UK: MiFID - Analysis of FSA´s July consultation paper

FSA's latest consultation paper (CP06/14 - Implementing MiFID for Firms and Markets) was published on 31 July 2006. The CP covers a number of general points of interest (which are outlined below), as well as markets and client assets/money (which will be dealt with in separate Law-Now articles).

However, in many aspects the CP fails to give a definitive answer on what the position will be, come implementation. This lack of clarity from FSA arises for a number of reasons including unresolved issues at the European level. This is particularly the case in relation to scope issues (including non-EEA firms and dual regulation below).

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FSA's latest consultation paper (CP06/14 - Implementing MiFID for Firms and Markets) was published on 31 July 2006. The CP covers a number of general points of interest (which are outlined below), as well as markets and client assets/money (which will be dealt with in separate Law-Now articles).

However, in many aspects the CP fails to give a definitive answer on what the position will be, come implementation. This lack of clarity from FSA arises for a number of reasons including unresolved issues at the European level. This is particularly the case in relation to scope issues (including non-EEA firms and dual regulation below).

The precise impact of MiFID on the scope of UK regulation (from 1 November 2007) remains uncertain because HM Treasury has not yet given its response to the consultation that it launched in December 2005. FSA's latest CP simply states that the legislative changes will be finalised by the end of this year.

The CP highlights the limited ability that FSA will have to grant waivers under the MiFID regime, (FSA is restricted under section 148 FSMA from granting a waiver that will be contrary to its international obligations). Therefore, where FSA implements a requirement on firms under MiFID through the amendment of an existing rule for which a firm may have a waiver in place it is likely that this waiver will not be available to the firm post-1 November 2007. Firms are advised to consider the waivers they currently hold to assess whether MiFID is likely to have an effect of the rule waived as in such cases the waiver may not be renewed, or continue after 1 November 2007.

One of the areas where there is continuing uncertainty at the European level is the position of non-EEA firms (ie. companies which are incorporated in a country outside the EEA, including Switzerland) that provide services in the EEA from an office outside the EEA, or from a branch within it. There is no express provision in MiFID that deals with this issue and this is an issue that has, and continues to be discussed at a European level. FSA gave its provisional view in CP06/3 that MiFID does not apply to these firms but did not expand on this point. FSA has expanded on this slightly in this CP stating that although these firms are not directly subject to MiFID, the relevant requirements such as Conduct of Business Rules, should be applied to them by individual member states. It remains to be seen how this will be decided at the European level.

The CP also flags an important issue relating to firms with branches in other member states and, indeed, firms operating on a global basis. This arises, partly because of the ambiguity of MiFID article 32(7) which impose the rules of two member states (in relation to conduct of business, transaction reporting and transparency requirements) on a branch of a MiFID investment firm. A reading of article 32(7) could indicate that a host state is only responsible for those services provided in that member state by a branch of an EEA firm. This would mean that where such a branch provides services on a cross-border basis into another state it will be the home state regulator, not the host state regulator that will be responsible. This means that host state rules will apply for business conducted by the branch within the host state and home state rules for business conducted by the branch in other member states. It would seem that a more desirable interpretation of this provision should be that a host state regulator will be responsible for all services a branch in its territory provides, whether these are to persons in the host state or elsewhere. It appears that FSA is keen to address the practical difficulties which the first interpretation could pose for regulators and for firms. The CP refers to the CESR Level 3 work programme and encourages firms affected by this issue "to become involved".

FSA says there is a lack of guidance on the question of whether a branch is conducting business within the host state where the branch is located; perhaps for tactical reasons they make no reference to their current guidance (in SUP App 3.6) on the place of supply under the Commission's interpretative communication (based on the "characteristic performance test").

FSA does not refer to another scope issue relating to branches – the territorial application of MiFID rules in relation to the activities of non-EEA branches. This is relevant to the dealings of non-EEA branches with EEA clients and also to the operation of "global books" which are managed by different branches around the world during the course of a 24-hour period. This is related to the points noted above in relation to the lack of clarity in relation to the position of non-EEA firms under MiFID.

FSA has already published this in relation to MiFID (see CP06/9).

The intention is to reduce the need for firms to apply for variations of permissions as a result of amendments to the Regulated Activities Order. Some firms, however, will need to apply for VOPs, eg. because of the changes to client classification requirements. It appears, however, that there will be no substantive proposals until the publication of FSA's practical guide ("planned for early 2007").

There are very few changes required to the authorisation requirements for firms to implement the authorisation requirements under MiFID. Although not part of the implementation of MiFID (as the provisions are purely guidance) FSA has stated that it intends to dismantle AUTH (the Authorisation Manual) and transfer all remaining requirements to SUP or PERG.

FSA indicates in the CP that changes will be required to the Approved Persons regime in relation to the requirements under MiFID. Unfortunately there are no details provided as to what these changes will be but, a separate consultation paper on this issue is to be published later this month.

Under MiFID, member states are not required to impose an authorisation requirement on firms that purely carry on services that MiFID describes as ancillary services (as set out in MiFID) (such as safekeeping and administration). However, firms can passport such services if they are providing the ancillary service in conjunction with an investment service or activity. Under MiFID, a firm cannot passport an ancillary service alone.

Those firms providing safekeeping and administration (or other services defined as ancillary under MiFID) separately from MiFID services may require local authorisation outside MiFID and, potentially, authorisation or top-up permissions in host states, eg. for EEA firms doing business in the UK. The UK will continue to require authorisation for safekeeping and administration even where it is not conducted on an ancillary basis. FSA does not address the (different) position of credit institutions that provide custody services under the Banking Consolidation Directive.

New passport applications: Where a UK firm is conducting cross-border services or branch business which falls within MiFID but outside ISD (eg. in relation to commodity, credit or exotic derivatives) it will need to make a new passport application. FSA is also concerned about the position of ISD business of ISD firms for which there are transitional provisions in MiFID and the matter is therefore being discussed at the European level.

Tied agents: MiFID gives member states the discretion as to whether or not investment firms which they authorise should be permitted to appoint tied agents (which would be able to conduct certain activities without themselves becoming authorised as MiFID investment firms). Member states have a separate discretion as to whether or not to allow tied agents operating in their jurisdiction to hold client money.

As announced by HM Treasury in December 2005, the UK will permit the appointment of tied agents by UK authorised MiFID investment firms (ie. MiFID authorised firms or credit institutions), but will not allow tied agents operating in the UK to hold client money.

Only one principal even for non-retail business: Various amendments will be made to the existing Appointed Representatives regime, both in the primary and secondary legislation and within the FSA Handbook. MiFID tied agents will be restricted to one principal only for all MiFID business; whereas the present UK restriction only applies to retail business. Tied agents will be able to have another principal for non-investment insurance (and may passport under IMD and MiFID). It appears that the tied agents may remain subject to the existing UK restriction on one principal across all designated investment business (MiFID products and life products) for retail clients.

The UK will be implementing the MiFID provisions which provide for UK registration of tied agents appointed by a UK firm where the tied agent is established in a member state which does not allow domestic investment firms to appoint tied agents. (Otherwise tied agents are registered in their "home country").

There are clearly a large number of potential permutations – location of principal head office/branch, tied agent head office/branch and member states which do/do not allow locally authorised principals to appoint tied agents. Not surprisingly, there are to be further discussions at CESR/Level 3. Where the tied agent operates from a head office or branch outside its principal's home state, the office/branch of the tied agent will be treated as a branch of the principal.

FSA has published some amendments to "flex" the application of PRIN in line with MiFID. In some respects, PRIN is extended; in others, it is narrowed.

FSA's investigations suggest MiFID will not apply to personal investment firms (PIFs) (except where they opt up into the passporting regime) and that most ECFs already have the MiFID minimum capital of EUR50,000. There is therefore unlikely to be great demand for the MiFID option of holding professional indemnity insurance (PII) or a comparable guarantee as an alternative to capital (ECFs that are not PIFs are not currently subject to PII). FSA does not therefore propose to develop a sophisticated "trade-off" structure, but the basic option of capital or PII/comparable guarantee will be available. (ECFs conducting insurance mediation are already subject to PII/comparable guarantees under PRU 9.2.) FSA also proposes a basic solvency requirement.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 02/08/2006.