The FCA has published Policy Statement 17/14: Markets in Financial Instruments Directive II Implementation – Policy Statement II (PS17/14).
PS17/14 follows Policy Statement 17/5, published in March this year, which covered mainly MiFID II markets and organisational requirements. It sets out final rules on conduct of business, client assets and final rules and guidance on certain other matters. The near final rules that were published in the earlier Policy Statement have also been finalised in PS17/14.
In PS17/14 the FCA summarises the feedback received to issues from across CP15/43, CP16/19, CP16/29, CP16/43, and CP17/8, but most notably the client asset rules from CP16/19 and the conduct rules from CP16/29.
In CP15/43 and CP16/19 the FCA published Handbook guides on, respectively, the implementation of the markets provisions in MiFID II and the organisational requirements in MiFID II. The FCA will publish the final versions of these guides in due course.
Structure of PS17/14
PS17/14 is a very large document, being 1,068 pages long. Pages 3 to 158 of PS17/14 provide the FCA’s feedback on its earlier consultations and comprises of 26 chapters and one annex. Pages 162 to 1,068 contain the updated final Handbook text.
Key chapters in PS17/14 include:
- chapter 2 (page 8) – additional requirements;
- chapter 4 (page 23) – client assets;
- chapter 6 (page 38) – inducements, including adviser charging;
- chapter 7 (page 48) – inducements relating to research;
- chapter 11 (page 85) – suitability;
- chapter 12 (page 87) – appropriateness;
- chapter 13 (page 89) – dealing and managing;
- chapter 15 (page 103) – investment research;
- chapter 17 (page 107) – product governance;
- chapter 19 (page 120) – taping; and
- chapter 23 (page 150) – structured deposits.
General points to note
In PS17/14 the FCA has made significant policy changes to some of its proposals, but for others it has maintained its approach. Points of note include:
- inducements in relation to research. The FCA will apply these provisions to collective portfolio managers and not only to the investment firms that are subject to MiFID II. Other than this discretionary extension of scope, the FCA is not going beyond the MiFID II regime. The FCA is also amending its guidance on how quickly research charge deductions should be passed into a research payment account (RPA) and clarifies that it does not require investment managers to have a single RPA per research budget;
- client categorisation. The FCA is revising its proposals for criteria for local authorities opting up to professional client status. The revised criteria has a lower threshold for the size of portfolio that a local authority has to have, and makes it easier for local authorities investing on behalf of a local government pension scheme fund to opt-up to professional client status if they wish to;
- best execution. The FCA will not, contrary to the proposals it consulted on, apply the changes in the best execution rules in MiFID II to Alternative Investment Fund Managers (AIFMs);
- The FCA maintains its view that collective investment undertakings other than Undertakings for Investments in Transferable Securities (UCITS), including non UCITS retail schemes and investment trusts, are neither automatically non-complex nor automatically complex; and
- The FCA will not apply a requirement for recording phone conversations and electronic communication (‘taping’) to all investment services and activities carried out in relation to corporate finance business. The FCA will, as proposed, remove the current partial exemption in its taping rules for discretionary investment managers albeit making some modifications to the way the rule applies. It has also decided that where Article 3 firms decide to take a note rather than record a telephone conversation it expects the note to include key details of any orders taken and the key substance of the main points of the conversation.
Going beyond the MiFID II requirements
Chapter 2 of PS17/14 deals with the circumstances where the FCA has gone beyond applying the minimum MiFID II standards. Points of note include:
- portfolio managers and firms operating pension funds that are not authorised under MiFID must currently transaction report. The FCA recognises that these firms would experience a significant increase in the burden of transaction reporting were they be subjected to the new rules under MiFID II. The FCA states that it will “therefore remove the obligation to transaction report from these firms for the time being”;
- the FCA will not in the main apply the conduct requirements in MiFID II to business involving pensions and insurance-based investments. Parts of the Insurance Distribution Directive package remain to be finalised and it will consult separately on the application of its conduct standards to insurance-based investments;
- the FCA will maintain its existing Retail Distribution Review (RDR) adviser charging and platform rules which it believes are crucial to managing conflicts of interest and the potential for bias in the sale of retail investment products;
- the FCA is extending the MiFID II inducement ban for firms providing independent investment advice and portfolio management. For firms providing services to retail clients, the FCA will: (i) extend the inducement ban to the provision of restricted (as well as independent) advice; and (ii) prohibit the acceptance of commission and benefits, rather than their acceptance and retention (i.e. to ban rebating of inducements). Both of these will require notifications to the European Commission;
- the FCA will keep existing CASS rules, specifically in the two areas that go beyond MiFID II. First, a requirement for a daily report on clients’ assets from prime brokers to their clients. Second, a restriction on set-off rights relating to client money. The latter will require a notification to the Commission;
- SYSC 4, when implementing MiFID, the FSA retained a rule that a firm needed to apportion responsibility for significant responsibilities relating to its operation amongst senior management and the FCA is not changing this rule as part of its MiFID II implementation;
- SYSC 6, when implementing MiFID, the FSA applied the organisational requirement that a firm should have adequate policies and procedures sufficient to ensure compliance with its obligations, not just to its obligations under MiFID but with “…its obligations under the regulatory system and for countering the risk that the firm might be used to further financial crime.” The FCA continue to believe that this requirement is important and is not changing it; and
- a table setting out the additional requirements in the FCA implementation of MiFID II can be found on page 15 of PS17/14.
Chapter 4 of PS17/14 covers responses to the questions in chapter 7 of CP16/19 and chapter 18 of CP16/29 on the proposed amendments to the Client Assets sourcebook (CASS) arising from MiFID II implementation.
The FCA’s feedback in this chapter covers:
- prohibition on transfer collateral arrangements (TTCAs) with retail clients;
- inappropriate use of TTCAs with non-retail clients;
- custody and client money liens;
- delegation of safekeeping duties to a third party;
- internal firm assessments of qualifying money market funds and express client consent;
- depositing client money in a group banks;
- preventing unauthorised use of assets;
- taking collateral when arranging securities lending; and
- appointment of a single officer for safeguarding of client assets.
Points to note in relation to custody and client money liens include:
- the FCA’s final rules implement the prohibitions set out in MiFID II with only the permitted exceptions stated in MiFID II. MiFID II does not include an exception for where a client has instructed the firm to grant a lien on its behalf that extends wider than the recovery of debts permitted under MiFID II, so the FCA has not included this in its new rules;
- the final FCA rules are not intended to disrupt the use of omnibus accounts in custody chains. The FCA has added guidance explaining how ‘applicable law’ should be understood in this context;
- the FCA agrees that the MiFID II rules on client money liens are already implemented in the CASS 7 acknowledgment letter rules. As a result it has deleted the client money lien rules on which it consulted;
- the FCA is not adopting any transitional provision for existing lien arrangements as the acceptable circumstances for general liens has been clearly identified in earlier technical advice from the European Securities and Markets Authority; and
- the FCA expects firms to record any security interest, lien or right of set-off in client contracts and in their books and records ultimately in a way that allows ownership rights to be readily established on insolvency. The FCA expects these records to evidence that the client has agreed to the firm being able to grant a third party a lien over the client’s assets (and not necessarily list all the terms in the client contracts) and to allow the firm to identify all the client assets that are subject to a lien (including where this involves the firm being informed by a third party) at all times.
Inducements, including adviser charging
In chapter 6 of PS17/14 the FCA provides its response to the feedback received to its proposals in chapter 2 of CP16/29 (inducements, including adviser charging).
Importantly, the FCA confirms that it is taking forward the changes necessary to implement the MiFID II inducement ban in relation to independent advice, and is extending these requirements to the provision of restricted advice but only where restricted advice is provided to retail clients in the UK.
The FCA is also proceeding with its consultation proposals concerning the additional requirements of banning firms that provide independent or restricted advice or portfolio management services to retail clients from accepting and rebating monetary benefits to such clients. The FCA considers that this is a necessary alignment with its existing RDR approach. As suggested in the consultation responses, the FCA will limit the territorial application of the additional domestic requirements so that they only apply where the retail client is in the United Kingdom.
Inducements relating to research
Chapter 7 of PS17/14 covers the FCA’s responses to feedback it received on its proposals concerning inducements and research that were set out in CP16/29.
Among other things, the FCA states that it has clarified the scope of COBS 2.3C – the requirement on brokers to price execution and research or other services separately – to make clear that investment firms do not have to price separately to third country firms based outside the EEA, although they may choose to do so voluntarily.
The FCA will proceed with its approach that pricing should be provided to all MiFID II investment firms regardless of the activities they are carrying out. The FCA views this as consistent with the specific provisions in MiFID II as well as the wider emphasis on transparency over costs and charges.
The FCA also confirms that it will proceed with its proposals to extend the MiFID II requirements on inducements and research to most forms of collective portfolio managers, including UCITS management companies, full-scope AIFMs and most small authorised UK AIFMs and residual collective investment scheme operators.
Chapter 15 of PS17/14 covers the FCA’s response to the feedback on its proposals concerning the MiFID II investment research requirements set out in CP16/29.
The FCA confirms its approach as consulted on in CP16/29 to implementing the MiFID II provisions on the production and dissemination of investment research. The FCA also reminds firms to carefully consider the application of the provisions set out in the new COBS 12.2. As set out in this new provision, the requirement for firms to maintain physical separation between analysts and other persons, as well as the provision stating that analysts should not participate in investment banking activities, apply only to producers of investment research. Producers of non-independent research should, however, consider their general conflicts of interest obligations under SYSC 10. Firms should also be aware that in CP17/5 the FCA is currently consulting on changes to COBS 12 to address conflicts of interest that arise during the production of research around the time that investment banking pitching efforts take place.
The FCA states that ultimately it is for firms to make a judgement on circumstances when it might not be proportionate to maintain a physical separation of analysts from other persons, and on the types of alternative information barriers that could be maintained when physical separation is not proportionate. The FCA reminds firms that they should be mindful of their obligations under SYSC 10.2 if establishing and maintaining a Chinese wall, which requires them to have policies in place permitting certain individuals to withhold information from other persons.
Chapter 19 of PS17/14 sets out the FCA’s feedback on the responses to its proposals in CP16/29 and CP16/43 to implement the MiFID II taping requirements.
Among other things, the FCA has considered the feedback it received on its proposal to extend the taping requirements to corporate finance business. MiFID II requires in-scope firms to record telephone conversations and electronic communications that occur when providing client order services that relate to the reception, transmission or execution of client orders, or when dealing on own account. In response to the feedback received the FCA will not extend the MiFID II taping regime to capture all aspects of corporate finance business. However, communications occurring during corporate finance business will be in-scope of the taping requirements insofar as they are automatically captured by the MiFID II requirements.
The FCA also confirms that it will continue with its approach as set out in CP16/29 and CP16/43 to apply the MiFID II taping requirements to energy market participants, oil market participants and firms conducting other non-MiFID commodity and exotic derivatives business.
In relation to structured deposits the FCA is making the changes to the application of COBS as proposed in CP16/29, and the consequential changes to Banking: Conduct of Business sourcebook proposed in CP16/43.
The FCA expects firms to continue with their preparations for the application of MiFID II on 3 January 2018. The FCA expects firms to take reasonable steps to meet this deadline.
Firms that need to apply for authorisation or variation of permission should prioritise their submission of a completed application as a matter of urgency. The FCA cannot, however, guarantee that these applications will be determined by 3 January 2018. Such firms must have contingency plans in the event that by 3 January 2018 they do not have the required permissions.
Alongside PS17/14 the FCA has published Consultation Paper 17/19: Markets in Financial Instruments Directive II implementation – Consultation Paper VI (CP17/19).
In CP17/19 the FCA proposes certain miscellaneous amendments to the Handbook which involve:
- bringing recognised investment exchanges operating multilateral trading facilities and organised trading facilities into the scope of the Financial Services Compensation Scheme;
- making certain changes to the Decision Procedures and Penalties Manual and Enforcement Guide as described in CP17/8 These arise from the final version of legislation implementing MiFID II; and
- technical changes to the Prospectus Rules and Glossary arising out of legislative changes which implement MiFID II.
The deadline for comments on CP17/19 is 7 September 2017. The FCA intends to publish the necessary rule changes by November 2017.
Further briefing notes
We will shortly be publishing more detailed briefing notes on PS17/14.