MiFID II: ESMA guidance on compliance function requirements

Background

ESMA published, on 5 June 2020, new final guidelines on certain aspects of the compliance function requirements under the recast Markets in Financial Instruments Directive (MiFID II)[1].

The new guidelines replace those issued in 2012, and have been updated in accordance with MiFID II requirements – specifically article 16(2) of MiFID II and article 22 of the MiFID II Delegated Regulation[2].

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IOSCO proposes updated Outsourcing Principles as Covid-19 drives operational resilience to the top of the agenda

Having initially delayed its planned consultation exercise to allow the financial services sector to focus on responding to Covid-19, the International Organization of Securities Commissions (IOSCO) subsequently found the pandemic a catalyst to proceed. Therefore, at the end of May, IOSCO launched its consultation on proposed updates to the 2005 Outsourcing Principles for Market Intermediaries and the 2009 Outsourcing Principles for Markets; feedback on the proposed new Outsourcing Principles (OPs) is requested on or before 1 October 2020. The decision to proceed reflects the acknowledgement that outsourcing is a key element for consideration when assessing operational resilience across the sector.

This post gives a high level summary of the consultation, with a link to our briefing that focuses in more detail on: the scope of application; IOSCO’s definition of outsourcing; intragroup arrangements; concentration risk; and access and audit rights. To provide additional context to IOSCO’s proposals, the associated briefing also catalogues relevant proposals and initiatives which are running concurrent to the consultation exercise.

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COVID-19: Temporary bans on short selling in the EU come to an end

Those national regulators in the EU which had put in place temporary restrictions on any short selling of securities admitted to trading on regulated markets in their jurisdictions have all confirmed that the prohibitions will not be extended. However, firms should be aware that ESMA’s temporary lower net short reporting threshold will remain in force until 16 June.

National regulators – end of temporary bans on short selling

The regulators in France, Belgium, Spain, Austria and Greece have confirmed that the bans on short selling will not be extended and will expire at 11.59 pm on 18 May. The Italian regulator has also confirmed it will end the prohibition one month earlier than its original 18 June deadline at 11.59pm 18 May (in line with the other jurisdictions).

The below summary table sets out the details of each jurisdiction’s prohibition.

Jurisdiction Latest national regulator public statement Date prohibition imposed Prohibition imposed until
France AMF 18 March 18 May
Belgium FSMA 17 March 18 May
Spain CNMV 17 March 18 May
Austria FMA 18 March 18 May
Greece HCMC 17 March 18 May
Italy CONSOB 18 March 18 May

ESMA – Lower net short reporting threshold still in place

While local regulators now plan to lift the bans on short selling, ESMA has confirmed that its decision to lower the threshold at which persons who hold net short positions in companies whose shares are admitted to trading on an EU regulated market must report to national regulators to 0.1% of the issued share capital (down from 0.2%) will remain in place until 16 June.

More information about the measures put in place can be found at our previous blogpost available here.

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Nick May
Nick May
Partner, London
+44 20 7466 2617
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Emma Reid
Emma Reid
Associate, London
+44 20 7466 2633

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

COVID-19: Pressure Points: FCA issues ‘Dear CEO’ letter with update to retail firms (UK)

The Financial Conduct Authority (FCA) has issued a ‘Dear CEO’ letter (the letter) with an update on key issues in light of COVID-19 to firms providing services to retail investors. In addition to the measures it has taken with the Bank of England (BoE) and HM Treasury (HMT), the FCA has considered many requests for forbearance and regulatory adaptations from firms and trade associations, some of which are discussed further below. The FCA has implemented a “significant package of reprioritisation and deprioritisaion of regulatory work” to allow firms to concentrate on their COVID-19 response efforts and protecting their consumers and has indicated that it will continue to update its approach in response the crisis.

The FCA will generally look favourably on forbearance requests for changes which support firms and consumers (some of which it will have the power to make immediately; others which may require co-ordination between the FCA and other UK Government or European agencies), and will only consider requests where there is a genuine need to help consumers or which, for example, would support the FCA’s response to the crisis.

Next steps for firms:

  • In light of the impact of COVID-19 on firms’ operational resilience, the FCA re-emphasised its expectations for firms to focus strongly on supporting and serving consumers and small businesses during this time. The FCA also expects firms to be actively managing their own financial resources/resilience (and in particular liquidity), with firms notifying the FCA immediately if they expect to face financial difficulties.
  • Where firms are re-directing resources due to reduced levels of staff, they should have regard to the FCA’s strong focus on consumer protection. Firms should consider documenting how these decisions are made, with the aim of allocating resources to achieve consumers protection as far as possible during this time.
  • Firms should keep up-to-date with developments by regularly checking the FCA’s website to ensure they are aware of the regulations and rules which continue to apply to them. Firms should also remain vigilant of scams which are increasingly prevalent during the COVID-19 crisis; both the FCA and National Crime Agency have released warnings on rising fraud levels and firms have a responsibility to ensure that consumers are protected.
  • Firms may also wish to consider making use of dialogue between trade associations and the FCA where appropriate to raise prevalent operational challenges with the FCA.

Key areas of focus:

In addition to the above, the FCA sets out in the letter its approach to a number of key issues to help firms manage their response to the crisis:

  • Financial resilience – The FCA has already published guidance on financial resilience and prudential issues. Importantly, the FCA has clarified that government loans cannot be used to meet capital adequacy requirements as they do not meet the definition of capital. Firms therefore need to ensure that they have other appropriate funding available to meet their capital adequacy requirements, if necessary.
  • Flexibility for client identity verification – Whilst firms must continue to comply with their obligations under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) to verify clients’ identities, they can be flexible with how they achieve this. The MLRs and Joint Money Laundering Steering Group guidance already provide that client identity verification can be carried out remotely, and outline appropriate safeguards and checks which firms can implement to assist with verification – some examples are given by the FCA. Firms can also consider seeking additional verifications once restrictions on movement are lifted.
  • Flexibility over best execution reports – The FCA and the European Securities and Markets Authority (ESMA) have both published clarification for firms on best execution obligations in the current climate (the ESMA public statement is available here). The FCA expects firms to continue to meet their best execution obligations, including on client order handling, taking into account current market conditions when determining the relative importance of execution factors. Firms may wish to consider using different types or orders to execute client orders and manage risk during market volatility.

Following ESMA’s guidance, the FCA will not take enforcement action where a firm:

    • does not publish its RTS 27 report by 1 April 2020, provided it is published no later than 30 June 2020; or
    • does not publish RTS 28 and Article 65(6) reports, provided they are published by 30 June 2020.
  • Flexibility over 10% depreciation notifications – Firms will not be required to inform investors in every instance where the value of their portfolio or leveraged position falls by 10% or more in value. Instead, until 1 October 2020, the FCA has confirmed that it will not take enforcement action provided that a firm:
    • has issued at least one notification to retail clients within a current reporting period notifying them that their portfolio has decreased in value by at least 10%; and
    • subsequently provides general market updates online, through other public channels, and/or generic, non-personalised client communications; or
    • chooses to cease providing 10% depreciation reports for any professional clients.

In what is currently a highly volatile market, firms may wish to think about adopting this new approach which could ease the impact of repeated communications on consumers and the operational burden on themselves, or using email or phone calls to notify clients as opposed to written notifications.

  • Pause on implementation of measures – The FCA’s policy statement on pension transfer advice has been delayed until Spring 2020 and follow-up work on assessing the suitability of retirement income advice has been paused. Rules on investment pathways and platform switching provisions have already been made; these have been referred to the FCA Board for further consideration. Ongoing work with firms providing defined benefit transfer advice will continue.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Susannah Cogman
Susannah Cogman
Partner, London
+44 20 7466 2580
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Katie McGrory
Katie McGrory
Associate, London
+44 20 7466 2669
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789
Cat Dankos
Cat Dankos
Regulatory Consultant, London
+44 20 7466 7494

COVID-19: Short selling restrictions and other reporting developments in the EU

[This post was last updated on 16 April 2020 to reflect the extensions to the temporary bans on short selling by EU national regulators]

SHORT SELLING REGULATION

During this unprecedented period of disruption, the European Securities and Markets Authority (ESMA) and other national regulators have taken various extraordinary steps to address the risks faced by financial markets in the EU.

In the past week, ESMA has issued a decision amending the notification threshold for net short positions under the EU Short Selling Regulation (SSR), with some local regulators also imposing temporary prohibitions on short selling transactions. While there has not been any change in the way that the underlying legislation operates, the practical impact of these steps will restrict activity in some markets. Firms involved in short selling need to adjust for the increased transparency obligations.

 1. ESMA – new short thresholds

On 16 March, ESMA published its decision to lower the threshold at which persons who hold net short positions in companies whose shares are admitted to trading on an EU regulated market must report to national regulators to 0.1% of the issued share capital (down from 0.2%).

This lower threshold applies automatically across all EU countries. It will be in place for three months, although ESMA may extend this. Certain exemptions continue to apply, including:

  • net short positions arising from market making and stabilisation activities; and
  • net short positions held in shares admitted to trading on an EU regulated market where the principal venue for the trading of the shares is located in a third (ie non-EU) country.

 2. National regulators –  temporary bans on short selling

In addition to the new EU-wide lowered reporting threshold, national regulators in certain EU jurisdictions have implemented temporary restrictions on any short selling of securities admitted to trading on regulated markets in their jurisdictions (both new and increasing net short positions). A summary table showing the relevant jurisdictions and duration of each prohibition is below:

Jurisdiction Latest national regulator public statement Date prohibition imposed Prohibition imposed until
France AMF 18 March 18 May
Belgium FSMA 17 March 18 May
Spain CMNV 17 March 18 May
Austria FMA 18 March 18 May
Greece HCMC 17 March 18 May
Italy CONSOB 18 March 18 June

Generally, those short selling transactions undertaken by market makers are exempt, and special provisions apply to index-related instruments. However, as these prohibitions are applied on a national (not EU-wide basis) firms will need to confirm the scope and application of the bans in each of the relevant jurisdictions (including any subsequent clarificatory guidance which may be published).

 3. Position in the UK

The FCA has applied ESMA’s amendment to the reporting threshold for net short selling positions (i.e. lowered from 0.2% to 0.1%). However, in a statement made by the FCA on 17 March 2020, firms were told to continue to report data in the UK using the previous threshold until further notice, while the FCA made the necessary technological changes in how it receives the data. Since then, the FCA has confirmed that the required changes have been made and that it will be ready to receive notifications at the lower threshold from 6 April 2020. Firms are not required to amend and resubmit notifications submitted to the FCA between 16 March 2020 and 3 April 2020. Firms should make best efforts to report at the lower threshold from 6 April 2020. Firms should contact the FCA if they are unable to amend their systems by this date.

The FCA has not as yet implemented any specific restrictions on short selling in shares admitted to trading in the UK[1]. In a number of recent statements, the FCA noted that it has never initiated an outright ban on short selling UK shares under SSR, and would set a high bar on imposing any such ban, but could not rule out that this might become appropriate in certain circumstances.

While the FCA’s statements do not suggest that a ban on short selling on shares admitted to UK regulated markets is imminent, firms should continue to monitor regulatory statements on this topic, as changes may be imposed on short notice.

 4. Non-EU markets

Firms should note that non-EU markets might have their own short selling reporting requirements/restrictions and monitor these accordingly.

DELAYS TO SECURITIES FINANCING TRANSACTIONS REGULATION (SFTR) REPORTING REQUIREMENTS

ESMA postpones implementation of reporting under SFTR

On 18 March, ESMA postponed the Securities Financing Transactions (SFT) reporting obligation start date from 13 April 2020, in light of COVID-19 disruption on wider implementation projects.

Trade repositories are also not required to be registered by 13 April 2020. All relevant parties (including trade repositories, entities responsible for reporting and investment firms) should be prepared for compliance by 13 July 2020, when the next phase of the reporting regime begins.

[1]       With the exception of imposing a one day ban on certain Spanish and Italian securities following a request from CNMV and CONSOB on 13 March 2020.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Nick May
Nick May
Partner, London
+44 20 7466 2617
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Emma Reid
Emma Reid
Associate, London
+44 20 7466 2633

MiFID II/MiFIR Review

Two years after MiFID II and MiFIR started to apply, the MiFID review process has begun, with both the European Commission and the European Securities and Markets Authority (ESMA) having recently published consultations on the framework.

European Commission consultation

The European Commission has launched a public consultation on the review of the MiFID II/MIFIR regulatory framework.  This consultation uses a questionnaire format divided into two main sections.  The first section covers general questions on the overall functioning of MiFID II/MiFIR, with the second section covering specific questions on “priority” and “non-priority” topics (see below). Continue reading

ESMA publishes report on product intervention measures under MiFIR

The European Securities and Markets Authority (“ESMA”) has recently published final technical advice on the effects of product intervention measures under the Markets in Financial Instruments Regulation (“MiFIR”). ESMA makes recommendations in relation to the product intervention framework under MiFIR, including proposing extending the framework to alternative investment fund managers (“AIFMs“) and UCITS management companies. In addition, ESMA has said that it will be monitoring the markets in financial instruments linked to crypto assets as it is aware that some national competent authorities (“NCAs”) are consulting on potential product intervention measures concerning these products. If necessary, ESMA will consider exercising its intervention powers in this area.

When MiFIR was introduced in 2018, ESMA was given the power to temporarily prohibit or restrict the marketing, distribution or sale of certain financial instruments, financial instruments with certain specified features or a type of financial activity or practice. ESMA has since used this product intervention power in relation to binary options and contracts for difference (“CFDs“) due to detriment caused to retail investors. ESMA has been asked to report to the European Commission on, amongst other MiFID II/MiFIR topics, its experience of temporary intervention powers, including areas in which legislative changes might be appropriate in relation to the product intervention framework.

For more information on regulators’ product intervention powers across various jurisdictions, please see our global guide on Product Intervention Powers and Design and Distribution Obligations in Financial Services, available here.

ESMA’s technical advice

The main elements of ESMA’s technical advice are as follows:

  • Level playing field between MiFID firms and AIFMs/UCITS management companies: ESMA and NCAs currently cannot exercise MiFIR product intervention powers in relation to AIFMs and UCITS management companies despite these firms being able to carry out certain MiFID services/activities. ESMA recommends that the European Commission addresses the risk of arbitrage between MiFID firms and these fund management companies, and advises that NCAs and ESMA should have the powers to apply restrictions/prohibition directly to AIFMs and UCITS management companies.
  • Extending time validity of ESMA’s temporary product intervention powers: ESMA’s product intervention measures currently only last for a short-term period (3 months – although this period will be increased to 6 months from 1 January 2022) and reviews for extension is resource intensive and burdensome for both ESMA and the NCAs. Additionally, ESMA notes that there are divergences in product intervention measures taken by different NCAs, particularly where permanent national measures diverge from temporary ESMA ones. ESMA recommends consolidation of temporary measures into permanent ones by the European Commission, or alternatively extending ESMA’s powers to allow the introduction of temporary product intervention measures for 18 months.
  • Interaction of national product intervention measures: Article 42(1) MiFIR permits NCAs to take product interventions measures “in or from” their Member State, which ESMA suggests means that an NCA has the possibility to take measures that only apply in that Member State (and not from), and vice versa. Confusion also arises where Member States take overlapping product intervention measures. ESMA advises the Commission to clarify the application of product intervention measures to firms acting on a cross boarder basis and how those measures will be supervised and enforced.
  • ESMA opinion on proposed national product intervention measures: NCAs are required under Article 42(3) MiFIR to notify ESMA of proposed national product intervention measures, at least one month before the measure is intended to take effect, in order for ESMA to issue an opinion on the measure (Article 43(3) MiFIR). In ESMA’s view, this requirement is burdensome. ESMA advises the European Commission that NCAs should be exempt from seeking an opinion where their national measures are exactly the same as ESMA’s temporary measures, and that ESMA should have the option (not an obligation) to give an opinion in these circumstances.
  • Further clarification on Article 40(3) MiFIR: ESMA considers the wording in Article 40(3) MiFIR (“Where … competent authorities have taken a measure under Article 42, ESMA may take any … measures … without issuing the opinion provided for in Article 43”) to be unclear, and is of the view that the situation described is unlikely to occur in practice. ESMA asks the European Commission for further clarification of Article 40(3) MiFIR.

Future use of product intervention measures

ESMA is aware that some NCAs are consulting on potential product intervention measures concerning certain financial instruments linked to crypto assets. ESMA will continue to monitor markets and will exercise its coordination role in relation to measures proposed by NCAs. ESMA will consider taking product intervention measures if issues become apparent which cause significant concerns around investor protection or a threat to the orderly functioning and integrity of markets.

Next steps and Brexit

The European Commission will now present a report to the European Parliament and the Council on product intervention, and a decision will be taken on whether to adopt any of the measures set out by ESMA in this final report. If so, we may see an expansion of the scope of product intervention powers in the future.

Now that the UK has formally left the EU, the UK’s FCA is no longer a member of ESMA’s Board of Supervisors nor can it participate in any of ESMA’s other governance bodies. However, until the end of the transitional period on 31 December 2020, EU law (including MIFIR) will continue to apply to the UK as if it were a Member State, which means that ESMA will have product intervention powers over financial instruments and firms in the UK. Therefore any extension of these powers prior to the end of 2020 could have an effect in the UK. From 2020 onwards, it remains to be seen whether the UK will follow the EU’s approach in relation to product intervention.

 

Clive Cunningham
Clive Cunningham
Partner
+44 20 7466 2278
Patricia Horton
Patricia Horton
Professional Support Lawyer
+44 20 7466 2789
Katie McGrory
Katie McGrory
Associate
+44 20 7466 2669