On 3 January 2022 the European Securities and Markets Authority (ESMA) published its Final Report on "Guidelines on certain aspects of the MiFID II appropriateness and execution-only requirements" (the 2022 Guidelines).1 The purpose of the 2022 Guidelines is to enhance clarity and to foster convergence of the appropriateness and execution-only requirements in the EU's MiFIR/MiFID II legislative and regulatory regime as well as how national competent authorities (NCAs) supervise financial services firms' compliance.
Under the EU's MiFIR/MiFID II rules firms providing 'non-advised services' are required to request information on the knowledge and experience of clients or potential clients to assess whether the investment service or product envisaged is appropriate, and to issue a warning in case the investment service or product is deemed inappropriate. The execution-only framework allows for an exemption to this assessment in certain conditions, including that the firm issues a warning to the client.
The publication by ESMA of the 2022 Guidelines closes the chapter on a workstream that started on 3 June 20192 in which ESMA first used a new tool, a common supervisory action (CSA), across the EU-27 with a view to driving convergence on rules, their interpretation and how NCAs monitor compliance by relevant firms. CSAs, when introduced, marked a shift in ESMA's approach and supervisory scrutiny well beyond what firms may have experienced in national led thematic reviews and/or action targeting specific firms (or indeed NCAs).
The 2019 CSA's results evidenced there was much need for convergence in the area of appropriateness and execution-only activities of firms. A public consultation on the draft of the 2022 Guidelines took place in January 2021.3 Consequently, the final 2022 Guidelines further refine and harmonise principles on several important points in the appropriateness process, spanning from the information disclosed to clients about the purpose of the appropriateness assessment, the arrangements necessary to understand clients and products, as well as the matching of clients with appropriate products and the effectiveness of warnings. The 2022 Guidelines further clarify the execution-only exemption and record-keeping and controls. The final 2022 Guidelines are now set to be translated into the official languages of the EU and published on ESMA's website and concurrently trigger a two-month period in which NCAs must confirm to ESMA whether they will comply with the 2022 Guidelines (there is an expectation that most NCAs will) or not. The final 2022 Guidelines will apply six months following the date of their publication on ESMA's website in all EU official languages.
This Client Alert provides a recap on the relevant MiFID II requirements that were assessed as part of the CSA, the findings ESMA published following completion of its 2019 CSA and an overview of the new 2022 Guidelines and the impact on affected financial services firms. In summary, relevant financial services firms will want to be prepared to respond to questions from NCAs and equally implement, where necessary, targeted changes to the selling practices of financial instruments in the EU-27.
Background to the relevant MiFID II requirements in scope of the 2019 and 2020 CSA
Since 3 January 2018, the EU's revised Markets in Financial Instruments Directive 2014/65/EU of (MiFID II) and its complementary Regulation (MiFIR) have been the key set of conduct of business rules concerning transactions in financial instruments as well as, amongst other things, investor protection rules. MiFID II distinguishes between advised sales, non-advised sales and execution only transactions. When providing investment services, notably advice to clients (i.e., an advised sale), a firm has to assess whether the MIFID financial instruments or investment service(s) it provides to the client are "suitable" for such client. Suitability means that that such instrument or service:
- meets the investment objectives of the client in question, including the client's risk tolerance levels;
- is such that the client is able financially to bear any related investment risks consistent with his investment objectives; and
- is such that the client has the necessary experience and knowledge in order to understand the risks involved in the transaction or in the management of the client's portfolio.
In the event that a firm concludes that the investment service, product or financial instrument is deemed inappropriate the firm has to issue the client with a warning to that effect.
If neither investment advice nor financial portfolio services are provided, the firm will only have to assess whether the financial instruments or service it offers to its client are appropriate for such client. In such instances the appropriateness test only requires that the third of the abovementioned items i.e., the client's experience and understanding is completed and documented.4
The rules in the MiFIR/MiFID II framework however do permit financial services firms to sell a financial instrument to a client without having assessed the appropriateness for that client. Such sales are referred to as "execution only" sales and are only permitted in the case of non-advised sales that relate to "non-complex" financial instruments. Such "non-complex" instruments include: (a) shares and bonds admitted to trading venues in the EU, (b) money market instruments and (c) shares in non-structured UCITS funds. If a firm is conducting such an execution-only sale then the firm is required to warn the client that it is not required to conduct an appropriateness assessment and thus that the client will not benefit from corresponding investor protection.
Given that the rules on suitability and appropriateness are mostly set out in MiFID II, i.e., an EU Directive, these rules had to be implemented by each EU Member State into "their" own domestic frameworks. Divergences have followed, especially as Member States, in implementing MiFID II, were permitted to make use of national options and discretions. Equally, the supervision of MiFID II (on these rules and generally) may, despite supervisory convergence efforts by ESMA, differ between NCAs. ESMA's 2019 CSA and the 2022 Guidelines seek to
As a directive, MiFID II had to be implemented into the domestic law of each EU Member State. In implementing MiFID II and in supervising its application, member states have a certain degree of discretion. Thus, the legal implementation and the supervision of MiFID II by the competent NCAs may vary between Member States.
1 Available here but which should also be read in conjunction with an earlier "Supervisory Briefing" from April 2019 (available here) from ESMA on the same subject, even if issued in the context of wider-reaching guidelines on suitability from May 2018 an area that itself was subject to a CSA in 2020. Technically the 2019 Supervisory Briefing still remains valid and in force even if it has not been updated to cross-refer to the 2022 Guidelines to which it is of course subsidiary in the rulemaking hierarchy. Moreover, firms will want to also read this Client Alert in conjunction with other coverage (available from our EU RegCORE Thought Leadership section) on ESMA's CSA, notably on its CSA on MiFID II Suitability Rules that was launched 5 February 2020 which concluded with publication of results on 21 July 2021 and the final Guidelines on the topic.
2 See announcement here.
3 See further details here. The consultation closed 29 April 2021 and ESMA received 33 responses of which 5 were confidential. ESMA also received advice from its "Securities and Markets Stakeholders Group". The public responses are available on the ESMA website.
4 As set out in Art. 56(1) of Delegated Regulation (EU) 2017/565).
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.