Hedgeweek MiFID II Blog Series: Considerations for Non-EU Entities

Duff & Phelps' Nick Bayley is a managing director in the Compliance and Regulatory Consulting practice and has partnered with Hedgeweek to provide a monthly blog series providing insight on this imminent regulatory change.

Prior to this, Nick was a Head of Department in the FCA's Markets Policy and International Division, FCA Senior Markets Advisor, and was responsible for the UK regulator’s MiFID II Policy Project.

I was recently in New York advising a large sell-side institution on the potential impact of MiFID II. During that meeting, I was talking through why the legislation was being introduced and reflected that it’s now nearly 10 years since the financial crisis, yet still we haven’t some of the regulatory mechanisms in place in Europe. 

Be that as it may, there seems to be a lot of misinformation flying around about how MiFID II will impact third countries.  Some may be keen to over-hype the regulation and the terrible impact it is going to have on people’s businesses, whilst others seem to have assumed it won’t affect them at all, despite their quite active involvement in EU financial markets. 

The broad nature of my US client’s business meant they were perhaps justified in having concerns.  US firms are very used to the extra-territoriality of their laws, with legislation like the Patriot Act spreading its tentacles across the world and perhaps understandably, they had concerns about the global reach of MiFID II 

In fact, very little of MiFID II applies directly to anybody outside the EU.  However, the indirect effects of the legislation on those sitting outside the EU but who have dealings with EU financial instruments and markets, are many and varied.

In situations where firms participate in EU trading venues, or where they provide their clients with direct electronic access to EU markets, for example, the legislation begins to bite.  Not because the non-EU firms are governed by MiFID II but because the EU markets with which they interface will effectively have to build the MiFID II regulations into their rules and apply them to all their participants and members, wherever in the world they are.  

There is also a need for EU trading venues to transaction report to their national regulator for all their direct participants that do not transaction report themselves.  This is less of an issue in the equity markets, where members of the LSE are almost all EU brokers that will transaction report.  The situation of EU futures exchanges, with numerous members outside the EU or the newly expanded MTFs operated by Bloomberg, Thomson Reuters and the like that have hundreds of participants across the world, is creating a logistical challenge.  All the non-EU firms that use these trading venues will have to supply quite a lot more data to the venue for the venue’s transaction reporting purposes.

Another aspect of MiFID II, which will affect some non-EU entities, is the new product governance rules. Again, the rules do not apply directly to anyone outside the EU.  However, if you are a fund manager (or other product manufacturer) whose product is actively distributed in the EU you will very likely have to supply product information (target markets assessments, risks, stress testing and the like) in a MiFID II format to your EU distribution partners. 

So, in many cases MiFID II will effectively be indirectly imposed on non-EU firms by contractual means.  

There is also the question of delegation.  If an EU firm delegates important services like portfolio management to, say, a US affiliate, the US firm will get drawn into the MiFID II web. The FCA has been quite clear on this. Their view is that they want the same outcomes for EU investors dealing through EU firms, regardless of whether the investment manager is located; in London or New York and the MiFID II requirements, such as best execution, will therefore provide the benchmark for assessing the execution performance of the US affiliate for EU investors. The FCA won’t be happy if someone in the UK outsources portfolio management back to the US and the proper controls and processes are not in place. 

A third aspect of MiFID II, which third country firms should be mindful of, is role MiFID II will play in the evolution of global standards.  In some cases, much of the world can be expected to move towards the MiFID II standard as a global approach.

Research unbundling is an interesting case in point. 

The fact that the SEC has now issued a 30-month ‘no action letter’ in relation to the MiFID II research rules, and that there are discussions going on across the globe, from Japan to South Africa, as to whether regulators should adopt the MiFID II standard on research unbundling, is noteworthy. 

Global institutions will also likely welcome global standards, especially in relation to matters like research unbundling. If I’m a global asset manager and I have committed to paying for research out of my P&L or through a Research Payment Account model, am I likely to restrict that decision to the EU?  Wouldn’t I prefer to adopt that model to pay for research across all my global offices?  Following the MiFID II route should mean that investors will have greater confidence that any potential conflicts of interest are being managed and that their money, if the investors pay directly for the research, is being spent properly. 

There are two forces at work: one coming from global regulators, who tend to analyse regulatory developments in the US and the EU and then broadly follow the same course; and the other coming from global financial organisations. Both of these forces, in my view, are likely to push the global industry towards a MiFID II standard and overall that cannot be a bad thing. 

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