On 3 July, the FCA published policy statement PS17/14 detailing their final rules on conduct of business and client assets as part of the implementation of MiFID II in the UK. In this article we focus on the new conduct requirements and provide a brief outline on the main changes being introduced on best execution, investment research and inducements.
Best execution
Under MiFID, firms are currently required to implement and maintain a written best execution policy that details the factors they consider when executing orders for their clients, such as price, size of an order, speed and likelihood of execution. However, MiFID II requires firms to tailor their execution policy to the specific markets and financial instruments in which they carry out their trading activities. Applying a uniform approach to achieve best execution will therefore become more difficult as the requirements will vary depending on the specific circumstances of each firm.
From 3 January 2018, firms will be required to make their best execution policies even more transparent and disclose at least the following to their clients:
- information on the different venues used to execute trades;
- the execution factors considered when choosing the execution venue;
- information detailing how the firm achieves best possible execution of trades.
Additionally, firms that solely place or transmit orders for onward execution will need to provide details of the third party they use for the actual execution of orders. They will also need to ensure that their best execution policy provides full evidence of how the firm achieves best execution.
For firms dealing in derivatives over the counter (OTC), the rules specify that when dealing in OTC products, firms must now consider the fairness of OTC prices, gathering market data on the price applied to such products by other firms and compare other execution factors where possible. Firms will also need to consider qualitative factors when selecting execution venues and brokers will need to assess the quality of the execution provided by these entities and document all this in writing.
MiFID II significantly enhances the disclosure requirements to retail clients and in addition extends these to professional clients. Firms must ensure they disclose clear information and comprehensive details of execution factors and the results obtained for their clients. Simply disclosing the policy will not discharge the firm’s obligations under the new requirements.
On an annual basis, firms must summarise and disclose the identity of the top five execution venues used in order of trading volumes. This summary should include information on the quality of execution obtained for each financial instrument in each venue in the previous year, and is intended to allow clients to make meaningful and quantitative comparisons.
Where investment firms execute orders themselves, but also place or transmit an order for execution by a third party, they will need to produce separate policies and make separate disclosures to their clients. In addition to the top execution venues used, they will also need to provide equivalent information on the third parties used when placing or transmitting orders.
The FCA will apply the MiFID II best execution standards to investment companies and management companies authorised under the UCITS Directive, as these deal mainly with retail investors. The new requirements will instead not be extended to AIFMs, small authorised AIFMs and operators of residual CISs.
Investment research and inducements
The rules on inducements are established for the purpose of preventing conflicts of interest and ensuring full transparency around the cost of services provided by firms and the fees charged to clients.
In respect of inducements offered to firms that provide independent or restricted advice to retail clients, retail advisers will no longer be able to receive rebates or any benefits in relation to the type of advice offered. Alongside this, MiFID II bans the acceptance and rebating of monetary benefits to UK-based retail clients who receive independent advice or portfolio management services. Where firms are providing these services to retail clients outside the UK, they will still be caught under MiFID II but will apply the requirements as if they were dealing with professional clients.
The general inducement rule, as it relates to non-monetary benefits, will be extended by the FCA under MiFID II to advice given on all retail investment products regardless of whether they fall under MiFID or not. However, as the Treasury’s response on the scope of the regulated activity of 'advising on investments' was published after the FCA’s consultation on inducements closed, the FCA has said it will consult again on its proposed expansion of the inducement ban on the provision of advice.
MiFID II also restricts the provision of hospitality and entertainment that could amount to inducements, although the FCA has allowed trial periods and the acceptance of non-monetary benefits that are directly connected to the main service.
Firms providing execution services and research to clients will need to unbundle their service offerings and charge for these separately, so that the respective costs of execution and research are identifiable clearly by clients. Research costs will therefore need to be itemised and can no longer be included or hidden within general fees charged to clients.
The FCA has confirmed in the PS that the new rules on inducements in relation to research will be extended to non-MiFID discretionary investment managers, consistently with the scope of the existing rules on dealing commissions. The production and dissemination of investment research by non-MiFID firms will therefore be protected against the risk of conflicts of interest, same as for MiFID firms.
MiFID II introduces the concept of a Research Payment Account (RPA) that firms will use to pay for the research they acquire from external providers and to receive fees paid by clients for the research the firm provides to them. Funds held in an RPA can only be used to purchase research. If there is a surplus in the RPA at the end of a period, it must be either rebated to clients or offset against the budget and charges for the following period. Firms will need to keep record of all the fees received in the RPA and payments made from the RPA.
Clients must be provided with information about the budget that a firm has allocated to buying research and an estimate of the fees they may be charged for receiving any research. On an annual basis firms must also provide information on the actual research costs incurred, and where requested, the payments made.
Key dates
| 31 October 2017 |
Deadline for operators of MTFs to provide information and apply to register as an SME growth market |
| 2 December 2017 |
Notification deadline for cross-border services |
| 3 January 2018 |
Implementation date
|
What you need to do next
If you have not done so already, we strongly encourage firms to start identifying and implementing the changes introduced by MiFID II that are relevant to your business. Firms should already be taking action, as failing to have the correct permissions or passports on implementation date will result in firms being unable to conduct regulated activities or provide cross border services. Firms are encouraged to undertake a gap analysis to determine if and how they fall in scope of MiFID II.
If your firm requires assistance then please do not hesitate to contact us. We can assist in a number of ways, from standard packages to tailored services, to ensure your firm is fully compliant with the new MiFID II requirements.
MiFID II Academy
Moore’ MiFID II Academy provides you with a comprehensive set of tools, insightful articles and exclusive access to seminars and workshops.