MIFID II – A second overhaul of Europe's regulatory framework

The below article is reproduced from the February 2018 edition of Exchange – International magazine. For more about financial services regulatory issues across the world, the full magazine is available for download here.

The second Markets in Financial Instruments Directive (2014/65) (MiFID II) came into force on 3 January 2018, alongside the Markets in Financial Instruments Regulation (600/2014) (MiFIR). Both pieces of legislation set out the framework of requirements for investments firms operating in the EEA and are aimed at achieving more transparency and greater protection for investors.

This article examines some of the key developments which took place in the run-up to the implementation date as well as the ongoing workstreams in relation to MiFID II and MiFIR.

European implementation of MIFID II

European Commission FAQs on MiFID II inducements and research reforms

On 26 October 2017, the European Commission (Commission) published a set of FAQs on the application of MiFID II to third country broker-dealers in order to assist MiFID II portfolio managers and their third country sub-advisors with implementation of MiFID II in a cross-border context. The FAQs reflect the Commission’s position and do not constitute authoritative interpretation of EU legislation but are likely to be followed as it is expected to be some time before any more authoritative interpretation is given.

The FAQs have been published following discussions between the Commission, the US Securities and Exchange Commission (SEC) and other non-EU jurisdictions, after UK market participants raised concerns with the FCA that, as MiFID II comes into effect, they would be unable to continue to access research in non-EU jurisdictions and comply with the MiFID II requirements.

Following discussions with the Commission, the SEC has also published a related press release providing information about no-action letters it issued to facilitate the cross-border implementation of the MiFID II research provisions.

The FCA published a statement welcoming the announcements of the Commission and SEC. It explained that the announcements enable arrangements that comply with MiFID II and other jurisdictions’ rules, while allowing EU firms’ continued access to research produced by US and other non-EU jurisdictions.

MiFID II technical standards published

On 26 October, two sets of technical standards required under MiFID and MiFID II were published in the Official Journal of the EU (OJ).

1. Authorisation of investment firms:
   
   Commission Delegated Regulation 2017/1943 contains regulatory technical standards (RTS) on information and requirements for the authorisation of investment firms. The RTS, developed under Article 7(4) of MiFID II, contain a harmonised list of information investment firms will have to submit to be authorised. They also set out the requirements applicable to the management of certain investment firms and the requirements imposed on shareholders and members with qualifying holdings.
   
   Commission Implementing Regulation 20 I 7/1945 contains implementing technical standards (ITS) with regard to notifications by the applicant firms and communication between the competent authorities and investment firms. The ITS, made under Article 7(5) of MiFID II, contain standard forms, templates and procedures for the notification or provision of information concerning applications for authorisation.
2. Acquisitions of qualifying holdings in investment firms:
   
   Commission Delegated Regulation 2017/1946, made under Article 10a(8) of MiFID and Article 12(8) of MiFID II, contains RTS on an exhaustive list of information to be submitted by proposed acquirers in the notification of a proposed acquisition of a qualifying holding in an investment firm. The proposed acquirer will be required to submit information, including the identity of acquirer and any persons that will effectively direct the business of the target entity, details of the acquisition and its financing and the new proposed group structure and its impact on supervision.
   
   Commission Implementing Regulation 2017/1944 contains ITS concerning the notification of a proposed acquisition of a qualifying holding in investment firms. The ITS were developed by the Commission under Article 10a(8) of MiFID and Article 12(9) of MiFID II. They lay down the standard forms, templates and procedures for the exchange of information between the competent authorities of the target and proposed acquirer.

All of the four Regulations listed above entered into force on 15 November 2017.

European Commission Equivalence Decisions

In December 2018, the Commission published two equivalence decisions to ensure that businesses and markets could continue to operate smoothly and without disruptions after 3 January 2018, when MiFID II and MiFIR became effective.

On 5 December 2017, the European Commission adopted an Implementing Decision on the equivalence of the legal and supervisory frameworks applicable to designated contract markets (DSMs) and swap execution facilities (SEFs) in the US under Article 28(4) of MiFIR. The legal and supervisory framework of the US applicable to DSMs and SEFs was considered by the Commission to be equivalent to the requirements laid down in MiFIR for trading venues. The Decision was published in the OJ on 6 December 2017 and entered into force on the next day.

The joint statement (Statement) issued by the European Commission and the US Commodity Futures Trading Commission (CFTC) explains that the US Decision allows EU counterparties to trade derivative instruments that are subject to the trading obligation on CFTC-authorised DCMs and SEFs in the US. This decision does not affect the ability of EU counterparties to continue to trade on any CFTC-authorised SEF or DCM with respect to those derivatives which are not subject to the EU’s trading obligation.

On 21 December 2017, the Commission adopted an Implementing Decision on the equivalence of the legal and supervisory framework applicable to stock exchanges in Switzerland (Swiss Decision) in accordance with Article 25(4)(a) of MiFID II. The Commission considered the legal and supervisory framework applicable to stock exchanges in Switzerland to be equivalent to the relevant EU requirements. SIX Swiss Exchange AG and BX Swiss AG are now considered equivalent to MiFID II regulated markets. This Decision is of limited duration and will expire on 31 December 2018 unless the Commission extends it prior to that date.

The Commission also explained that Switzerland differs in a number of ways from other jurisdictions that have been granted equivalence. The scope of this decision is much greater because the trading of Swiss shares in the EU (and vice versa) is more widespread than with the other jurisdictions that were recently recognised. As a result, “trading in Switzerland will have a bigger and more immediate impact on the integrity of EU financial markets, including regarding the prevention of market abuse”.

ESMA statement on delaying the implementation of LEIs

On 20 December 2017, ESMA published a statement on the introduction of LEI requirements. The statement postpones the full application of the rules for six months, subject to certain conditions.

Under the rules introduced in MiFID II, EU investment firms will be prohibited from providing certain services to clients until the LEI code for that client has been obtained by the client. Similarly, EU trading venues will have to identify every issuer of financial instruments traded on them with an LEI code. In order to support the smooth introduction of the LEI requirements, ESMA is going to allow investment firms and trading venues to comply with a lighter set of requirements for a period of six months.

Investment firms will be able to provide services to clients without LEIs if they obtain the necessary documents from those clients to apply for an LEI code on their behalf, and the trading venues will be allowed to report their own LEI codes instead of LEI codes of non-EU issuers currently not having their own LEI codes.

To put these temporary arrangements in place, the FCA is required to change a validation rule in its transaction reporting system. In its response to ESMA’s statement, the FCA explained that it will make the required amendments as soon as possible, but was not able to do so before 3 January 2018, the date the requirements began to apply.

Delegated Regulation under MiFIR relating to trading obligation for derivatives

On 22 December 2017, Commission Delegated Regulation 2017/2417 supplementing MiFIR with regard to RTS on the trading obligation for certain derivatives was published in the OJ.

Article 28 of MiFIR introduces a trading obligation for derivatives. It requires that derivative contracts which are subject to the trading obligation may only be traded on a regulated market, multilateral trading facility, organised trading facility or third-country trading venue deemed to be equivalent by the Commission. Article 32(1) of MiFIR required ESMA to develop RTS specifying the derivatives that should be subject to the trading obligation and the date or dates from which this trading obligation must take effect.

ESMA submitted the draft RTS to the Commission in September 2017, which adopted the RTS in a Delegated Regulationon 17 November 2017, listing the relevant derivatives in its Annex. Neither the European Parliament or the Council of the EU raised objections to the Delegated Regulation, which entered into force on 23 December 2017.

ESMA consults on systematic internalisers’ quote obligations

On 9 November 2017, ESMA published a consultation paper on the proposed amendment of article 10 of Delegated Regulation 2017/587 (RTS I). The consultation paper also addressed some other amendments to RTS 1 to enable a more consistent and unambiguous application of its provisions.

ESMA was required under article 14(7) of MiFIR to draft RTS to specify, with regard to the quoting obligation for SIs, “the determination of whether prices reflect prevailing market conditions”. ESMA’s draft RTS were endorsed by the European Commission and published in the OJ in March 2017.

ESMA later considered whether SIs’ quotes “should under certain circumstances reflect the same minimum price increments as orders and quotes submitted to trading venues trading for the same financial instrument”. ESMA took the view that, in order to ensure that SIs’ quotes adequately reflect prevailing market conditions, it may be necessary to link them to the minimum tick sizes applicable to trading venues.

The consultation closed on 25 January 2018, and ESMA intends to use the input from stakeholders to finalise the amendments to RTS I.

UK implementation of MIFID II

FCA published position limits for commodity derivative contracts

On 18 October, the FCA published a webpage containing position limits for commodity derivatives. The FCA is required under MiFID II to set limits on the maximum size of positions held by a person together with those held on its behalf at an aggregate group level. The webpage lists some of the commodity derivative contracts which the FCA has identified as trading on a UK trading venue, including the entries for bespoke contracts and de minimis aggregated contracts.

The position limits apply as of 3 January 2018. The FCA notes that these may be revised if it decides it is necessary to do so or as a result of an ESMA Opinion.

FCA “Dear CEO” letter on payment for order flow

On 13 December 2017, the FCA published a “Dear CEO” letter regarding the Payment for Order Flow (PFOF), which follows the publication of the FCA Market Watch 5l on PFOF in September 2016.

In the letter, the FCA expressed its view that the practice of brokers demanding “payments from counterparties as a condition for conducting client business with them substantially undermines a broker’s ability to act as a good agent”. It also repeated its concerns that PFOF arrangements are (i) bad for markets, (ii) undermine the transparency and efficiency of price formation, (iii) inhibit competition and (iv) lead to poor outcomes for end clients. The regulator further stated that firms continuing to charge PFOF will be in breach of MiFID II standards and highlighted that action had to be taken in order to ensure compliance.

The market intelligence gathered by the FCA suggested that some brokers were designing structures to avoid the rules introduced by MiFID II and provided examples of such structures. The FCA stated that “Mills will be a priority area of supervisory focus after January” and warned against any attempts to circumvent the requirements. Furthermore, the FCA stated that any market makers offered to enter into arrangements that attempt to avoid complying with the rules should not only decline to do so but also notify the FCA of these attempts.

MiFID II — Implementation status of member states

For reference, we have included a table setting out the implementation position for MiFID II in our key European jurisdictions. If you require any additional information on those countries listed below please refer to your local DLA Piper contact below.