MiFID 2: Treasury's Way Forward

Stay up-to-date with the latest developments in securities law through access to both news and all statutes and regulations. Find relevant corporate filings through a searchable EDGAR database. And...

By Andrew Barber and Emma Radmore

With the 3 July 2017, the date domestic MiFID 2 implementation packages need to be finalised, being less than 6 months away, HM Treasury has published a document setting out a summary of the responses it received to its March 2015 consultation on the transposition of the MiFID 2 Directive into U.K. law and its responses. The annexes to the document set out three amended statutory instruments to give effect to the transposition policy.

Of course, Treasury had received responses to its consultation not only before various EU level 2 legislation and technical standards were finalised, but also before the Brexit referendum. So some comments have been superseded and others, that look beyond the likely date of the U.K.'s formal exit from the EU, may prove irrelevant. However, as the government and regulators have often stated, the U.K. will continue to implement EU legislation until the date it leaves the EU.

Third Countries

Respondents almost unanimously agreed with the government’s proposal to maintain the current third country regime and therefore not to take up the option under Article 39 of MiFID 2 to require a third country firm to establish a branch in the U.K. when providing MiFID investment services and activities to retail or elective professional clients. The current overseas persons exclusion and the use of the “with or through” route in the Financial Services and Markets Act 2000 (FSMA) (Regulated Activities) Order 2001 (RAO) brings significant benefits to third country firms. However, some respondents asked that Treasury keep its decision not to opt in to imposing the authorisation requirement under review.

Treasury had expressed the view in its consultation that, if a third-country firm benefited from an equivalence decision and was registered with ESMA, a branch of that firm authorised under a national regime, rather than under Article 39, would not be able to provide services to clients in other Member States. Some respondents disagreed. Treasury's view is that the current regime has the virtue of being sufficiently tailored to client types and to the risks in question, and balances the need to maintain investor protection, market integrity and financial stability, while remaining open to business internationally. It welcomes further views on this point. However, it has made changes in the updated draft statutory instruments to enable both an Article 39 MiFID 2 branch from another member state and a third country firm registered with ESMA to navigate the general prohibition so that they can provide services to U.K. clients.

Data Reporting Services

MiFID 2 introduces authorisation requirements for three specific data reporting services (DRSs) and their providers (DRSPs): Approved Reporting Mechanisms (ARMs), Approved Publication Arrangements (APAs) and Consolidated Tape Providers (CTPs).

Treasury's proposal to create a standalone regulation for DRSs met with support, so it will proceed with this. DRSs will therefore fall under this, and there will not need to be new regulated activities within the RAO for them. The government will also maintain the direct copy out approach of the MiFID 2 definitions in respect of CTPs, ARMs and APAs. The definition of “data reporting service” has been amended to refer directly to the services to reduce circularity, even though Treasury and respondents agreed that MiFID 2 itself creates significant circularity within the terms.

Some respondents queried the definition of CTP, but after discussions at EU level the government maintains that a data reporting service which provides trade data with respect to 100% of equity and equity-like instruments traded on all trading venues is a CTP. So entities providing a consolidated tape for 100 percent of trading all equity and equity-like instruments must therefore obtain authorisation under the Data Reporting Regulations (DRR).

Treasury had asked whether to create new offences akin to Sections 89 and 90 of the Financial Services Act 2012 in relation to market manipulation by DRSPs. Respondents were split on the question, but Treasury has decided it would not be proportionate to create new offences and there are already sufficient powers to capture potential conflicts of interest. These sections already apply to misleading statements or impressions made or given by DRSPs. FCA can impose financial penalties and other sanctions for market manipulation concerning MiFID 2 financial instruments under FSMA.

Treasury had asked whether the draft DRRs had given FCA sufficient powers. Generally, respondents agreed that it had. Member States are required to provide national competent authorities with the necessary powers to fulfil their duties under MiFID 2 and MiFIR. In response to questions, Treasury confirmed it will not provide FCA with any specific competition powers, as it considers the MiFID 2 delegated legislation already sets out what is required for provision of DRSs on a reasonable commercial basis.

The 5 p.m. deadline in relation to ARMs reporting transactions “as quickly as possible, and no later than the close of the following working day” has been amended to 11:59 p.m. in response to respondents' comments.

Recognised Investment Exchanges (RIEs), investment firms and credit institutions operating trading venues can provide DRSs separately under the DRRs. This would be in addition to their respective statuses under FSMA. Treasury will feed back separately on its views on whether central securities depositories should be exempt from MiFID 2 authorisation where they provide the service of an ARM.

Position Limits and Reporting

Treasury had proposed implementing the position limits requirements in the main MiFID 2 implementing Regulations, and giving FCA power to intervene to enforce the limits. It also noted its plans to amend the RIE Recognition Requirements Rules and FCA rules as appropriate, to give position management powers to trading venues.

Generally, respondents approved the proposals, but several asked for some clarifications. The government considers that the regulations properly give effect to the position limit regime and are sufficiently clear on application. However, in places Treasury has redrafted provisions to be more of a copy out of MiFID 2, with the aim of making things clearer. It has also allowed for FCA to receive applications from non-financial entities.

Respondents broadly agreed with the amendments to the Recognition Requirements Regulations but noted a few errors in drafting and clarity, which Treasury has addressed by reverting more closely to copy-out.

All of the responses received agreed that the position reporting and management regime for investment firms and credit institutions operating trading venues should be set out in FCA rules. The government thinks FCA already has sufficient powers in relation to these obligations, and has clarified in the regulations that its relevant intervention powers can only be used for the purposes of MiFID 2 and MiFIR. It has also confirmed that FCA taking action against a person for breaches under the Regulations does not preclude a trading venue from also potentially doing so, in accordance with its obligations.

Unauthorised Persons

Respondents agreed with the approach to unauthorised persons, and considered the powers provided to the FCA in respect of unauthorised persons are appropriate, but Treasury has made some changes to the relevant parts of the regulations to address some drafting queries.

The government will now consider whether an amendment to FSMA is necessary in respect of unauthorised persons with proprietary rights to a benchmark, now the Benchmarks Regulation has been finalised.

Structured Deposits

Respondents broadly agreed that the list of regulated activities “switched on” in relation to structured deposits in the proposed amendments to the RAO, including article 25(2) RAO, reflect the MiFID 2 concept of “selling” or “advising.” One respondent queried whether it was right to switch on the managing activity, but Treasury believes it is. Another queried whether the dealing in principal activity should be switched on to capture credit institutions that issue structured deposits. Treasury agreed this activity would be caught as “selling” but says Article 5 RAO already captures it. In summary, then the regulated activities of dealing as agent (article 21 RAO), arranging (both article 25(1) and 25(2)), managing (article 37) and advising (article 53) are switched on in respect of structured deposits. Respondents agreed that the definition of structured deposits is sufficiently clear. The FSMA (Financial Promotion) Order 2005 (FPO) required amendment to reflect the RAO activities turned on in relation to structured deposits. One respondent noted the original proposed change had not taken into account the article 53 RAO. Treasury has corrected this.

Power to Remove Board Members

Treasury had consulted on whether the powers MiFID 2 requires competent authorities to have to remove individuals from the management board of an investment firm or market operator were, for the most part, already in place for investment firms, and would need only a few amendments to meet all the MiFID 2 requirements. It recognised that new powers would be needed in relation to RIEs. Treasury has reflected and believes that, in fact, the current powers are lacking in several respects, in particular because not all natural persons on the board of a designated investment firm (that is, a dual-authorised firm) will be approved persons. As a result, PRA and FCA would not have the necessary powers to withdraw their approval, although they would have the power to ban them. Also, it feels the reasons for withdrawing approval from approved persons do not align with the MiFID 2 requirements. As a result, it has decided to implement a stand alone power for the regulators to comply with this part of MiFID 2, and that power will apply in respect of both investment firms and credit institutions. Since it has decided to do this, it has also decided to apply this part of the new regulations to RIEs.

If the appropriate regulator wants to use these powers, it must give notice, and the person to whom the notice relates and the relevant investment firm, credit institution or RIE will have the right to refer the matter to a tribunal.

FCA already has relevant administration and enforcement powers, but PRA will need to be given similar powers.

Organised Trading Facilities

Respondents agreed that the amendments to the RAO and the Recognition Requirements Regulations appropriately transposed the MiFID 2 investment service of operating an organised trading facility (OTF) and that is it unnecessary to have a separate permission and notification regime in order to “deal in investments as principal.” FCA is now consulting on its notification regime.

In response to queries, the government confirmed that the proposed changes to the FPO in respect of the new controlled activity of operating an OTF will apply only to MiFID 2 non-equity financial instruments and that an RIE will not need a Part 4A permission to operate an OTF (but will need FCA approval to do so).

The government agrees with respondents that non-discriminatory access to the facilities of an OTF is an important principle and which is required by MiFID 2. This will be transposed through the Recognition Requirements Regulations for market operators operating an OTF and through FCA Rules for investment firms and credit institutions operating an OTF. This will provide a consistent approach to the one taken in relation to Multilateral Trading Facilities (MTFs) and enable FCA to supervise firms against this requirement and take enforcement action where necessary.

Binary Options

All respondents agreed that binary options should be treated as financial instruments under MiFID and the government will legislate accordingly. In response to queries, it has clarified that it believes binary options that present similar risks to other derivative products should be treated in a similar way. Treasury also believes the perimeter should be limited to binary options with certain underlyings only. It intends to have made clear in its drafting that binary options are financial instruments where similar derivative contracts would be regarded as financial instruments, with underlyings such as currencies, stock indices, individual shares, commodity prices and economic statistics.

Amendments have been made to the proposed change to Article 85 RAO to specify that a binary option should be a “derivative contract of a binary or other fixed outcomes nature.” Contracts for difference that are not binary options and have a variable payout are already a specified investment.

The government considers it needs to include making arrangements with a view to transactions in relation to binary options within the regulatory perimeter. Accordingly, the new Article 85(4B)(e) RAO specifies that a binary option is a specified investment where a person is carrying on the activities specified by Article 25(2) RAO in relation to them. So this will, for example, catch those who introduce a person to a firm that buys or sells binary options.

The FPO has been also amended to include binary options (as defined by the new Article 85(4A) RAO) as a new controlled investment.

Ahead of the legislation coming into force, the government will consider what changes it might need to make to the Gambling Act 2005 as regulation of relevant binary options transfers from the Gambling Commission to FCA. They will also consider appropriate fee arrangements to seek to minimise the burden on firms who hold a Gambling Commission Licence at the point the regulation is transferred. The government is also considering the implications of these legislative amendments for the relevant tax framework.

Other Issues

A few other issues arose out of the consultation and developments since it was published.

  •  Treasury will provide for commencement of parts of the new statutory instruments early in 2017, so that firms can apply to FCA and PRA for appropriate authorisations and permissions, and will consider whether it should commence other provisions early;
  •  The Commission has sought to harmonise the definition of financial instruments in relation to foreign exchange derivatives by specifying in delegated legislation that other derivative contracts relating to currencies are not financial instruments where, inter alia, they are a spot contract or a means of payment. Treasury has amended the RAO accordingly;
  •  MTF and OTF operators now have to meet similar requirements to investment firms in respect of investor compensation scheme provision. Treasury will amend FSMA and FSCS rules, and FCA will consult on how to apply FSCS to these operators;
  •  Treasury has amended FSMA and the Appointed Representatives Regulations to the mandatory nature of the tied agents provisions in MIFID 2, as opposed to the optional regulatory regime in MiFID. Other changes reflect the new requirements relating to structured deposits and Article 3 MiFID exempt firms; and
  •  The Part 20 FSMA regime for exempt professional firms has been updated in line with EU level 2 legislation.

New Legislation

Alongside the response, Treasury has published three draft statutory instruments, and a transposition table.

The FSMA (Markets in Financial Instruments) Regulations 2017

These are the main implementing Regulations and designate FCA, PRA and the Bank of England as competent authorities under MiFID 2. There are many parts to the Regulations, dealing with:

Exempt and third country investment firms: Firms can apply for permission, or a variation of permission, to carry on regulated activities as an “exempt investment firm.” The Regulations set out the conditions that apply (that is, a firm that comes, and wishes to be exempt under, Article 3 of MiFID 2). In relation to third country firms, the Regulations provide that a third country firm:

  • (a) that has an EEA branch will not be regarded as carrying on a regulated activity if it does so in the course of exercising rights under an equivalence decision, but only once it has met the service conditions for incoming EEA firms;
  • (b) that is a third country firm registered with ESMA providing services or is providing services to professional clients or eligible counterparties will not be regarded as carrying on a regulated activity if it does so in the course of exercising rights under MiFID 2.

FCA has rights of intervention over firms with EEA branches or registered by ESMA. The Regulations also provide that certain financial promotions made by third country firms are exempt from the financial promotion restriction.

Position limits in commodity derivatives: This part sets out FCA's procedure for setting position limits and the obligations on firms in respect of them. It caters for applications by non-financial entities and FCA's powers to require information, to intervene and its notification obligations to ESMA.

Algorithmic trading, provision of direct electronic access (DEA) and clearing services and business clocks: This part sets out the obligations on members of markets who engage in algorithmic trading or provide DEA in respect of their procedures, systems and controls and information they must provide to FCA. It also sets out the requirements on general clearing members, and gives FCA the power to impose certain requirements on algorithmic traders, DEA providers and general clearing members, as well as setting out the requirements on unauthorised or exempt firms for synchronising business clocks.

Removal of persons from management boards: This part sets out the regulatory powers and procedures to be followed when removing persons from management boards and the right to refer to the Tribunal.

Administration and enforcement: A separate part sets out FCA's functions and supervisory and sanctioning powers in relation to parts of the Regulations, and an offence of misleading FCA. It also makes appropriate modifications of FSMA in relation generally to PRA and FCA's powers that relate to MiFID 2.

Amendments to other legislation: The Schedules include amendments to FSMA, including in respect of appointed representatives and tied agents, cancellation of permission, connected persons, power to suspend auctioning of financial instruments, sanctioning powers, the compensation scheme and various provisions in relation to recognised bodies. They then set out amendments to secondary FSMA legislation, mainly the recognition requirements, and to other primary legislation (mainly to update references).

The FSMA (Regulated Activities) (Amendment) Order 2017

The RAO Amendment order is intended to come into force in part as soon as 1 April, mainly for the purposes of making the necessary legal and administrative changes to allow FCA to accept applications. The main changes are to the defined terms, to insert the new regulated activity of operating an OTF and to bring structured deposits within the instruments for which a dealing as agent, arranging, managing or advising permission is needed and to amend the overseas persons exclusion to account for "equivalent" third country firms. There are also changes to the specified investments to include emission allowances and amend the definitions of futures, options and contracts for differences as well as amending the schedules that recite extracts from MiFID to update them to cater for MiFID 2. This order also contains the changes to other secondary legislation, particularly the FPO in relation to structured deposits, OTFs and emission allowances.

The Data Reporting Services Regulations 2017

These Regulations set out the authorisation and operating requirements for DRSPs, and attendant FCA functions, reporting procedures, and investigation and enforcement powers.

Is There More?

Confirmation of these changes is obviously a welcome piece in the MiFID 2 implementation jigsaw. U.K. firms definitely have enough certainty now to have reached a fairly advanced stage of their implementation planning. But the devil is in the detail and we continue to wait for the final form of the regulatory requirements—in particular how certain parts of FCA's rules will look. Only then can firms finalise their MiFID 2 preparation, but very few will have time to wait until then even to start.

Andrew Barber, partner, and Emma Radmore, legal director, are members of Bond Dickinson's financial services team, London. They may be contacted at andrew.barber@bonddickinson.com and emma.radmore@bonddickinson.com.

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

Request Securities & Capital Markets on Bloomberg Law