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.
1 European Economic Area (members comprised of EU member states, Iceland, Norway and Liechtenstein)
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.