Contributors
In line with the UK financial services regulators' appeals to UK businesses to keep calm and carry on, FCA is pressing ahead with its planning for implementation of the revised Markets in Financial Instruments Directive (MiFID 2) and Regulation (MiFIR) package, due to be implemented and to apply from 3 January 2018.
Previously, FCA had published a discussion paper and a consultation paper. The consultation paper had focused on the markets aspects of the MiFID 2 package. The second paper focuses on other trading issues and high level organisational requirements.
Timing and outstanding issues
FCA confirms it is now working to the new implementation timetable, and acknowledges there are still several further changes it will need to make to its Handbook that it has not yet consulted on. The planned third consultation paper, for later this year, will include the main changes to the Conduct of Business Sourcebook, the rules on product governance and some changes to the Perimeter Guidance Manual.
FCA believes industry finds it helpful to receive staggered consultations, but notes that it has changed its original plan to feedback separately on its first consultation. It cannot yet provide this feedback as some final provisions will depend on decisions Treasury needs to make. As a result, FCA will now probably instead publish a single policy statement next year.
Approach to branches of third-country firms
FCA is using this paper also to expand upon its approach to regulating UK branches of third-country firms. MiFID 2 allows (but does not require) member states to keep their national regimes that govern third-country firms, provided those firms do not receive more favourable regulatory treatment than MiFID firms can have. FCA has already consulted on how it can apply provisions from directly applicable legislation made under MiFID 2 to such firms. To date, it has used what it calls a modular approach to applying rules to these firms. Broadly, this means it has tended to apply as rules the provisions of the Handbook that focus on conduct, but either to switch off, or just apply as guidance, those with a prudential focus. So far as possible, FCA plans to continue this approach with the new or changed rules that MiFID 2 introduces.
Approach to article 3 firms
MiFID 2 allows firms with specific business (domestic businesses that do not hold client money or assets and which receive and transmit orders only in transferable securities or collective investment scheme units to authorised firms and provide related advice) to remain outside the scope of MiFID 2, but requires that national regulators subject these firms to "at least analogous" requirements to MiFID 2. Under the current MiFID, the UK has permitted article 3 firms, if they wish, to "opt in" to MiFID, and so has up to now imposed rules which are of MiFID standard. It now can choose whether to apply the new MiFID 2 requirements that fall outside the specified "analogous" provisions. FCA notes that there are, in the UK, more article 3 investment firms than there are MiFID investment firms. Within each relevant section of its paper it addresses any specific effects of the MiFID 2 changes on how it applies its rules to article 3 firms.
Commodity derivatives
FCA plans to introduce a new section in the Market Conduct Sourcebook (MAR) - MAR 10 - setting out guidance and directions on the rules on position limits, position management and position reporting for commodity derivatives contracts. Next year, it will set position limits that will take effect on 3 January 2018. The new chapter will address:
- Application: this will include guidance on the territorial scope of position limits, clarifying that the limits will not apply where two persons outside the EEA with no link to the UK trade OTC contracts that are economically equivalent to contracts traded on UK trading venues
- Position limit requirements: this will give guidance on FCA's obligation to set and apply limits and also explain when FCA may consider granting an exemption to non-financial firms that may otherwise exceed the position limit.
- Position management controls: this will include rules for investment firms and branches of non-EEA investment firms operating an MTF or OTF that mirror the rules FCA has already proposed for regulated markets.
- Position reporting: again, this includes the requirements for relevant MTF and OTF operators to mirror those for regulated markets. This part also sets out draft directions on reporting positions in economically equivalent OTC contracts
- Other reporting, notification and information requirements.
Supervision Manual
FCA proposes changes to SUP relating to breach reporting, and to take account of the provisions of MiFIR and implementing Regulations not made under FSMA. Specifically, SUP will require firms to notify FCA of a breach of directly applicable regulations under MiFID 2 or Treasury regulations. FCA also needs to make changes to introduce transitional provisions to address the obligations of firms to report breaches under the current MiFID implementing Regulation, which will be revoked when MiFID 2 takes effect. Further changes will update passporting requirements. FCA has already proposed signposts to the relevant ESMA technical standards, but now proposes new forms to address cancellation of passports.
Prudential standards
FCA needs to make changes to prudential sourcebooks to cater for the introduction of the new regulated activity of operating an OTF and the abolition of the current exemption from MiFID for local firms. FCA plans to update its prudential classifications to reflect the new OTF operator status and to include these firms within the IFPRU 730K firm classification. To deal with the abolition of the "local" exemption, FCA will in the main merely delete relevant references, mainly in IPRU(INV). It notes that it has assumed a traded options market maker is a type of local.
Senior management arrangements, systems and controls
FCA plans significant changes to SYSC to reflect the requirements of MiFID 2 and to take account of the directly applicable EU regulations. It is also consulting on its approach to applying organisational requirements to branches of non-EU firms and to firms that benefit from the article 3 exemption. It needs to ensure these firms comply with rules "at least analogous" to the MiFID requirements, but believes few changes are required to the current SYSC structure to achieve this. It needs to make changes to implement parts of articles 9, 23 and 16 of the MiFID 2 directive. It will need to do this by making changes to chapters 4-10 of SYSC. Its general approach will comprise:
- Keeping its current "common platform" framework and the 5 year record retention requirement;
- Transposing into SYSC relevant MiFID 2 directive provisions and signposting the supplementing provisions from the MiFID 2 implementing Regulation. The key changes concern:
- Conflicts of interest – while MiFID 2 does not make major changes to the current situation, FCA will amend SYSC 10 to align it with the new requirements. It has also decided to apply the requirements of the MiFID 2 implementing Regulation to all firms, but some provisions will still apply only as guidance to firms which are not common platform or article 3 firms;
- Management bodies – FCA proposes changes to SYSC 4.3.A which will apply to common platform firms, and will apply as rules to article 3 firms, and will include the extended obligations MiFID 2 introduces. For third-country branches, FCA is keen to keep any current equivalence approach, but will in some cases mandate a firm follows the SYSC provisions as rules.
- extending the application of several provisions in the MiFID 2 implementing Regulation to the entire business of a UK MiFID investment firm, whether or not the specific business in question falls within MiFID.
FCA also notes the changes will affect UCITS investment firms and AIFM investment firms in respect of their MiFID business, and proposes tables showing how the SYSC rules will apply to these firms.
Remuneration requirements for sales staff
FCA plans to introduce a new section in SYSC to address this, but does not intend to cross-cut standards for firms that are regulated under other EU directives. FCA has already sought views on how it should address MiFID 2's remuneration requirements, given it already has detailed remuneration codes and rules for specific types of firm, some stemming from other EU legislation. It now proposes to apply MiFID 2 remuneration standards for sales staff and advisers only to common platform firms, article 3 firms and branches of third-country firms in respect of activities they carry on from a UK establishment. It proposes a new chapter SYSC 19.F and also to require article 3 firms and third-country firms to comply with a requirement similar to that in Article 27 of the MiFID 2 implementing Regulation.
Whistleblowing
FCA is planning to consolidate within one chapter in SYSC the MiFID 2 and domestic provisions on whistleblowing and provide signposts to rules that implement the provisions of other EU legislation. FCA does not think it can create a "common platform" of whistleblowing requirements across all relevant legislation as to try to do so would involve gold-plating some standards and under-delivering on others. FCA thinks it best to bring together a new chapter in SYSC (SYSC 18.6) to pull together all the requirements.
Client assets
FCA plans changes to CASS necessary to implement MiFID 2 and, in line with its current approach, will apply the changes to all designated investment business. Again, it does not need to make fundamental changes but plans to use "intelligent copy out" to include within CASS any requirements MiFID 2 introduces which are not already in its rules. There will be no change to the ability of professional clients to opt out of the client money rules, but FCA will need to amend its rules on total title collateral arrangements to reflect MiFID 2's ban on these for retail clients. Minor adjustments are also needed to the custody rules and rules on depositing client money in a group bank, where MiFID 2 reaffirms current standards and includes specific possible exemptions. Since several parts of CASS will change, the consultation paper includes a table outlining the new requirements. Finally, FCA says it intends to keep the CASS rules in relation to which it had made "article 4" notifications to the Commission under the current MiFID.
Complaints handling
FCA plans a new section in DISP that will cover the wider application of the complaints rules that MiFID 2 requires. FCA's general belief is that the same rules should apply to complaints handling regardless of the subject matter, but DISP already caters for specific requirements in EU sectoral legislation. FCA proposes to amend DISP now to implement MiFID 2's requirements, including by introducing a definition of "MiFID complaint" and a new DISP 1.1A.
Fees
FCA needs to update the fees manual to account of initial and ongoing fees for those who apply to operate OTFs (or MTFs), and the on-boarding fees of firms that connect to FCA's Market Data Processor. Discussion on periodic fees can come later.
Implementation guide
FCA has also provided a guide intended to help firms to navigate SYSC.
Draft new rules
The draft new rules included in the consultation comprise amendments to:
- The Glossary: this includes many new definitions, including some that have been amended from the previous consultation version, and many amendments to existing defined terms
- SYSC, including significant changes to the application of various provisions to certain types of firm as well as changes to chapters 4-10, 18 and parts of 19
- FEES, including a few changes to parts not affecting the new regulated activities or DRSPs
- IFPRU and IPRU(INV)
- CASS, which has significant changes discussed above
- MAR to introduce MAR 10 on commodity derivatives
- SUP to make changes to various chapters, including 13 15 and 16
- DISP, including the new DISP 1.1A and amended application provisions
- New forms
- A SYSC navigation guide.
When does consultation end?
FCA asks for comments by 28 October.
What next?
All firms that carry on any MiFID business, whether they derive their authorisation from MiFID or other EU sectoral legislation, whether they are an article 3 firm or a third-country firm, should read this paper carefully. While in many areas MiFID 2 does not require significant changes to UK regulation, there are some areas which require FCA to introduce new requirements or substantially amend existing ones. There are also some changes which may appear minor but may nevertheless have a significant effect on some firms' policies, procedures and business practices. Even with the extension to the MiFID 2 application date, there is unlikely to be time for any meaningful further discussions with FCA, so firms must be sure to communicate any concerns or confusion sooner rather than later.
