FCA Publishes MiFID II Consultation Paper No.3-CP16/29

On Thursday, September 29, 2016, the FCA published what is probably their third and last MiFID II Consultation Paper - CP16/29. The two previous CPs dealt with a wide range of items and this one wraps up the remaining elements. It covers in particular conduct of business issues and also some slightly more contentious topics which the FCA has given itself a little longer to think about. This Consultation runs to 4 January 2017 except Chapter 16, dealing with SUP, where responses are required no later than 31 October 2016.

MiFID II is maximum harmonizing but permits Member States, where specified, to ‘gold plate’ certain provisions at the domestic level. The UK has notified the EU Commission where it intends to do so and has specified these situations in the consultation papers. The intention of the FCA is to issue its MiFID II Policy Statement in the first half of 2017 when the applicable date for MiFID II could only be six months away. The FCA in implementing MiFID II clarifies where it is not permitted to make its own rules, because these are EU regulations, and explains where it can. In some circumstances the FCA is copying out regulations into its Handbook and clarifying their meaning, to assist UK firms in complying with these provisions.

We have identified the following areas from this latest CP as likely to be of most interest. However, we will be keeping a close eye on MiFID II implementation and we intend to comment further on specific elements in future.

Client Classification

MiFID II’s client classification rules change the existing regime by increasing regulatory protection for certain public bodies, such as local authorities. Client classification, in the main, remains untouched except in relation the inability, from 3 January 2018, to opt-up elective professional clients to eligible counterparty status.

Suitability

MiFID II expands the suitability requirements which apply to firms carrying on MiFID or equivalent third country business, as well as applying them to exempt MiFID Article 3 firms.

Appropriateness

Appropriateness applies only to ‘complex products’ when these are being distributed where no personal recommendation is made or when a discretionary portfolio management service is not taking place (as these are subject to suitability which is a wider test than simply Appropriateness). Complex products cannot be distributed on a pure execution only basis.

MiFID II has narrowed the list of products categorized as ‘non-complex’ and by definition the universe of ‘complex’ products has increased. This is something firms need to be aware of if they are not providing a personal recommendation or undertaking portfolio management services

Inducements

MiFID II implements enhancements to the existing Inducements regime applicable here in the UK for a variety of firms (e.g. personal investment firms and MiFID investment firms). The FCA’s Consultation deals with the ‘Use of Dealing Commission’ separately from the more general MiFID II inducement provisions.

Inducements and Research (use of dealing commissions)

The FCA points specifically to the clients of portfolio managers and firms which provide investment advice in the context of the Use of Dealing Commissions. The FCA proposes to transpose the provisions of MiFID II in this regard to a new COBS section (COBS 2.3B) that will also link to the new general inducement provisions (COBS 2.3A), discussed in the section directly above.

Collective Portfolio Management Firms/Collective Portfolio Management Investment Firms

Of particular note, the FCA intends to apply the Use of Dealing Commissions’ provisions to Collective Portfolio Management Firms (CPM) and Collective Portfolio Management Investment Firms (CPMI). These are UCITS ManCo, Full-scope UK AIFM (including an internally managed AIF), Small Authorized UK AIFM, residual CIS operators and incoming EEA AIFM branches.

Dealing and Managing

The FCA is proposing substantive changes brought about by MiFID II in regard to Best Execution (COBS 11.2) and Client Order Handling (COBS 11.3).

Disclosure Requirements

The proposed COBS Disclosure Requirements introduce new chapters or sections to: GEN 1 (appropriate regulator approval and emergencies), COBS 1 (application), COBS 2 (COBS obligations), COBS 4 (communicating with clients, including financial promotions), COBS 6 (information about the firm, its services and remuneration), COBS 14 (providing product information to clients) and COBS 16 (reporting information to clients).

Knowledge and Competence Requirements

The FCA believes their existing Training and Competence Sourcebook (TC) provides a sound base from which to ensure MiFID firms meet the knowledge and competence provisions of MiFID II. However, to ensure this, the FCA is proposing to make changes to the TC sourcebook and, as necessary, to SYSC 5. These will apply to all common platform firms. The proposal is to extend the scope of the TC sourcebook to include reference to the MiFID II’s ESMA Guidelines on the Assessment of Knowledge and Competence.

Recording of Telephone Conversations and Electronic Communications (taping)

MiFID II introduces an obligation on firms to record telephone conversations and electronic communications. This applies when providing specified client order services that relates to the reception, transmission and execution of orders or when dealing on own account. The UK has had its own ‘taping regime’ since 2009 which implemented provisions similar to those now required by MiFID II. However, the FCA is now proposing to extend the application of these provisions to certain exempt MiFID Article 3 Firms.

Of particular note to Asset Managers

There are some interesting FCA proposals for Asset Managers, some of which were expected, some not. Two significant ones are the FCA’s proposals as they apply to:

1. Collective Portfolio Management Firms (CPM) and Collective Portfolio Management Investment Firms (CPMI) for the whole of their business, on the application to them of the Use of Commissions, Best Execution Transparency (notably the inconsistent application to UCITS ManCo and AIFM) and the Taping Rules. CPM/CPMIs are not directly subject to MiFID but do undertake similar activities to firms’ authorized under MiFID.
2. The Discretionary Investment Manager (Portfolio Manager) taping exemption is to be abolished, meaning that these Firms will have to then meet these provisions in full from 3 January 2018.

Duff & Phelps MiFID Gap Analysis Tool

Duff & Phelps is developing a tool to assist firms, within the scope of MiFID II, to identify the changes the firm has to make to its policies, procedures, systems and controls.