European Union: MiFID II – ESMA Publishes Discussion Paper And Consultation Paper

Following the adoption of MiFID II by the EU Council on 13 May 2014, we signalled in our most recent MiFID II Briefing (available here) that the European Securities and Markets Authority (ESMA) was expected to begin producing consultation papers in respect of the over 50 sets of regulatory technical standards, 16 sets of implementing technical standards, and various sets of recommendations, guidelines and pieces of technical advice which it had referred to in its 2014 Regulatory Work Programme.

In advance of the expected publication of MiFID II in the Official Journal in June 2014, ESMA has now published both a Discussion Paper (available here) and a Consultation Paper (available here), further details of which are set out below.  The papers focus on:

• the structure, transparency and regulation of financial markets; and
• the strengthening of investor protection.

The deadline for responses to the questions asked by ESMA in both the Discussion Paper and the Consultation Paper is 1 August 2014.  In advance of that deadline, ESMA will host three public hearings (on the topics of secondary markets, investor protection and commodity derivatives) on 7 and 8 July 2014.

The Discussion Paper

The Discussion Paper focuses on the "more innovative or technically complex" technical standards that ESMA is required to issue.  Based on responses received to the Discussion Paper, ESMA will then issue a consultation paper that will include the drafts of those technical standards and the other technical standards that it is required to issue.

The key topics covered in the Discussion Paper are:

• investor protection (in particular, the authorisation of investment firms, passporting and best execution);
• transparency (in particular, the broader pre-trade transparency requirements for equity markets, the post-trade transparency regime for shares and equity-like instruments traded on trading venues, the extended systematic internaliser regime, the new trading obligation for shares admitted to trading on a regulated market or traded on a trading venue, the liquid market for non-equity financial instruments, the pre and post-trade transparency requirements for non-equity instruments, the transparency regime of non-equity large in scale orders and transactions, and the trading obligations for derivatives);
• data publication (in particular, authorisation and organisational requirements for data reporting services, the promotion of efficient and consistent dissemination of information, how the disaggregation of data is to be managed, and specifying which party to a transaction has to make the transaction public);
• access (in particular, the conditions under which trading venues will have access to central counterparties, and accessing and licensing benchmarks);
• microstructural issues (in particular, the definitions of "trading system" and "real time" (the latter in the context of algorithmic trading), together with the parameters for defining "severe market stress" and "disorderly trading conditions", organisational requirements for investment firms engaged in algorithmic trading, organisational requirements for trading venues that permit algorithmic trading, the 'Order-to-Transaction Ratio' regime, co-location services enabling access to trading venues, fee structures and tick-size regimes);
• requirements applicable in respect of trading venues (in particular, admission to trading, and suspending and removing financial instruments from trading);
• commodity derivatives (in particular, when an activity will be viewed as ancillary, position limits and position reporting);
• market data reporting (in particular, the obligation to report, and record-retention obligations); and
• post-trading issues (in particular, the obligation to clear derivatives traded on regulated markets and the timing of acceptance for clearing, and indirect clearing arrangements).

The Consultation Paper

On 24 April 2014, the European Commission (the Commission) asked ESMA to provide it with technical advice on various aspects of MiFID II within 6 months of MiFID II coming into force (MiFID II will come into force 20 days following publication in the Official Journal).

Key topics in respect of which the Commission has sought technical advice, and in respect of which ESMA is consulting, are as follows:

• investor protection, in particular:
  • when an activity is provided in an incidental manner;
  • possible changes to the definition of "investment advice" to remove the reference to "through distribution channels";
  • improvements that could be made to the compliance function, complaints-handling and recording-keeping;
  • organisational requirements for investment firms in the area of telephone recording and electronic communications;
  • product governance requirements for manufacturers of investment products;
  • safeguarding client assets, and the use of title transfer collateral arrangements;
  • improvements to the existing conflicts of interest framework;
  • organisational, conduct of business and conflicts of interest requirements in respect of underwriting and placing;
  • remuneration policies and procedures, and how they interact with firms' duties to act in the best interests of clients;
  • conditions for information to be fair, clear and not misleading;
  • the provision of information to clients about investment advice and financial instruments, in particular as regards suitability and complexity, whether advice is being provided on an independent basis, and costs and charges;
  • the management of inducements;
  • the general suitability provision and the contents of the suitability report;
  • reporting to clients (ESMA is not expected to recommend significant changes);
  • best execution (again, ESMA is not expected to recommend significant changes, but is instead expected to propose small refinements to promote efficiency and investor protection);
  • client order-handling (ESMA has indicated its view that the existing provisions should be confirmed);
  • transactions executed with eligible counterparties (ESMA believes that the existing provisions should be confirmed, with the exception of the ability to recognise undertakings that are not large undertakings as eligible counterparties); and
  • the criteria for exercising the new product intervention powers (as the European Banking Authority (EBA) will also have product intervention powers in respect of structured deposits, the EBA is expected to issue a separate consultation in this area);

• transparency, in particular:
  • criteria for determining whether an equity or class of equity instrument is to be considered as liquid;
  • clearly delineating between bonds and structured finance products and money market instruments by further specifying the definition of money market instruments; and
  • regarding systematic internalisers (investment firms which, on an organised, systematic, frequent and substantial basis, deal on own account by executing client orders outside a regulated market, multilateral trading facility or organised trading facility without operating a multilateral system), the criteria for specifying what can be considered as exceptional market conditions enabling the withdrawal of quotes, when prices can be said to fall within a public range close to market conditions, when the number or volume of orders can be said to "considerably exceed the norm", and pre-trade transparency;

• data publication, in particular:
  • access to systematic internalisers' quotes; and
  • what constitutes a "reasonable commercial basis" in the context of the provision of certain data;

• micro-structural issues, in particular distinguishing between algorithmic trading and high-frequency algorithmic trading technique;

• trading venues, in particular:
  • the requirements that SME growth markets will need to meet, and the registration and deregistration of those markets;
  • the suspension and removal of financial instruments from trading where there could be significant damage to investors' interests and the orderly functioning of the market; and
  • when the operations of a trading venue in a Member State would be considered to be of substantial importance for the functioning of the securities market and investor protection;

• commodity derivatives, in particular:
  • contracts that must be physically settled; and
  • position reporting thresholds;

• portfolio compression.

We will continue to issue updates once further consultation papers and draft technical standards are issued, and once ESMA's technical advice to the Commission is finalised.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.