement powers.
- The Data Reporting Services Regulations 2017: these were also made in June and set out an authorisation requirement for all data reporting services providers to be authorised by FCA and included on a public register (unless they are a permitted MTF or OTF operator or an RIE, or are passporting in under the appropriate single passport). They also set operating conditions for each type of DRSP and reporting and record keeping provisions as well as setting out offences in relation to DRSP activities and FCA's powers in respect of these entities.
While almost all the changes at regulator level fall to FCA to make, PRA has made some changes to its rules, which it finalised almost unnoticed. The changes:
- introduce new rules on management body and organisational requirements;
- delete several rules that are now superseded by the directly applicable Level 2 "Org Regulation"
- maintain common platform by applying Org Regulatoin to non-MiFID business of MiFID firms, and MiFID and non-MiFID business of CRR firms
- make consequential changes to rules and supervisory statements
- allow for authorisations for OTF operation and in respect of emission allowances and binary options being added to existing activities
- set up the process for receiving notifications and granting authorisations for dealing, advising, managing and arranging structured deposits
- make other necessary changes to the General provisions and the Glossary.
FCA, on the other hand, has had a mountain of work. One discussion paper and five consultation papers before March have now culminated in two hefty sets of feedback with almost all final rules now published.
We wrote a separate article on the "near final" rules published in March, which included changes to:
- MAR to address authorisation and supervision of DRSPs, algorithmic trading, HFT and DEA activity protections, changes to the chapter on MTFs and a new chapter on OTFs, and position limits, position management and position reporting for commodity derivatives
- PRIN to apply many of the Principles to ECP business
- Prudential rules to reflect new OTF activities
- SYSC to import key requirements from the Org Regulation, make changes to implement the "at least analogous" requirement where necessary for Article 3 firms, address MiFID 2; and requirements on whistleblowing and conflicts management and make a new part of Chapter 19 on remuneration and performance management of sales staff.
Policy Statement 17/14
We eagerly awaited FCA's mega-policy statement, which duly went to the wire and was published on 3 July. It did not disappoint, and provided significant feedback on many points and the finalised rule change text. The package contains four final rules instruments (including the final version of the "near final" rules from March, and a further (hopefully final) consultation on some consequential changes.
FCA notes in its policy statement that MiFID 2 implementation has given it the opportunity to help it further to achieve its regulatory objectives. It points out that many of the conduct provisions in MiFID 2 is familiar in the context of the UK regulatory framework anyway. However, firms will need to make specific adjustments and, while doing so, FCA wants them to take the opportunity to consider their existing approach to compliance and how they put their clients' interests at the heart of what they do. It has also, of course, noted that this is not the end for imminent regulatory change, and warned of publication of its second consultation paper on IDD implementation, which will also affect COB requirements. As ever, and as with the current MiFID, FCA has in places gone beyond the EU requirements, which it reiterates is a conscious choice to ensure the right regulatory regime for the UK is in place.
FCA has in the main made the new rules substantially in the consultation form. However, it has made significant changes in some areas. It highlights the need to go beyond MiFID 2 in order, in particular, to maintain the RDR adviser charging and platform rules, extend the inducement ban to the provision of restricted advice and keep in place appropriate CASS rules (in particular those on daily reporting and restrictions on using set-off). It also notes, in relation to Article 3 firms, that it has not loosened up any requirement as a result of MiFID 2 implementation:
In the main, FCA will not apply these rules to business involving pensions and insurance-based investments. FCA will extend these provisions to collective portfolio managers but will otherwise not go beyond what MiFID 2 requires. It has also amended its rules to allow greater flexibility on the timing of how quickly research charge deductions should be passed into a research payment account and clarifying that it does not expect investment managers necessarily to have a single RPA per research account. Respondents generally agreed with FCA's proposals, while requesting clarification of what some of the rules were intended to cover. FCA has made changes, for example to clarify that a separate pricing model is not required where clients are outside the EEA, although they may use one if they wish. The key is to deliver discrete pricing of execution services by UK firms on an EU-wide basis. FCA also comments that it can see how certain services would be inherent to the execution process and others not – for example, it can envisage that a MiFID firm could accept transaction reporting offered by a broker as part of the execution service it provides to its clients, so long as it does not influence best execution and it is offered as a standard term of business by the broker to all firms. But services like third party trade analytics would not be covered.
FCA has implemented its proposal to apply the rules on independent advice also to restricted advice given to retail customers. FCA notes the new distinction the FAMR has brought to the investment advising activity. It says it will be consulting on amendments to its rules to make it clear that advisory firms cannot continue to receive significant hospitality or other inducements from product providers and claim it is compatible with the rules because it does not benefit individual clients. FCA will notify the Commission in due course of this super-equivalence, if it adopts its proposals. FCA has also confirmed that only the MiFID 2 standards will apply in relation to advice on structured deposits, and not the wider RDR requirements, despite most respondents favouring extension to treat structured deposits in the same way as retail investment products;
Client categorisation and local authorities
FCA has considered the opt-up criteria for treating local authorities as professional clients, and has lowered the size of portfolio a local authority needs to have. It says this will make it easier for local authorities investing on behalf of a relevant pension fund to opt up. FCA confirms it will apply these standards, and the conditions for opting up to ECP status, to both MiFID business and to non-MiFID designated investment business (DIB).
FCA will apply MiFID requirements to non-MiFID DIB only where it can be inferred from existing provisions and does not present an additional burden to these firms. It thinks this is important for consistent presentation of information and therefore giving customers the ability to compare it.
FCA will apply the MiFID 2 independence standards for personal recommendations to retail clients in relation to non-MiFID retail investment products – which do include insurance-based investments and personal pensions. It says it is doing so because to do otherwise would be confusing for clients.
FCA has decided not to apply the MiFID 2 changes to best execution requirements to AIFMs or residual collective investment schemes. They will, however, apply to article 3 firms (except for the reporting requirement in RTS 28), and to UCITS firms.
FCA will apply MiFID 2 requirements to certain types of non-MiFID firms in line with what it currently does. It believes the risks are the same and should be addressed in the same way.
The MiFID 2 product governance requirements will apply as guidance to firms that carry on non-MiFID DIB.
FCA has confirmed its view that collective investment undertakings other than UCITS are not automatically either complex or non-complex for the purposes of the appropriateness test. So NURS and investment trusts must be assessed, and not assumed to be non-complex
FCA will not apply the taping requirement to all corporate finance-related activity, but will remove the partial exemption for discretionary investment managers. It notes that, where article 3 firms choose to take a note rather than to record a phone call, the note should include key details of any orders taken and the key substance of the main points of the conversation. Many respondents had commented it was hard to understand which conversations fall within the taping requirement, because advisory services do not require to be taped (or otherwise recorded by article 3 firms) but they are often provided together with client order services, which do. FCA considers the "intention" of the client is important in assessing whether the advice relates to a desire to undertake a specific transaction. So, if a client responds to advice by saying they need to go away and think about it, that need not be recorded – but any subsequent correspondence once the client has reached a decision must be. FCA has also provided some ideas on what it considers the appropriate information should be, where article 3 firms are taking a note of the call.
Knowledge and competence
FCA notes its requirements go above ESMA guidance where individuals provide investment advice in relation to retail investment products, and it will retain these higher standards.
The extension of the SMR will make it clearer to firms who is responsible and accountable for specific aspects of a firm's business, and FCA is not changing its requirements in SYSC to require firms to apportion responsibility and to have in place adequate policies and procedures to ensure compliance with its obligations (which goes wider than just MiFID obligations).
Other consultation outcomes
The feedback statement summarises comments received from respondents and explains where FCA has not made changes in response to them.
- In relation to CASS changes, FCA received a number of comments and requests for clarification, and FCA has answered some of the questions in its feedback. However, it has made no substantive and only a few clarificatory or presentational changes to the consultation version of its rules. Changes include deleting the proposed client money lien rules, when respondents pointed out the requirements were already in existing rules. It also notes that it will consider the interaction of the CASS single officer requirement with the SMCR in the context of investment firms in an appropriate consultation; and
- In relation to complaints handling, some respondents had asked for the FOS jurisdiction to cover all MiFID 2 scope complaints, but FCA has explained why it is not appropriate for FOS to handle complaints from customers who are not consumers or small businesses.
Where are the new rules?
FCA has made four legal instruments to implement all these changes.
Several new definitions are now already in force, including many relating to DRSPs. The rest will take effect on 3 January 2018 and comprise a mixture of new definitions, amendments to existing definitions and deletion of definitions (that refer to, or derive from, MiFID 1 measures).
This instrument is already in force and is a short instrument amending FEE in relation to DRSPs.
This is a huge instrument, coming into force over six different dates, but with many provisions already in force except where MiFID 2 delays their application. The instrument changes:
- PRIN, particularly in respect of territorial application
- SYSC to substantively amend and add to the application charts to show which rules apply to which types of firm, to copy out many relevant parts of the MiFID Org Regulation, to amend many of the chapters that apply to common platform firms, by combination of amendments, stripping out current text and reference instead to relevant part of the MiFID Org Regulation, and adding new chapters (such as new subchapters on whistleblowing and remuneration requirements)
- APER to change references to updated SYSC requirements and FIT to make a minor change;
- GEN to add provisions on its application to third country firms
- FEES and IFPRU to update the categories of regulated firm
- IPRU(INV) in relation to chapters 3 (non-MiFID securities and futures investment firms, Exempt BIPRU or IFPRU commodity firms), 8 (exempt CAD firms) and (minimally) 13 (personal investment firms)
- COBS to delete the reference to per se ECPs in the context of firms covered by exemptions from MiFID 1 that will no longer exist
- ICOBS to update a couple of SYSC references
- MAR to substantively amend and, mainly, add new provisions in chapter 5 (MTFs) and new 5A (OTFs), to delete MAR 6.5-6.14 and all of MAR 7, to insert a new MAR 7A (algorithmic trading) and a new MAR 9 (data reporting service) and MAR 10 (commodity derivative position limits and controls, and position reporting)
- SUP to make changes to chapter 10A (approved persons) to update with MiFID 2 references, 13 (passporting), 15 and 16 (minor amendments on notification and reporting), to delete the current SUP 17 and replace it with a new SUP 17A (transaction reporting and supply of reference data) and to amend certain transitional provisions. There are also a raft of new SUP forms for passporting
- DEPP to reference the MiFID Org Regulation as applied in SYSC
- CONC to update a SYSC reference
- REC to update references and insert a new 2.4A on the management body, insert new text in 2.5 (to cater for algorithmic trading) and 2.6 (on order execution on regulated markets), insert a new 2.7A (position management and position reporting in relation to commodity derivatives) and significantly amend other parts of chapter 2, including amending 2.16A to include OTF operation, plus amendments to chapters 3, 4 and 6 to take account of new references, passporting arrangements and venues
- SERV (the Service Companies Handbook Guide) to update MAR references
- EG to remove references to locals
The Conduct, Perimeter Guidance and Miscellaneous Provisions (MiFID 2) Instrument 2017
This is the largest of the instruments, containing mainly (but not only) changes to COBS. The vast majority of it takes effect from 3 January 2018. The changes affect:
- PRIN to delete references to local authorities from the ECP reference
- SYSC to further amend the application guidance, to insert new provisions in SYSC 5 on knowledge and competence, to make minor changes to chapter 10 (conflicts) and add a new 10A (recording telephone conversations and electronic communications)
- FIT to update the introduction in respect of MiFID 2 requirements;
- TC to update the scope of application and insert a new chapter 4 on specified modified requirements
- GEN to update references and include transitional provisions
- COBS to make significant changes to almost every chapter. Chapter 1 explains, among other things, how COBS applies to structured deposits and ECP business, most other chapters include a new "A" chapter as we described in our article on the relevant consultation paper (link to https://www.bonddickinson.com/insights/publications-and-briefings/mifid-...), so that the original chapter as amended applies (normally) to non-MiFID investment business and the "A" addition to MiFID business and usually also to Article 3 firms (otherwise called firms doing "optional exemption business") and third-country firms – but Article 3 firms should always check as there are areas in relation to which FCA is not bound to apply "at least analogous" requirements. Among key changes from the consultation, Chapter 3 now contains the revised ECP opt up conditions.
- BCOBS in relation to structured deposits
- CASS to many parts, particularly on title transfer collateral arrangements, deposit of assets with third parties, diversification of client money, qualifying money market funds , information to clients and record keeping requirements
- MAR in respect, mainly, of SME growth markets and position reporting
- SUP mainly in respect of appointed representatives and tied agents, and passporting
- DEPP in respect of warning notices
- DISP mainly to insert a new DISP 1.1A for complaints handling in respect of MiFID complaints and the jurisdiction of FOS
- COLL and FUND to make minor changes to references
- PROF to confirm how professional firms should take account of MiFID 2 in their exempt business
- Minor changes to REC and the Listing , Prospectus and DTR rules
- PROD, the new sourcebook on product intervention and product governance, which applies to MiFID investment firms, CRD credit institutions, Article 3 firms and branches of third-country investment firms when manufacturing or distributing financial instruments or structured deposits. It includes FCA's statement of policy on temporary and general product intervention rules as well as the dutues on manufacturers and distributors, and how the distribution chain should be managed
- PERG, mainly to chapters 2 and 13, to explain, primarily, the regulatory perimeter and interpretation of key terms.
Although one might hope that everything is now in place, FCA has now published a sixth consultation. It is, at least, short, and consults on:
- FCA's proposal to bring RIEs that operate MTFs and OTFs within FSCS scope. MiFID 2 requires a compensation scheme to apply, so FCA proposes that FSCS costs the levy so that these operators pay levies for the specific costs directly related to the paying of compensation and compensation costs
- FCA's wish to amend DRPP and EG n respect of its new powers that Treasury has now legislated for
- Consequential changes to the Prospectus Rules and the Glossary, again arising out of the recent Treasury legislation.
FCA asks for comments on this by 7 September.
The mantra has been that there can be no transitional or grace periods for MiFID 2 implementation, and, except in the few circumstances where application is delayed because of provisions in the EU legislation, firms must be compliant with it. Andrew Bailey has recently confirmed in response to questions following a speech that FCA does not have the discretion to allow firms longer time to make the necessary changes. However, there may be a slight recognition at least of the task firms have. FCA says it expects firms to take "reasonable steps" to meet the deadline and says it will continue to support firm with their implementation. It also notes that it is still considering its approach to supervision against the new standards although many of them relate, in any event, to the priorities it has already outlined in its business plan.
FCA also took the opportunity to remind firms that if they require variations of permission, they should have applied by now, and that, if they did not apply before 3 July, they should have contingency plans in place in case FCA has not been able to determine their application before 3 January.
The main practical issue firms will now face, quite apart from the human and other resources needed to make all the necessary changes to their policies, procedures and documents, is that FCA, perhaps unsurprisingly, is some time away from being able to provide consolidated handbook text, showing how it will look when all the changes are in force. The time travel option is a particularly useful feature of its Handbook, but FCA has not set a date by which it will have integrated the new rules to enable this function to work. Most firms will not be able to wait – and should take great care that they have checked each instrument for changes to key rules. As can be seen from the summary above, many of the Sourcebooks have been amended by more than one of the rules instruments.
The saving grace is that there have been few substantive changes since the consultations, and firms hopefully took the consultations into account in their gap analyses and compliance planning. And the changes that have been made will hopefully make things better, rather than worse.