ESMA proposes changes to MiFID II inducements and costs and charges disclosure regimes

On 1 April 2019 the European Securities and Markets Authority (ESMA) published its final report to the European Commission (EC) setting out its technical advice on the impact of the inducements and costs and charges disclosure requirements under MiFID II (Directive 2014/65/EU).

ESMA expresses some concerns over the efficacy of the current inducements disclosure regime and proposes some changes designed to improve clients’ understanding of inducements. ESMA considers but rejects certain more fundamental changes, including the introduction of a more general inducements ban and the creation of a new sub-category of sophisticated retail clients.

ESMA finds that the costs and charges disclosure regime generally works well and helps investors make informed investment decisions, but recommends that certain requirements should be scaled back for eligible counterparties and professional clients.

Disclosure requirements for inducements under Article 24(9) MiFID II:

Overall, ESMA finds that the impact of the MiFID II inducement disclosure rules has not been as positive as expected and has not facilitated the development of independent investment advice (with clients remaining reluctant to pay separately for such advice).

In terms of specific changes proposed, ESMA recommends that the EC take the following steps to improve client understanding of inducements:

  • clarify that the ex-ante and ex-post disclosures (where applicable) should always be made on an ISIN-by-ISIN basis;
  • introduce the obligation to include a simple, consistent explanation of the meaning of “inducements” (for instance, third-party payments) in all inducements disclosures; and
  • strengthen the MiFID II requirements around quality enhancing services by requiring firms to notify clients of the specific services the firm could be benefitting from (but reject the introduction of a closed list of quality enhancing services without further market impact assessment).

Other key areas considered by ESMA in the report are as follows:

  • A complete ban on inducements for all MiFID investment services was considered but not recommended at present. Instead, ESMA recommends that the EC assesses the potential impact of a ban and possible mitigating measures, including by consideration of more extensive inducements bans introduced in the UK and the Netherlands.
  • It is not appropriate for a new category of clients (“sophisticated retail clients”) to be created for the purposes of the inducements regime.
  • Placing agent fees or underwriting fees should only be disclosed where the firm also, respectively, provides an investment service to the investor buying the financial instruments it is placing, or sells the financial instruments issued to investors in addition to underwriting.
  • For level playing field reasons, the disclosure requirements should be extended beyond MiFID financial instruments to capture comparable investment products (in particular certain insurance products).
  • Further analysis of potential measures to tackle investor protection issues arising in bank-led closed-distribution models is recommended.

Costs and charges disclosure requirements under Article 24(4) MiFID II:

On costs and charges, ESMA is of the view that the disclosure regime generally works well, and helps investors make informed investment decisions. The main change recommended by ESMA is the reduction of mandatory disclosures for eligible counterparties and professional clients, as follows:

  • Eligible counterparties should be allowed to opt out of the entire costs and charges disclosure regime, and the obligation to provide the illustration of the impact of costs on return should never apply.
  • Professional clients should be given flexibility to opt out of the costs and charges regime entirely for investment services other than portfolio management and investment advice.
  • For retail clients or professional clients receiving portfolio management and investment advice services, the existing regime should continue to apply (subject to recommended clarifications).
  • ESMA once again rejects the creation of a sub-category of retail clients for “sophisticated retail clients”, as described above.

With regard to the current regime, ESMA believes this has proven effective so should remain in place, subject to certain recommended amendments:

  • Certain ESMA Q&As should be incorporated into the MiFID II Delegated Regulation (2017/565/EU) to foster convergence across member states.
  • Ex-post disclosures should show both total costs and costs on an ISIN-by-ISIN basis (but with more optionality for portfolio management clients). Implicit costs should be included.
  • Firms should monitor and track clients’ portfolios on a day-to-day basis so that they can show actual costs incurred by a client in ex-post disclosures as accurately as possible.
  • For telephone transactions requested by the client, where not possible to provide the ex-ante costs disclosure before the completion of transactions, disclosures may be provided immediately afterwards.
  • As with the inducements rules, the costs and charges disclosure regime should be harmonised across MiFID instruments and other substitutable products (e.g. insurance).
  • Electronic communications should become the default “durable medium” for communicating with clients (rather than requiring consent to electronic disclosure). Personalised client consent to best execution and conflicts of interest policies should also be abolished provided that they are freely available on the firm’s website.

Potential impact on firms:

The implementation of the changes recommended by ESMA will require legislative action by the EC. No indicative timetable is given and under current circumstances this could take some time to implement. The EC may also reject or diverge from the technical advice in various respects, or commission further review. It is also unclear whether and in what respects these recommendations or any subsequent legislative revisions at EC level may be taken forward by the UK.

Nevertheless, investment firms should be aware of this technical advice, as the changes recommended could, if taken forward, impact the ways in which firms communicate with and apply the rules to their client base, and the information they are required to gather and provide to clients, both for MiFID instruments and other comparable investment products. The advice also gives some indicators of ESMA’s expectations on points such as ISIN-level inducement disclosures and disclosure of implicit costs.

Firms should also be aware of ESMA’s rejection of a more flexible regime for sophisticated retail clients that cannot be opted up to professional status, and alive to the possibility that certain key areas remain under consideration, including the possibility of a more extensive inducements ban.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Katherine Dillon
Katherine Dillon
Of Counsel, London
+44 20 7466 2522
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789
Katie McGrory
Katie McGrory
Associate, London
+44 20 7466 2669

COURT OF APPEAL UPHOLDS DISCLOSURE ORDER DESPITE RISK OF PROSECUTION IN IRAN

The Court of Appeal has upheld a first instance decision requiring the claimant Iranian bank to produce customer documents in unredacted form, subject to measures to protect their confidentiality, despite the fact that compliance would put the claimant in breach of Iranian law: Bank Mellat v HM Treasury [2019] EWCA Civ 449.

This case gives a helpful illustration of the court’s approach where a party asserts that the production of documents under its disclosure obligations will contravene foreign criminal law. The court will balance the actual risk of prosecution in the foreign jurisdiction against the importance of the documents to the fair disposal of the trial. While the risk of prosecution will be a factor to weigh in the balance, it will not be determinative.

It is interesting to compare the High Court’s similar decision, albeit in a contrasting context, in the recent case of ACL Netherlands BV v Lynch (considered here). In that case the court declined to grant a party permission to use documents received on disclosure in the English litigation in order to comply with a US grand jury subpoena. Both decisions deal with a scenario where documents are required for proceedings in one jurisdiction but production will put the party in breach of its obligations under the (civil or criminal) law of another jurisdiction. Both decisions highlight the difficulties that may be faced by a party that finds itself caught between conflicting obligations in this way.

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Herbert Smith Freehills edits and contributes chapters to Getting the Deal Through – Financial Services Litigation 2018

There has been a significant rate of global growth of litigation in the financial services sector following the 2008 global financial crisis. While the existence of financial services litigation is truly a global phenomenon, it has become apparent that the law and procedures in relation to such disputes have evolved in different ways across the jurisdictions.

The recently published third edition of Getting the Deal Through – Financial Service Litigation, edited by Damien Byrne Hill and Ceri Morgan, compiles chapters dedicated to financial services litigation from jurisdictions across the globe, including those contributed by a number of our offices.

The text charts the growth of litigation in the financial sector worldwide, with expert authors answering key questions in major jurisdictions. Topics include: common causes of action; powers of regulatory authorities; alternative dispute resolution; specialist courts and procedures; disclosure requirements; data governance issues; remedies and enforcement; and changes in the regulatory landscape since the financial crisis.

Please find attached a copy of the publication, also available on the Getting the Deal Through website.

Contributing offices

AustraliaAndrew Eastwood, Tania Gray and Simone Fletcher

FranceClément Dupoirier and Antoine Juaristi

GermanyMatthias Wittinghofer and Tilmann Hertel

Hong KongGareth Thomas, William Hallatt, Hannah Cassidy, Dominic GeiserJojo Fan and Valerie Tao

IndonesiaAlastair Henderson and Emmanuel Chua

South AfricaPeter Leon and Jonathan Ripley-Evans

United Arab EmiratesStuart Paterson, Natasha Mir and Sanam Khan

United KingdomDamien Byrne Hill, Karen Anderson, Ceri Morgan, Ajay Malhotra, Sarah Thomas and Ian Thomas

United StatesScott Balber, Jonathan Cross and Michael R Kelly

Accreditation: Reproduced with permission from Law Business Research Ltd. Getting the Deal Through – Financial Services Litigation 2018 was first published in August 2018. For further information please visit www.gettingthedealthrough.com.

SFC focuses on the role of financial advisers and valuers in advising listed companies in corporate transactions

The Securities and Futures Commission (SFC) has issued a circular to financial advisers to provide guidance on its expectations as to their role when advising listed companies on corporate transactions (FA circular). The FA circular reminds financial advisers of their obligations under the Corporate Finance Adviser Code of Conduct (CFA Code) and provides specific guidance as to steps financial advisers should take to discharge their obligations. At the same time, the SFC issued a statement to valuers (liability statement) highlighting their potential liability for valuation reports and related information in disclosure documents published by listed issuers. The SFC warns that those who fail to follow the FA circular and liability statement are at greater risk of investigation and regulatory action.

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#MAR_bitesize

MAR MONDAY

On 3 July 2016, the EU Market Abuse Regulation (MAR) (EU 596/2014) replaced the Market Abuse Directive (MAD) and the current UK regimes for market abuse and inside information.  To help guide you through the first six months under the new regime, we will be issuing fortnightly "bitesize" updates providing concise snapshots of a number of key practical areas of interest under MAR. This first "bitesize" update on MAR focuses on the impact that MAR will have on listed companies' decisions to delay the disclosure of inside information in the UK.   Continue reading

Use of predictive coding for e-disclosure endorsed by English High Court

A decision of the English High Court handed down earlier this week has expressly approved the use of predictive coding (also known as technology assisted review) for a large disclosure exercise: Pyrrho Investments Limited & Anr v MWB Property Limited and Others [2016] EWHC 256 (Ch).  Judicial approval of the use of predictive coding should also encourage the UK regulators (both PRA and FCA) to consider its use in facilitating disclosure of documents in the context of regulatory and supervisory investigations.

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UK Court orders disclosure of confidential SFO and client documents: Harlequin Property (SVG) Ltd & Anor v Wilkins Kennedy

The recent case management decision in Harlequin Property (SVG) Ltd and Another v Wilkins Kennedy [2015] EWHC 3050 (TCC) considered an application by the Defendant to withhold documents from inspection on the basis of confidentiality. The documents in question fell into two categories, namely: (i) documents created in the course of an investigation into the Claimants by the Serious Fraud Office (“SFO“); and (ii) documents that were confidential to the Defendant’s third party clients.

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Irish court endorses use of predictive coding for disclosure

A recent decision of the High Court in the Republic of Ireland has endorsed the use of predictive coding for a disclosure exercise, rejecting the opposing party’s insistence on a linear manual review of all the keyword responsive documents and its arguments that this form of technology assisted document review was not compatible with the relevant disclosure obligations: Irish Bank Resolution Corporation Limited & Ors v Sean Quinn & Ors [2015] IEHC 175.

Predictive coding has been endorsed and even advocated by the US courts since 2012.  US case law has moved beyond Magistrate Judge Andrew Peck’s initial decision in Da Silva Moore v. Publicis Group, 287 F.R.D. 182 (S.D.N.Y. Feb. 24, 2012) agreeing to the use of predictive coding (which was the main decision referred to by the Irish High Court) to his more recent 2015 decision in Rio Tinto Plc v. Vale S.A., 1:14-cv-3042 (S.D.N.Y. Mar. 2, 2015) in which he remarked that “In the three years since Da Silva Moore, the case law has developed to the point that it is now black letter law that where the producing party wants to utilize [technology assisted review] for document review, courts will permit it.”

To date, however, predictive coding has been used relatively infrequently in English litigation, though Herbert Smith Freehills has used it in a number of matters on behalf of our clients.  The recent Irish decision appears to be the first endorsement of the technology by courts in Europe.  Celina McGregor, a senior associate in our London office, and Alan Simpson, deputy practice group lead (Disputes) in our Belfast office, outline the decision below.  Read more from their post.

Australia: ASIC’s report card on handling confidential information – ‘could do better’

Following the selective briefing of analysts by Newcrest in mid-2013, ASIC announced that it would sit in on communications between companies and analysts during the next reporting season.  Armed with the output of that survey, as well as interviews of listed entities and their advisers engaged in corporate transactions, ASIC has now issued its report on Australian market practice in handling confidential market-sensitive information.  Issuers, analysts and investment banks in the UK will read the findings with some interest, not least since the FCA is launching a thematic review into investment banks’ controls in respect of inside information this year. Continue reading