United States: FCA Comments On The Extraterritorial Effect Of MiFID II

Last Updated: August 18 2017
Article by Philip J. Morgan, Michael W. McGrath and James D Kerr

For a broader discussion of the key components, requirements, and impact of MiFID II, including those discussed in this update, please refer to our " MiFID II Toolkit for Global Investment Managers."

In a letter to the Alternative Investment Management Association (AIMA) made available to AIMA members on Monday, August 7, the Financial Conduct Authority (FCA) responded to a request from AIMA seeking interpretation and guidance on MiFID II requirements related to the delegation of certain management functions to non-EU firms, including U.S. subadvisors. The provisions at issue (specifically, Article 31 (outsourcing) of the MiFID II delegated regulation and Article 24 (inducements) of the MiFID II Directive) are of particular importance because they represent one of the most likely avenues of MiFID's extraterritorial effect on firms that are not directly subject to MiFID. While the FCA's letter is clear that MiFID-licensed firms may not absolve themselves of their responsibilities under MiFID II through delegation, it does present the possibility that MiFID-licensed firms and their non-EU delegates may achieve compliance through alternative arrangements that ensure that the substantive requirements of MiFID II are met.

BACKGROUND

Article 31 of the delegated regulation provides that MiFID-licensed investment firms outsourcing operational functions deemed "critical or important" shall remain fully responsible for discharging all of their obligations under MiFID II and for ensuring that (i) outsourcing does not result in delegation of responsibility by senior management; and (ii) the relationship and obligations of the investment firm towards its clients under MiFID II are not altered. Article 24 of the Directive prevents MiFID-licensed firms from receiving material third-party payments or benefits in connection with the management of client accounts that could induce the firm to act against the best interests of the client. Famously, this provision, together with Article 13 in the MiFID II delegated directive, requires MiFID-licensed firms to unbundle research costs from execution costs, and to either pay the cost of research directly or pay for research through a research payment account (RPA) funded by separate research charges to the client.

THE FCA'S RESPONSE LETTER

In the letter, the FCA quickly disposes of the notion that the delegation of portfolio management responsibilities can entirely relieve the delegating party of its responsibilities to ensure that clients receive the level of protection afforded by MiFID II. Thus, a MiFID-licensed manager cannot avoid unbundling research from execution simply by delegating portfolio management responsibilities to a non-EU manager that is not subject to MiFID II, as this would expose clients to the very conflicts arising from inducements that Article 24 was intended to address. Although not expressly stated in the FCA's letter, the FCA's comments should be taken as referring to delegations to both affiliated and nonaffiliated delegates of the MiFID-licensed manager as both types of delegation are considered outsourcings under MiFID II.

However, the FCA does not express the position that a MiFID-licensed firm must ensure strict compliance by a delegated manager with all of the requirements of the MiFID II inducement regime. Instead, the FCA takes the position that a delegating firm must "take steps to secure for its clients substantively equivalent outcomes as they would expect to receive on the relevant investor protection provisions in MiFID II," and that this responsibility "may" be satisfied if the delegated manager conforms to the substantive requirements of MiFID II "through other operational arrangements that are consistent with, but without necessarily being precisely the same as, the MiFID II provisions."

The FCA specifically refers to the issue that arises where a U.S. manager cannot make separate payments to a U.S. broker for research, indicating that, in this case, the obligation could be met by MiFID-licensed firms securing "the most comparable standards possible" from the U.S. manager by requiring it to:

  1. Set a budget for the maximum research costs it will incur on behalf of the delegated funds, and provide a policy for how that budget will be used;
  2. Fully account for the research inputs it receives in relation to managing the delegated funds, the value of the research inputs used (using objective benchmarks or metrics to make this value-assessment), and control payments made to research providers in line with the valuation of services; and
  3. Have systems and controls to ensure the receipt of research does not influence order routing and best execution decisions, or give rise to any other conflicts of interest that risks material detriment to the delegated clients' funds.

We note that "the most comparable standards possible" is a watering down of the substantially equivalent concept, which may be read to open the door for similar relaxations in relation to delegation to managers in other jurisdictions in analogous circumstances.

PRACTICAL IMPLICATIONS

The FCA was careful to qualify its comments by noting that formal, legal interpretations of the MiFID II outsourcing provisions must come from either or both of the European Commission and European Securities and Markets Authority. Absent this formal guidance, or similar guidance from other member state regulators, the FCA's views set forth in the letter are not authoritative for MiFID-licensed firms operating in other EU member states.

Nevertheless, the letter represents important insight for firms struggling with the implementation of MiFID II in the adviser/subadviser context, particularly where a U.S. or other global manager provides subadvisory services to a MiFID-licensed firm. Specifically, the FCA's position appears to open the door for U.S. managers to satisfy the demands of these clients through enhanced tracking and reporting of their soft dollar usage, without needing to establish formal RPAs that introduce numerous complications under U.S. law that have not, as yet, been addressed by the SEC or its staff. Ultimately, the specific manner and scope of these protections must be negotiated between manager and subadviser.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.