Pan-European Regime for the Financial Services Industry
The Markets in Financial Instruments Directive ("MiFID") came into force on 1 November 2007. It comprises three main pieces of legislation; the Level 1 "MiFID Directive" being Directive (2004)/39/EC) and the Level 2 measures implementing the MiFID Directive being the Commission Directive (2006/73/EC) and Commission Regulation 1287/2006 (collectively referred to as "MiFID I"). MiFID marked the introduction by the European Union of a new and broad ranging, pan European regime for the financial services industry. MiFID represented one of the key elements of the EU's Financial Services Action Plan, a set of EU legislation which was introduced with the objective of producing an effective single financial services market in the EU. MiFID establishes a regulatory framework for the provision of investment services by investment firms. It imposes obligations on investment firms relating to conduct of business rules and their organisational structure.
The European Commission's objectives in terms of MiFID are to open up trading in securities to competition so as to reduce transaction costs for investors, to apply equivalent regulatory rules to different market models which perform similar functions and to enhance, standardise and harmonise investor protection across the EU. These objectives give effect to the broader EU Treaty objective of creating a single market in financial services in the EU.
In December 2010, the European Commission published a consultation paper relating to proposed amendments to MiFID I. Following that consultation process, the European Commission published draft legislative proposals in the form of a draft Directive and a draft Regulation, referred to together as the "draft MiFID II Legislation" in October 2011. The draft MiFID II Legislation includes potentially comprehensive reforms to the existing regulatory regime. The proposals introduce a range of measures which seek to address deficiencies in the MiFID I regime exposed by the financial crisis. It focuses in particular on addressing problems that have arisen from the expansion in OTC trading in comparison with trading on exchanges and the related issue of transparency of such trading. MiFID II carries fundamental implications for the nature and shape of financial markets by shifting trading from the more opaque OTC market to more transparent organised markets. Please see section entitled "MiFID II - Proposed Changes" for further information.
Investment firms which provide investment services to third party clients or conduct, on a professional basis, investment activities in relation to certain financial instruments may be within the scope of MiFID.
Broadly speaking, the types of firm likely to fall within MiFID's scope 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 Regulated Markets ("RMs") and Multilateral Trading Facilities ("MTFs");
- providers of custody services, and
- commodities and venture capital firms.
Regulation of Investment Firms
MiFID requires that member states of the EEA1 ("Member States") must license and regulate investment firms carrying out investment services in their jurisdiction.
It also establishes high-level organisational and conduct of business standards that apply to all investment firms. These standards include managing conflicts of interest, best execution, customer classification, suitability requirements for customers and pre-trade and post-trade transparency requirements. The draft MiFID II Legislation contains proposals to enhance these high level organisational and conduct of business standards.
MiFID also requires that Member States recognise investment firms licensed in other Member States and permit such investment firms to operate within their jurisdiction without imposing any further requirements on them.
The access rights of third country firms (i.e. non-Member States) is not harmonised under MiFID and is therefore subject to national laws; currently national regulators impose equivalency requirements on third country firms operating in their territories. The draft MiFID II Legislation contains proposals to permit third country firms that wish to provide cross border investment services across the EEA to do so on the basis of a passport. Please see section entitled 'MiFID II - Proposed Changes' for further information.
APPLICATION OF MIFID IN IRELAND
Irish MiFID Regulations
MIFID has been transposed into Irish law by the European Communities (Markets in Financial Instruments) Regulations, 2007 as amended (the 'MIFID Regulations') with effect from 1 November, 2007.
Central Bank Authorisations
Regulation 4 of the MiFID Regulations provides that the Central Bank of Ireland (the "Central Bank") is the competent authority in Ireland for the purposes of MiFID.
The Central Bank is therefore responsible for the authorisation of entities under the MiFID Regulations. Such authorisation may be unconditional or subject to such conditions or requirements as the Central Bank sees fit.
Withdrawal/Suspension/Revocation of Authorisation
The Central Bank also has the power to withdraw or suspend an authorisation in certain circumstances or apply to the High Court for an order revoking the authorisation of an investment firm.
Register of Authorised Investment Firms
The Central Bank is required to maintain a publicly accessible register of authorised investment firms and investment firms authorised in other Member States passporting into Ireland. This register appears on the Central Bank's website.
Who is Affected?
Investment firms offering financial services to clients or customers located within the EEA are potentially affected by MiFID, either directly or indirectly.
Acting as an Investment Firm in Ireland
Regulation 7(1) of the MiFID Regulations provides that any party that proposes to act as an investment firm (or claim to be an investment firm or represent itself to be an investment firm) in Ireland must be either:
- authorised by the Central Bank in Ireland to do so, or
- authorised to do so under MiFID by the competent authority in another Member State.
DOES YOUR BUSINESS COME WITHIN THE SCOPE OF THE MIFID REGIME?
Are you acting or proposing to act as an "Investment Firm"?
If your regular occupation or business is the provision of one or more investment services to third parties on a professional basis, or the activity of dealing on own account on a professional basis, relating to financial instruments then you will be considered an investment firm for the purposes of the MiFID Regulations.
The definition of investment firm is set out in Regulation 3(1) of the MiFID Regulations. The key elements of this definition are examined in more detail below.
Are you providing or do you propose to provide "Investment Services"?
The investment services covered by the MiFID Regulations are as follows:
- the reception and transmission of orders in relation to one or more financial instruments; execution of orders on behalf of clients;
- dealing on own account, meaning the activity of trading against proprietary capital resulting in the conclusion of transactions in one or more financial instruments;
- portfolio management;
- investment advice;
- underwriting of financial instruments or placing of financial instruments on a firm commitment basis;
- placing of financial instruments without a firm commitment basis;
- operation of MTF.
What "Financial Instruments" are covered?
For MiFID to apply, the investment services provided have to relate to one or more of the following financial instruments:
- transferable securities;
- money-market instruments;
- units in collective investment undertakings;
- derivative contracts that relate to securities, currencies, interest rates, yields, other derivative instruments, financial indices which may be settled physically or in cash;
- derivative contracts relating to commodities that may be settled in cash other than on default or other termination event;
- derivative contracts relating to commodities that can be physically settled if traded on a RM and/or MTF;
- derivative contracts relating to commodities, physically settled, but not for commercial purposes which have characteristics of other derivative financial instruments having regard to whether they are cleared and settled through recognised clearing houses or are subject to margin calls;
- derivative instruments for the transfer of credit risk;
- financial contracts for differences;
- derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash as well as derivative contracts relating to assets, rights, obligations, indices etc.
Are the services to be provided "on a professional basis"?
MiFID applies when you are providing investment services relating to financial instruments to third parties on a professional basis.
Unfortunately, there is no Irish guidance as to what is meant by providing services "on a professional basis". UK FSA guidance indicates that one needs to consider the overall commercial nature and scale of the activity but we consider that a commonsense approach is needed.
What is covered by "Investment Advice"?
The provision of investment advice is an investment service under the MiFID Regulations and covers the provision of personal recommendations to a client in respect of one or more transactions relating to financial instruments. It does not include recommendations issued exclusively through distribution channels or to the public. The draft MiFID II Legislation provides that firms providing the investment service of investment advice must provide information to clients or potential clients of the basis upon which they provide this advice, i.e. whether this advice is provided on an independent basis and whether it is based on a broad or a more restricted analysis of the market and shall indicate whether the firm will provide the client with the ongoing assessment of the suitability of the financial instruments recommended to clients.
Detailed definitions of "investment advice" and "personal recommendations" are set out in Regulation 3(1) of the MiFID Regulations.
Are you automatically exempt if providing such services "on your own account"?
Any entity which carries out own account dealing on its own behalf may fall within the scope of the MiFID Regulations unless one of the exemptions apply or alternatively its investment positions are not held with trading intent, i.e. if investments are held for long term gain as opposed to short term resale and/or with the intention of benefiting from actual or expected short term price differences between buying and selling prices or from other price or interest rate variations.
Is your business exempt?
Regulation 5 of the MiFID Regulations exempts a variety of entities from the requirement to obtain authorisation under the MiFID Regulations, (insurers, entities who provide services exclusively to group entities, administrators of employee participation schemes, investment funds and pension funds and their managers and depositories, various public bodies etc.)
There are other exemptions for investment firms which carry on own account dealing activities (provided not a market maker or dealing outside a RM or a MTF in certain circumstances) and other exemptions specific to persons whose main business consists of dealing on own account in commodities and/or commodity derivatives.
Importantly, note that Regulation 5(3) of the MiFID Regulations also exempts investment firms that meet the following three criteria:
- they are not allowed to hold clients' funds or securities and therefore are not allowed at any time to place themselves in debit with their clients;
- they are not allowed to provide any investment service except as follows: (i) receiving and transmitting orders in transferable securities and units in collective investment undertakings; (ii) providing investment advice in relation to those securities and units; and
- they are only transmitting those orders to certain specified entities.
Is your business "operating within the State"?
If you are not "operating within the State" or deemed to be "operating within the State" you do not need an Irish authorisation or to effect a passport notification.
Under Regulation 8(1) of the MiFID Regulations, an investment firm shall not be regarded as operating within the State, if-
- the investment firm has no branch in the State;
- the investment firm's head or registered office is: (i) in a state other than a Member State, or (ii) in a Member State outside the State, and the investment firm does not provide any investment services in respect of which it is required to be authorised in its home Member State for the purposes of MiFID; or
- the investment firm is authorised in a Member State outside the State, under MiFID, but provides only investment services of a kind for which authorisation under MiFID is not available during the provision of the investment services.
Importantly, Regulation 8(2) of the MiFID Regulations clarifies that notwithstanding paragraph (1), an investment firm, for the purposes of Regulation 7, shall be regarded as operating within the State if the investment firm provides investment services to individuals in the State who do not themselves provide one or more investment services on a professional basis.
Do you provide or intend to provide any of the "Ancillary Services"?
Where an investment firm is authorised to carry out investment services, it can also apply for its authorisation to cover the following ancillary services (authorisation under the MiFID Regulations cannot be granted solely for ancillary services):
- safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management;
- granting credits or loans to an investor to allow the investor to execute a transaction in one or more financial instruments, where the investment firm granting the credit or loan is involved in the transaction;
- advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to mergers and the purchase of undertakings;
- foreign exchange services where these are connected to the provision of investment services;
- investment research and financial analysis or other forms of general recommendation relating to transactions in financial instruments; and
- services relating to underwriting.
Implications of draft MiFID II Legislation
The draft MiFID II Legislation proposes to extend the application of MiFID to more firms; for example to certain commodity firms, data providers and third country firms. The draft MiFID II Legislation also proposes to bring additional instruments such as structured deposits and emissions allowances within the scope of MiFID. Please see section entitled 'MiFID II - Proposed Changes' for further information.
IS AUTHORISATION UNDER THE MiFID REGULATIONS IN IRELAND THE CORRECT OPTION?
Initial 4 Step Check
The following steps should be taken by an investment firm to determine if it business is within the scope of the MiFID Regulations and, if so, what actions this may require.
Step 1 - Determine whether the investment firm requires authorisation under the MiFID Regulations?
Step 2 - Determine if the presence in Ireland requires authorisation by the Central Bank or if the business can passport its authorisation from another Member State.
Step 3 - If authorisation is to be sought in Ireland, the investment firm should consider the Central Bank's authorisation requirements fully to ensure that these can be met.
Step 4 - As part of this process, the investment firm should also consider the ongoing operational and conduct of business requirements that will be imposed to ensure that these can be adhered to.
An investment firm should not proceed to make an application for authorisation under the MiFID Regulations until it has given full consideration to each of the steps above. It may be the case that a firm will be deemed to be carrying out an IIA service only (see below) and not a MiFID service (e.g. acting as a deposit broker or deposit agent).
Investment Intermediaries Act may still apply
The Investment Intermediaries Act, 1995 as amended (the "IIA"), has not been repealed and a firm therefore has to consider the potential application of both the MiFID Regulations and the IIA to its business.
A different regulatory regime will apply to a firm depending on whether it offers an IIA service or a MiFID service and it is most important to note that the definitions of "investment services" and "financial instruments" under the MiFID Regulations are of "investment business services" and "investment instruments" under the IIA.
If your business involves the provision of "investment business services" or provision of services relating to "investment instruments" under the IIA, you may need to obtain authorisation as an investment business firm under section 10 of the IIA.
If your business involves the provision of investment services under the MiFID Regulations and also covers investment business services and / or investment instruments under the IIA, it will be necessary to seek authorisation under the MiFID Regulations with a specific extension to cover the additional IIA investment business services/investment instruments. Such an authorisation is referred to as a "hybrid" authorisation.
AUTHORISATION UNDER THE MIFID REGULATIONS - APPLICATION PROCEDURE
Preliminary Meeting with the Central Bank
The Central Bank requires each proposed investment firm to meet with them at a preliminary stage to discuss the firm's business and the proposal to seek authorisation. The Central Bank has issued a MiFID agenda document which is attached hereto at Appendix A. This agenda document is to be used for the purposes of the initial meeting with the Central Bank to discuss a proposed MiFID application. The MiFID agenda document places increased focus on:
- the Board of Directors;
- Staffing and Organisation Structure; and
- Financial Information and Capital Requirements Directive 2006/49/EC as amended (the "Capital Requirements Directive").
Only on satisfying the Central Bank's preliminary enquiries can the application proceed.
Next Step - Documents Submission
The application process requires the following documentation to be submitted to the Central Bank:
- completed Application Form (standard form);
- detailed Business Plan;
- drafts of all policies and procedures manuals;
- certified copy of Memorandum and Articles of Association or equivalent;
- Individual Questionnaire (electronic version) for each director and key individuals (ie. senior managers);
- full ownership (direct and indirect) details, group structure chart (highlighting all regulated group entities) and accounts of all entities in ownership chain;
- audited annual accounts for the previous 3 years (or since establishment, if less than 3 years in existence);
- quarterly management accounts since the last audited accounts (highlighting all regulated group entities).
Application Form and Business Plan
The Application Form and Business Plan submitted to the Central Bank need to provide full and sufficient details about the firm and its business to enable the Central Bank to make a determination as to whether the investment firm meets the conditions for authorisation, discussed in more detail below.
This must also include details inter alia on officers responsible for compliance, finance, antimoney laundering and internal audit.
Draft Policies and Procedures Manuals
Draft Policies and Procedures Manuals will need to submitted to the Central Bank for review evidencing how the firm proposes to manage its business in compliance with the ongoing organisational and conduct of business requirements, discussed in more detail below.
The process for authorisation will usually take between 4 and 6 months from the date of original submission of complete application.
Better prepared, more detailed submission documents tend to reduce the timing of authorisation process.
CONDITIONS FOR AUTHORISATION
The proposed investment firm must be constituted in one of the following forms:
- a company incorporated by statute or under the Companies Acts 1963 to 2012;
- a company incorporated outside Ireland;
- a company made under Royal Charter;
- constituted under a partnership agreement as an unincorporated body of persons;
- an industrial provident society, or
- a sole trader.
Normally, a private limited liability company is the chosen vehicle.
Capacity to Provide Investment Services
The proposed investment firm's constitutional documents must give the investment firm sufficient capacity to conduct investment services.
The proposed investment firm must have sufficient capital in line with the Capital Requirements Directive.
Suitability of Qualifying Shareholders
The Central Bank must be satisfied as to the suitability of each of the qualifying shareholders of the proposed investment firm. Full details need to be provided, including group structure charts, details of all regulated entities in the group, accounts for all entities in ownership chain and evidence showing ownership of each entity in that chain.
Structure, Skill, Staffing
The Central Bank must be satisfied as to the organisational structure and management skills of the proposed investment firm and that adequate levels of staff and expertise will be employed to carry out the investment firm's proposed activities.
The MiFID Regulations also apply high level organisational and conduct of business standards to all investment firms - please see below the section titled "Ongoing Organisational Requirements" for further information.
Fitness and Probity
The Central Bank published new fitness and probity standards for persons performing a Pre- Approval Controlled Function ("PCF") or a Controlled Function ("CF") on a professional basis in a regulated firm. The fitness and probity standards are built on requirements of competence, capability, honesty, integrity and financial standing. In relation to an investment firm authorised under the MiFID Regulations, the following would be regarded as performing a PCF;
- director (executive and non executive);
- chair of the board or of any of a number of significant committees of the board;
- chief executive;
- the head of finance, compliance, internal audit, risk and anti-money laundering compliance.
Any person who performs a PCF in a MiFID authorised firm must be approved by the Central Bank in advance of his / her appointment. In this regard, a detailed questionnaire must be completed and submitted electronically to the Central Bank.
Minimum Competency Code
The Central Bank issued its new Minimum Competency Code (the "Code") on 1 September 2011 replacing the Minimum Competency Requirements (the "Requirements") which came into effect on 1 January 2007. The Code took effect on 1 December 2011 and replaces the Requirements from that date.
The Code applies to persons carrying out a PCF or a CF on a professional basis in a regulated firm, the exercise of which includes;
(a) providing advice to consumers on retail financial products;
(b) arranging or offering to arrange retail financial products for consumers; and
(c) carrying out one of the specified functions set out in Appendix 2 of the Code, for example assisting a consumer in making an insurance claim, determining the outcome of an insurance claim or adjudicating on a complaint which relates to advice about a retail financial product or the arranging or offering to arrange a retail financial product for a consumer.
The Code contains categories of products which are considered to be retail financial products which are set out in Appendix 1 of the Code and include savings, investments, collective investment schemes, life assurance products, tracker bonds, shares in a company listed on the Stock Exchange, pensions, insurance and housing loans. The Code sets out the minimum level of knowledge and competence required for each category of retail financial product in Appendix 3 of the Code.
The Capital Requirements (Amendment) Directive 2010/76/EU of the European Parliament and of the Council of 24 November 2010 (the "CRD III rules" and which amended the Capital Requirements Directive 2006/49/EC) were transposed into Irish law with effect from 1 January 2011 by the European Union (Directive 2010/76/EU) Regulations 2010. The CRD III rules require investment firms to adopt remuneration policies and practices that promote sound and effective risk management and apply to senior managers, risk takers, staff engaged in control functions and any employee whose total remuneration (including discretionary pension provisions) takes them into the same bracket as senior managers and risk takers. In particular the CRD III rules limit the size of bonuses that may be paid as a proportion of salary, provide for compulsory deferral of bonuses in certain cases, provide that all upfront bonuses be capped and limit the circumstances where guaranteed bonuses can be paid.
Depending on the nature of activities of the investment firm it may be possible to dis-apply certain of the remuneration requirements.
Passporting into Ireland of Authorised Investment Services
An investment firm authorised in another Member State may provide, within Ireland, investment services and any ancillary services, if the services are permitted under the investment firm's authorisation in its home Member State.
Passporting into other Member States
An Irish investment firm authorised to provide investment and ancillary services in Ireland can passport into other Member States.
An investment firm providing services on a cross border basis (without the establishment of a branch) need only comply with the conduct of business rules of its home Member State.
When operating on a branch basis, the organisational requirements of its home Member State regulation will continue to apply but it will also be required to comply with the conduct of business rules of its host Member State for activities within the host Member State.
The passporting regime under the MiFID Regulations is set out in Part 9 of the MiFID Regulations.
Implications of draft MiFID II Legislation
The draft MiFID II Legislation contains proposals to permit third country firms (i.e. non- Member States) that wish to provide cross border investment services across the EEA to do so on the basis of a passport. Please see section entitled "MiFID II - Proposed changes" for further information.
ONGOING ORGANISATIONAL REQUIREMENTS
The MiFID Regulations apply high-level organisational and conduct of business standards to all investment firms. The organsiational requirements include the following:
General Compliance Procedures
The firm must establish adequate policies and procedures sufficient to ensure its compliance with its obligations.
Conflicts of Interest Procedures
The firm must maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps designed to identify potential conflicts of interest and take steps to prevent these conflicts adversely affecting the interests of its clients.
If a conflict of interest cannot be prevented, the investment firm must disclose the nature and/or sources of the conflict of interest to the client before undertaking the business.
Business Continuity Procedures
The firm must ensure continuity and regularity in the performance of investment services and activities by implementing and carrying out appropriate and proportionate systems, resources and procedures.
Operational Risk Control Procedures
The firm must take reasonable steps to avoid undue additional operational risk when relying on third parties for the performance of certain operational functions.
The firm must ensure that any outsourcing of important operational functions is not undertaken in such a way as to impair materially: (i) the quality of the firm's internal control, or (ii) the ability of the Central Bank to monitor the firm's compliance with all of the investment firm's obligations.
Where a firm outsources critical or important operational functions or any investment services or activities, the firm remains fully responsible for discharging all of the firm's obligations under the MiFID Regulations.
Administrative and Accounting Procedures and Systems Control Procedures
The firm must have in place and use (i) sound administrative and accounting procedures and internal control mechanisms, (ii) effective risk assessment procedures, and (iii) effective control and safeguard arrangements for information processing systems.
Record Retention Procedures
The firm must keep records of all services and transactions undertaken and ensure that the records are sufficient to enable the Central Bank to monitor the firm's compliance with the MiFID Regulations and, in particular, to ascertain whether the firm is complying with its obligations with respect to clients or potential clients. This requirement will also apply to passporting entities with branches in Ireland.
Procedures for Safekeeping of Financial Instruments held on behalf of clients
When holding financial instruments belonging to clients, the firm must make adequate arrangements to (i) safeguard clients' ownership rights, especially in the event of the firm's insolvency, and (ii) prevent the use of a client's instruments on own account, except with the client's express consent.
Procedures for Safekeeping of client money
When holding funds belonging to clients, the firm must make adequate arrangements to safeguard the clients' rights and, except in the case of credit institutions, prevent the use of client funds for the investment firm's own account.
Business, Procedures, Internal Controls and Reporting
Each firm must establish, implement and maintain:
- decision-making procedures and an organisational structure relevant for its business;
- internal control mechanisms to ensure compliance with these procedures;
- records of the business and internal organisation;
- security and confidentiality procedures to safeguard this information.
Monitoring and Evaluating Systems Control Mechanisms
Regulation 35 of the MiFID Regulations requires that firms must monitor and evaluate the adequacy and effectiveness of their systems and internal controls on a regular basis and take appropriate measures to address deficiencies. This must include maintaining a permanent, independently operating compliance function.
Risk Management Function
A firm is required under Regulation 36 to establish, implement and maintain adequate risk management policies and procedures, to adopt processes and arrangements to manage those risks and to monitor compliance with those risk policies and procedures.
An independent risk management function is envisaged where it is proportionate and appropriate in light of the nature, scale and complexity of the investment firm's business.
Internal Audit Function
Regulation 37 of the MiFID Regulations envisages that a separate internal audit function be established and maintained where it is proportionate and appropriate in light of the nature, scale and complexity of the investment firm's business.
Reports to Senior Management
Regulation 37 of the MiFID Regulations also requires reports on internal controls and risk management to be provided to senior management on a frequent basis (and at least annually).
A firm is required under Regulation 38 of the MiFID Regulations to maintain effective and transparent procedures for the reasonable and prompt handling of complaints and keep records of such complaints and their resolution.
Implications of draft MiFID II Legislation
The draft MiFID II Legislation contains proposals to enhance these high level organisational standards. Pleasae see section entitled "MiFID II - Proposed Changes" for further information.
CONDUCT OF BUSINESS REQUIREMENTS
The MiFID Regulations contain certain conduct of business requirements which apply to the activities of an investment firm which include:
All clients must be classified as either; (i) retail clients; (ii) professional clients; or (iii) eligible counterparties and must receive specific information depending on such classification.
Clients must receive prior notification of the nature and degree of risk involved, details of fees and expenses etc and subsequent information about the status of execution of the instruction and must also receive regular statements and reports on the products and services acquired via the investment firm.
Retail Clients: By default, clients who are neither eligible counterparties nor professional clients are considered to be retail clients. This means most natural persons. Retail clients enjoy the highest level of protection.
Professional clients: These are large businesses which conform to criteria of size in terms of their balance sheet, turnover and/or share capital. The definition of "professional client" is set out in Schedule 2 to the MiFID Regulations. Obligations to such clients in terms of information are, consequently, limited.
Eligible Counterparties ("ECPs"): These are professional clients (e.g. investment companies, credit institutions, pension funds, central banks, etc.) who operate in the financial sector. The definition of "ECPs" is set out in Regulation 3 to the MiFID Regulations. Certain obligations concerning information provision, best execution requirements, prompt, fair and expeditious execution of client orders etc will not apply to transactions with ECPs.
An investment firm is required (under Regulation 81(1)(b)) to notify clients about the right to request a different catergorisation in certain circumstances and about any limitations on the level of client protection that different categorisations would entail.
Investment firms must take reasonable steps when executing orders to ensure the best possible result for their clients, taking account of price, cost, speed, likelihood of execution and settlement, size, nature and any other consideration relevant to the execution of an order.
Investment firms must establish and implement an 'order execution policy' that will ensure the best possible result for the client. This policy must include information on different venues where the investment firm executes its client orders and the factors affecting the choice of the venue. Firms must also provide appropriate information to their clients on the order execution policy and are required to obtain the prior consent of their clients to the execution policy.
If the order is executed outside a RM or an MTF, the investment firm must inform their clients of this possibility in the policy. Prior 'express' consent must be obtained by the investment firm before proceeding to execute orders outside a RM or an MTF. This consent may be obtained in the form of an agreement or in respect of an individual transaction.
A firm will need to monitor the effectiveness of its order execution arrangements including execution venues and execution policy to achieve best execution opposed to any alternatives at least on an annual basis. Firms are required to advise customers of any material changes to their order execution policy or arrangements.
If an investment firm is only providing execution-only services and/or the reception and transmission of client orders, it will not be required to assess the suitability of the product or service if it relates to certain instruments, namely: shares admitted to trading on a RM (includes equivalent markets outside the EU); money market instruments, bonds, or securitized debt (excluding bonds or securitized debt that embed a derivative); and noncomplex financial instruments.
Execution-only services can be provided only at the initiative of the client. The client must be clearly informed that as there is no requirement to asses the suitability of the instrument or service offered, the client will not benefit from the full conduct of business rules. The firm must also warn the client that it has not assessed the suitability of the product/service.
The firm must also ensure that it complies with the conflict of interest rules set out in Regulation 74 and 75 of the MiFID Regulations when providing execution-only services.
Client Order Handling
Investment firms are required to take all reasonable steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order.
Order Allocation Policy - This is required to ensure the fair allocation of aggregated orders and transactions and to address how the volume and price of orders relates to how they will be allocated in each case.
This policy must:
- provide for the prompt, fair and expeditious execution of client orders by that investment firm, and
- provide for the execution of comparable client orders in accordance with the time of their receipt by the investment firm.
Implications of draft MiFID II Legislation
The draft MiFID II Legislation contains proposals to enhance these high level conduct of business standards. Please see section entitled "MiFID II - Proposed Changes" for further information.
The Capital Requirements Directive sets out the level of regulatory capital which an investment firm must maintain. The Capital Requirements Directive introduced a pillar approach to capital requirements. The Capital Requirements Directive was transposed into Irish law via the European Communities (Capital Adequacy of Investment Firms) Regulations 2006 (S.I. No. 660 of 2006) and European Communities (Capital Adequacy of Credit Institutions) Regulations 2006 (S.I. No. 661 of 2006). The amount of regulatory capital depends on a number of factors such as the size of the investment firm and the investment services which it provides.
If the proposed investment firm is considered to be small and non-complex then a lower initial capital requirement will apply and will be either â,¬50,000 or â,¬125,000. If the investment firm wants to carry out the investment service of dealing on own account then the initial capital requirement is increased to â,¬730,000. The minimum capital requirement will be the greater of the initial capital requirement or 25% of projected fixed overheads as set out in the financial projections. The Central Bank also has discretion to impose a buffer under Regulation 19(3) of S.I. 660 of 2006, which would be equal to the total of the firm's fixed overheads for the first 3 months of operation. This figure would be added to the higher of the firm's initial capital requirement or fixed overhead requirement to produce a figure for the firm's capital requirements. Pillar 2 of the Capital Requirements Directive provides that investment firms would also need to consider whether they need to hold additional capital against firm-specific risks which are not covered by Pillar 1 of the Capital Requirements Directive.
Each investment firm is required to formulate an Internal Capital Adequacy Assessment Process (ICAAP) as a means of determining an adequate level of capital required to cover the business's risks.
The Central Bank distinguishes between "small, non-complex firms" and "large and/or complex firms" when assessing and applying capital requirements.
The Central Bank has outlined guideline criteria to identify which category is appropriate for investment firms. The criteria under which an investment firm will be considered large/complex includes: (i) if it is authorised to trade for its own account; (ii) if it is authorised to underwrite issues on a firm commitment basis; (iii) if it uses models to determine regulatory capital; (iv) if it describes itself as large or complex; (v) if it has a significant presence in the local market and/or has large international activities; or (vi) if it is a member of the Irish Stock Exchange. Firms that fall outside this criteria would generally considered to be small, non-complex firms.
Small, non-complex firms will be required to prepare an ICAAP on the basis of the Central Bank's ICAAP Questionnaire. Large and/or complex firms will be will be required to prepare an ICAAP on the basis of the Central Bank's ICAAP Portal.
The ICAAP Portal requires a more detailed and sophisticated level of risk calculation appropriate for more complex businesses. In practice, it will typically require an investment firm to maintain a higher level of capital to cover risk than that required for small, noncomplex firms under the ICAAP Questionnaire.
MiFID II - PROPOSED CHANGES
The proposals contained in the draft MiFID II Legislation are comprehensive and represent significant changes to the regulatory regime currently in place in Ireland. The purpose of this section is to summarise the key changes which the draft MiFID II Legislation proposes to introduce to the current regulatory framework. The draft MiFID II Legislation is divided into two parts;
(i) a revised Directive which will be an amendment and restatement of MiFID, (the "MiFID II Directive"); and
(ii) a new Regulation which will set out requirements relating to trade transparency and the mandatory trading of derivatives on organised venues, (the "MiFID II Regulation"). EU Regulations take effect as soon as they are published by the European Commission and are binding on all EU Member States as soon as they become effective. EU Regulations do not require any implementing measures. It is hoped that the MiFID II Regulation will minimise any scope for divergences in the interpretation of transparency and transaction reporting provisions.
The European Securities and Markets Authority ("ESMA") has been asked to draft accompanying technical standards, (the "Technical Standards") which as yet have not been published. Therefore it will not be possible to assess the full extent of the proposed changes until the Technical Standards are published. Furthermore it is likely that additional changes will be made to the draft MiFID II Legislation as it is negotiated between the European Commission, European Parliament and the European Council.
Implications of MiFID II
The draft MiFID II Legislation will have implications for existing investment firms which are authorised under the MiFID Regulations and for firms that will be brought within the scope of the regulatory regime as a result of the proposed changes contained in the draft MiFID II Legislation. The proposals expand the scope of MiFID as follows:
- At Firm level - a larger number of investment firms will now fall within the scope of MiFID for the first time; e.g. a broader range of commodities firms, certain data providers and third country firms;
- At Product level - a larger number of products will be covered; e.g. structured deposits and emission allowances;
- At Service level - Custody services, (safekeeping and administration of financial instruments for the account of clients) which were previously classified as ancillary services, will now become a core investment service instead of an ancillary service, which will bring standalone custodians in Ireland within scope of the MiFID Regulations (as opposed to falling to be regulated under the Investment Intermediaries Act 1995 as is currently the case).
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