MiFID Rules for Firms and Markets

August 2006

The FSA has published a Consultation Paper (CP) giving proposals for implementing the EU's Markets in Financial Instruments Directive (MiFID) for FSA regulated firms and markets. MiFID was drawn up with the intention of improving competition and providing a level-playing field when trading financial instruments around Europe. It is also supposed to improve consumer and investor protection. It sets the initial authorisation conditions and ongoing regulatory requirements for investment firms, Regulated Markets (RMs) and Multilateral Trading Facilities (MTFs), and covers pre and post trade transparency requirements for equity markets. There are also more extensive transaction reporting requirements, and an expansion of the range of investment services and financial instruments that can be offered on a "passported" basis between EU states.

1. Introduction and Overview - what this is about

   The CP, entitled "Implementing MiFID for firms and markets" (CP 06/14) covers:

   • authorisation and passporting;
   • appointment of tied agents;
   • regulatory enforcement and cooperation;
   • principles for businesses;
   • client assets and certain prudential requirements;
   • Regulated Markets (RMs)* and Multilateral Trading Facilities (MTFs)*; and
   • markets transparency and transaction reporting.

   The CP is in three parts.

   Part I covers:

   • the scope of UK regulation;
   • authorisation of investment firms and their passporting rights;
   • the registration of tied agents; and
   • the enforcement powers and regulatory co-operation obligations of competent authorities.

   Part II covers MiFID requirements on client assets and prudential and capital adequacy data requirements for MiFID firms that are exempt from the Capital Adequacy Directive.

   Part III contains proposals on Regulated Markets (RMs)* and Multilateral Trading Facilities (MTFs)* where they are not already covered by proposed Treasury legislation. It also deals with pre and post trade transparency for transactions in shares admitted to trading on a RM and concluded either on RMs, MTFs or by investment firms trading outside an RM or an MTF, including those acting as Systematic Internalisers*; and the MiFID provisions on transaction reporting.

   Some of the FSA's proposals are based on the HM Treasury's proposed amendments to the Financial Services and Markets Act (FSMA) and secondary legislation to implement MiFID. These are therefore dependent on any changes which might be made to those amendments. Some changes will be made at legislative level and not as part of the FSA rules.

   Note
   * REGULATED MARKET - is a market place, trading system or exchange which meets the minimum EU standards set out in title III of MiFID. MiFID provides that entities offering multilateral trading for financial instruments (such as an order book), must be organised as either an RM or an MTF, with slightly different standards applying to each.
   * MULTILATERAL TRADING FACILITY - is, in broad terms, a system that brings together multiple parties (e.g. retail investors or other investment firms) that are interested in buying and selling financial instruments and enables them to do so. These systems can be crossing networks or matching engines that are operated by an investment firm or a market operator. Instruments may include shares, bonds and derivatives. This is done within the MTF operator's system.
   * SYSTEMATIC INTERNALISER - is, in broad terms, an investment firm making markets outside an RM or an MTF. Level 2 measures will establish criteria for determining when an investment firm is a Systematic Internaliser and set up particular pre trade transparency requirements for Systematic Internalisers that are dealing in "liquid shares" as defined under the Directive.

2. The Key Points

   The FSA has drawn attention to the following key areas in the paper:

   • A tightening of the tied agents regime - agents are to be restricted to a single investment firm principal for their business with all categories of client, and not solely, as now, with private clients. A MiFID tied agent that wishes to act for more than one principal, will have to seek authorisation as an investment firm.
   • Replacement of the current opt-out from client money protection rules for professional clients. An alternative set of arrangements will be brought into effect, with the FSA saying this will have a similar economic effect. There are other amendments intended to make the client money regime more flexible for firms, particularly when performing reconciliations.
   • The proposals include a requirement for those UK firms that are exempt from the risk based requirements of the Capital Adequacy Directive (CAD) to have either capital or Professional Indemnity Insurance (PII) (or a comparable guarantee), of prescribed minimum levels, or an equivalent combination of the two.
   • The replacement of the current Alternative Trading Systems requirements with MiFID authorisation and compliance requirements for MTFs. MTFs will also be brought within the scope of the Capital Requirements Directive (CRD).
   • Introduction of the new MiFID pan-EU pre and post trade transparency regime for transactions in shares admitted to trading on a RM, which will apply (although there will be some differences in detail) to deals done on RMs and MTFs, and to investment firms trading outside RMs and MTFs.
   • A proposed extension of transaction reporting to include commodity, interest rate, and foreign exchange derivatives contracts that are admitted to trading on RMs which are required under MiFID. There are also other requirements, not specifically required by MiFID, (gold-plated or super-equivalent measures) on the definition of a reportable transaction and the content of a transaction report.

3. Implications and what is going to happen next

   The consultation period closes on 31st October 2006, and feedback, together with rules and guidance to take effect from November 2007 will be published in January 2007.

   A further consultation on the consequential changes (mostly minor) to the Handbook will be issued in due course, possibly by being included in a miscellaneous quarterly CP. There will also be further communications covering changes to procedures on passporting, notification of information changes under MiFID and waivers. A practical guide will be published early in 2007 setting out how the FSA proposes to go about this exercise.

   MiFID will apply to all firms currently subject to the Investment Services Directive (ISD), plus some firms providing investment advice or investment services related to commodity derivatives. The types of firm likely to fall within MiFID scope, and hence those that should consider this paper in detail, include:

   • retail banks;
   • investment banks;
   • portfolio managers (excluding firms acting as managers of collective investment schemes);
   • stockbrokers and broker-dealers;
   • many futures and options firms;
   • corporate finance firms;
   • wholesale market brokers;
   • operators of RMs and MTFs;
   • providers of custody services; and
   • some commodities and venture capital firms.

   Credit unions, and general insurance and mortgage brokers will not be affected by the proposals in this CP, unless they also provide MiFID services or conduct MiFID activities and do not fall within any of the exemptions - including Article 3 - provided for in the Level 1 Directive. This is because significant elements of the UK securities and investments market will fall outside, or will be exempted from, the scope of MiFID, although the effect on some types of investment firms is currently unclear.

   The FSA has repeated its commitment, originally made in November 2005, to provide help to firms so that they can identify whether they are inside or outside MiFID's scope and if they are inside MiFID scope which prudential category they fall under. This is awaited.

   Member States are required to finalise legislation and rules to give effect to the MiFID provisions (i.e. transpose it) by 31st January 2007. The Treasury and FSA have said that they intend to meet this deadline. Firms will then need to comply with these by 1st November 2007. In the UK, amendments will be required to be made to the FSMA and its secondary legislation, as well as to FSA rules.

4. Where to go for extra detail

   The CP can be found at the following link:
   http://www.fsa.gov.uk/Pages/Library/Policy/CP/2006/06_14.shtml

   Additional bulletins covering the Joint Implementation Plan for MiFID and the changes to SYSC and the Common Platform provisions can be found on the Grainger Consulting website at the following link: http://www.graingerconsult.com/topics/index.shtml

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