The HM Treasury consultation document on UK implementation of the Markets in Financial Instruments Directive ('MiFID') was issued 15 December 2005. HM Treasury's consultation deals with the legislative changes (mainly to the Financial Services and Markets Act 2000 ('FSMA') and secondary legislation such as the Regulated Activities Order ('RAO') required for transposing MiFID into UK law. Changes to FSA rules triggered by MiFID implementation will be subject to FSA consultation due to commence in March 2006.
With the finalisation of the Level 2 implementing measures still pending, the Treasury's consultation document does not cover some of the detail but otherwise provides a comprehensive overview of proposed legislative changes. In summary, these include the following:
- Changes to the RAO – these involve proposals to add to the list of regulated activities the operating of a multilateral trading facility ('MTF') and to widen the scope of financial instruments to include certain options, futures and derivatives not currently covered by UK definitions. HM Treasury further proposes to exercise the exemption in Article 3 of MiFID to take certain financial advisers and firms receiving and transmitting investment orders outside the scope of MiFID (and its more onerous prudential requirements), unless they seek to exercise passporting rights and do not therefore wish to be treated as exempt. The structure and language of the RAO will largely remain intact.
- Changes to FSMA – these will be required to give FSA power to write financial promotion rules (without lifting restrictions on the promotion of unregulated collective investment schemes), to take enforcement action against exchanges and to veto changes in control over exchanges.
- Changes concerning clearing and settlement – there will be new rights for members of regulated markets to designate the location of settlement of transactions.
- Changes affecting regulated investment exchanges – it is proposed that operators of regulated markets must become recognised investment exchanges ('RIE'), that RIEs operating MTFs will have to comply with certain recognition requirements and that RIEs will be subject to a bespoke controllers regime that will be distinct from the existing UK controllers regime applying to authorised persons.
Comments on HM Treasury's consultation document are invited by 31 March 2006.
Implementing scope provisions
Who will be covered?
The general scope of application of MiFID implementing measures is determined by three different provisions:
- the Article 3 optional exemption under MiFID;
- the MiFID override; and
- the definition of "investment firm".
HM Treasury proposes to exercise the optional exemption in Article 3 of MiFID. Article 3 allows Member States not to apply MiFID to firms receiving and transmitting investment orders and/or giving investment advice provided that they:
- are not allowed to hold client's funds or securities and are not allowed to place themselves in debit with their clients;
- are only allowed to transmit orders to certain persons (e.g. authorised credit institutions); and
- are subject to regulation at national level (together the 'qualifying conditions')
The effect of this is that exempt firms will not be subject to MiFID implementing measures that take the form of regulations but will continue to be subject to UK regulation. If however, exempt firms wish to exercise passporting rights under MiFID, current proposals provide for these firms to 'opt in' by notifying the FSA accordingly. Whether or not firms meeting the qualifying criteria will have to comply with MiFID implementing measures will therefore depend on their own commercial judgement.
The proper implementation of MiFID requires that investment firms may only rely on RAO exclusions taking them outside UK regulation where such exclusions correspond with MiFID exemptions. Under existing legislation certain RAO exclusions are already disapplied for investment firms (see Article 4(4) RAO, the so-called ISD override). The RAO currently provides for exclusions in circumstances not permitted by MiFID. According to current proposals, the new MiFID override will therefore extend to the exclusions in Articles 67 (professional activity), 71 (employee share schemes) and 72 (overseas person) RAO, making them non-available for investment firms. Extending the MiFID override to the overseas person exclusion is controversial. It would prevent the situation arising where UK investment firms can operate outside of the UK and provide services in the UK; HM Treasury has commented that it considers this to be incompatible with MiFID. Also, EEA investment firms would no longer be able to rely on this exclusion which until now has been particularly useful in circumstances where there is uncertainty as to whether or not an activity amounts to the provision of regulated activities in the UK.
Finally, it is proposed that the definition of "investment firm" shall be restricted to EEA firms only. Because MiFID does not expressly require that non-EEA firms must not benefit from a more favourable treatment than EEA firms, HM Treasury suggests deleting the existing Article 4(5) RAO provision. In consequence, non-EEA firms would be able to rely on exclusions from the authorisation requirement not otherwise available to EEA firms under the MiFID override (see above). Specifically, non-EEA firms carrying on significant activities in the UK would be able to benefit from the Article 69 RAO group exclusion while EEA firms could not (because Article 69 is disapplied for "investment firms" under the MiFID override). By way of example, a UK branch of a US company would be allowed to engage in certain intra-group dealings/activities in the UK subject to the Article 69 RAO exclusion whilst a UK firm would not. The proposals are likely to create a significant competitive advantage for non-EEA firms over EEA firms. We consider that some firms may feel particularly strong about these proposals and may wish to submit their comments to HM Treasury.
Operating an MTF
HM Treasury is also consulting on whether or not to introduce the activity of operating an MTF as a separate RAO activity for the sake of greater clarity. Strictly speaking, this is not required for implementing purposes as firms operating facilities that are MTFs within the meaning of MiFID are currently covered by articles 14 (dealing as principal), 21 (dealing as agent) and/or 25 (arranging) RAO.
The list of derivative financial instruments in the RAO must be widened. At this stage HM Treasury proposes to extend articles 83, 84 and 85 of the RAO to cover those options, futures and contracts for differences that are not within the scope of existing legislation. This is done by way of cross-reference to the relevant list of instruments in MiFID itself. This approach is likely to be an interim solution until the Level 2 text defining the boundaries between the various MiFID derivative instruments will be finalised.
HM Treasury proposes that, as of 1 November 2007, authorised persons will automatically have their existing Part IV permissions 'switched' to the new regime. Operators of alternative trading systems which constitute MTFs will be treated as having a Part IV permission to operate an MTF whilst investment firms, credit institutions and UCITS management companies will have their Part IV permissions extended to cover the wider range of financial instruments in MiFID. The automatic extension of existing permissions will be subject to an opt-out which firms will have to exercise between 1 April 2007 and 1 October 2007 if they do not wish to become an MTF or otherwise consider aspects of the extension unsuitable.
Implementing authorisation and operating conditions for investment firms
MiFID implementing measures will require changes to the rules relating to the form and content of marketing communications. Under current legislation, FSA has power to make financial promotion rules only in certain circumstances. HM Treasury is seeking views on whether the existing restriction on FSA's rule making power in this field should be lifted generally (HM Treasury's suggested approach) or with regard to MiFID firms only. Lifting the restriction generally would involve 'gold plating' of the Directive whilst a partial removal of the restriction for MiFID firms would create a regulatory imbalance between UK firms in respect of the same financial promotion.
HM Treasury further proposes to implement the tied agent regime by amending the legal framework for appointed representatives under section 39 FSMA and the Appointed Representatives Regulations. Essentially, appointed representatives/tied agents will only be exempt from FSA authorisation if entered on a public register and the scope of activities that may be carried on by tied agents will be broadened to include the activity of placing financial instruments and providing advice to clients in relation to the placing of financial instruments.
Implementing MiFID requirements concerning enforcement and cooperation powers
For MiFID implementation purposes FSA requires extended enforcement and supervisory powers as a host state regulator over EEA firms passporting into the UK where they contravene MiFID requirements. FSA will be responsible for enforcing compliance of incoming branches providing services in the UK and under current proposals would therefore have extended powers of intervention/disciplinary powers over them. The proposed rules also implement the intervention process set out in MiFID in respect of EEA firms passporting into the UK on a services basis; FSA's extended intervention powers in this regard include the right to take all appropriate measures needed to protect investors and/or the proper functioning of the financial markets if measures taken by the incoming firm's home state regulator fail to remedy the situation or prove inadequate.