Swotting up on MiFID revisions

Swotting up on MiFID revisions


Simon Lovegrove, global head of financial services knowledge at Norton Rose Fulbright, explores the latest consultation from the European Securities and Markets Authority (ESMA) on the practicalities of the implementation of the revised Markets in Financial Instruments Directive (MiFID II)

ESMA has launched a consultation process for the implementation of MiFID II and the Markets in Financial Instruments Regulation (MiFIR). Enhanced transparency, data publication and commodity derivatives are some of the areas covered by proposals in the consultation and discussion paper. The papers divide the main issues into those concerning the financial markets structure and those concerning investor protection. Responses to both documents should be received by 1 August 2014.

What topics are caught by ESMA’s discussion paper?

The discussion paper is structured around seven key topics:

  • investor protection
  • transparency
  • data publication
  • micro-structural issues
  • requirements applying on and to trading venues
  • commodity derivatives
  • market data reporting

Note that this is only the first half of the proposals with a follow up consultation paper being due later this year.

What are ESMA’s main proposals in relation to investor protection in the consultation paper?

The investor protection section of the consultation paper is massive, being some 150 odd pages. It covers a wide range of issues including:

  • the exemption from the applicability of MiFID for persons providing an investment service in an incidental manner (MiFID, art 2(1)(c)).
  • record keeping
  • product governance
  • conflicts of interest
  • remuneration, and
  • inducements

There is too much information in these pages to pick up every single proposal but some interesting points include:

MiFID, art 2(1)(c)

ESMA states that common criteria for the exemption should be developed noting that the word ‘incidental’ should not solely be defined through temporal criteria (ie frequency or duration of services). Instead, the provision of the investment service should have an inherent connection to the main area of the professional activity and be of minor and subordinated scope in comparison. Further, ESMA states that an investment service would not be considered as being provided in an incidental manner if the person who provides the investment service markets its ability to provide investment services. A positive and negative example of how the exemption could occur is given in the consultation paper.

Record keeping

ESMA discusses MiFID II, art 16(7) which introduces organisational requirements for investment firms, requiring them to record telephone conversations or electronic communications relating to certain investment services. Among the many points that ESMA makes is one concerning internal calls. ESMA considers that some internal calls are subject to the MiFID II recording requirement where the internal call in question ‘relates to or is intended to result in transactions’ in the provision of investment services subject to the telephone recording requirement. According to ESMA this view aligns with recital 57 of MiFID II.

Product governance

ESMA proposes to introduce two sets of policy proposals for product governance arrangements for:

  • investment firms to adopt when manufacturing products (product governance obligations for manufacturers), and
  • investment firms to adopt when deciding the range of products and services they intend to offer to clients (product governance obligations for distributors)

ESMA proposes to impose on investment firms a positive duty to check that products function as intended rather than only requiring them to react when detriment becomes apparent or at issuance or re-launch of the same product.

Conflicts of interest

ESMA proposes to make explicit the principle in art 22 of the current MiFID Implementing Directive that investment firms should not over-rely on disclosure or use it as a self-standing measure to manage conflicts. ESMA considers that before relying on disclosure, investment firms should first consider whether other reasonable measures effectively mitigate the conflict of interest and prevent potential detriment. ESMA also notes that, under MiFID, while there is no explicit obligation requiring investment firms to periodically review conflicts of interest policies it is normal business practice for them to do so. ESMA proposes to formalise this process by requiring investment firms to assess and periodically review, at least annually, their conflicts of interest policy.


ESMA considers the relevant areas set out in the Commission’s mandate including the definition and conditions for ‘minor non-monetary benefits’ that can be received when providing independent advice or portfolio management. In relation to minor non-monetary benefits, ESMA believes that this exemption should be strictly interpreted, such that non-monetary benefits likely to influence the behaviour of the recipient should not be allowed. ESMA proposes that, for financial analysis to come within the exemption, it would need to be intended for distribution so that it is, or is likely to become, accessible by a large number of persons, or for the public at the same time. ESMA considers any re-search which involves a third party allocating valuable resources to a specific portfolio manager would not constitute a minor non-monetary benefit and could be judged to impair compliance with the portfolio manager’s duty to act in their client’s best interest.

What are ESMA’s main proposals in relation to transparency?

The transparency section in the discussion paper is huge (153 pages). There is not enough room to pick up on every single proposal but some interesting points include:

Pre-trade transparency—equities

ESMA covers a lot of ground on pre-trade transparency for equities including large in scale waivers, reference price waivers, negotiated trade waivers and double volume cap mechanism. In relation to large in scale waivers, ESMA notes that under MiFID in its current form, the average daily turnover (ADT) is used to determine when an order should be considered to be large in scale compared to normal market size. ESMA asks for stakeholder feedback on whether ADT remains an appropriate measure.

Post-trade transparency

ESMA considers the content of the information in trade reports currently required for shares admitted to trading on a regulated market to still be valid and applicable to other equity-like instruments. In relation to identifiers, ESMA believes that the 2010 Committee of European Securities Regulators technical advice on post-trade transparency standards remains valid.

Pre-trade and post-trade transparency—non-equity instruments

To get a useful understanding of ESMA’s work, readers would be well-advised to look at the introduction on page 105. MiFIR describes a new transparency regime for a wide range of non-equity instruments and ESMA has to develop the majority of the implementing measures for this new regime. The discussion paper illustrates that ESMA has already done a lot of thinking on the regime by setting out its initial understanding as to how the regime should work. It has also produced a detailed analysis of the European bond markets and describes six threshold scenarios for determining whether a bond shall be deemed liquid. However, it is also worth noting that there is still a lot more thinking to be done in the follow up consultation paper. ESMA states:

‘ESMA is therefore only describing the overall scope of the transparency regime and is publishing a potential taxonomy of how to categorise and divide non-equity instruments into classes and is seeking input on whether those classes are correct and whether there is anything missing.’

The consultation paper also contains proposals for transparency. It covers various issues including the definition of systematic internaliser. Here ESMA discusses the meaning of ‘frequent and systematic’. For liquid financial instruments ESMA proposes a threshold based on a percentage of the total number of trades calculated for each financial instrument. For illiquid financial instruments ESMA recognises that it would not be feasible to apply relative thresholds and instead proposes to use an absolute number of transactions. This absolute number is to be set at different levels depending on the liquidity of the financial instrument with higher thresholds for instruments which trade more frequently during the day.

What are ESMA’s main proposals applying on to trading venues?

In the discussion paper the micro-structural issues section includes a discussion of the organisational requirements for trading venues and the monitoring and review of trading systems and algorithms.

On the organisational requirements for trading venues ESMA sets out a preliminary view that not only all prospective members of participants of a trading venue (one that permits algorithmic trading through its systems) should be subject to adequate due diligence to ensure they meet certain pre-defined parameters, but also all its current members/participants should meet those parameters. To that end, ESMA states that periodic reviews should be designed and implemented by trading venues. ESMA provides a draft list of elements that at least should be analysed by the trading venue when performing due diligence.

ESMA’s preliminary view is that investment firms should flag their algorithms as an internal risk management tool to be able to identify rogue behaviour of an algorithm and the responsible trader/client and/or trading desk in an emergency situation. The flagging of algorithms should be taken into consideration when establishing the firm’s business continuity plan.

The discussion paper includes a short section on requirements applying on and to trading venues. It has two sub-sections covering:

  • admission to trading, and
  • suspension and removal of financial instruments from trading

In relation to admission to trading, ESMA states that it will be taking the existing rules in arts 35–37 of the current MiFID Implementing Regulation as the basis for developing technical standards that are envisaged in MiFIR, art 51(6)(a). However, it also warns that some of the technical standards will need to be developed from scratch.

Position management controls operated by trading venues is not covered by the discussion paper as ESMA is not mandated under MiFID II to develop regulatory technical standards in this area. However, ESMA states that this regime will operate in tandem with position limits set by national competent authorities.

Are there any other significant proposals put forward by ESMA?

Commodity derivatives

In the discussion paper ESMA discusses commodities and in particular:

  • the ancillary activity exemption in MiFID II, art 2(1)(j), and
  • position limits

In relation to the ancillary activity exemption, ESMA proposes a procedure for determining whether firms fall within the scope of the exemption which is based on two tests which it terms ‘the ancillary activity test’ and the ‘trading activity test’. On position limits, ESMA recognises that this is a completely new policy area and whilst setting out a broad approach to scope and methodology poses a number of questions for stakeholders. More developed thinking should appear when the follow up consultation paper is published.

Direct electronic access (DEA)

In the discussion paper, ESMA states that its intention is to specify more clearly that the provider of DEA is expected to monitor intraday, and on a real-time basis, the credit and market risk to which it is exposed as a result of the clients’ trading activity so that the DEA provider can adjust the pre-trade controls on orders (as well as the credit and risk limits) as necessary. ESMA reminds DEA providers that wherever they source their pre-trade controls it is important that they have the ability to cancel a trade which is in-built and automatic if the trade poses a risk.

Post trading issues

The final section of the discussion paper covers post trading issues. It covers two issues:

  • obligation to clear derivatives traded on regulated markets and timing of acceptance for clearing, and
  • indirect clearing access

In relation to the second issue ESMA notes that the mandate given to develop regulatory technical standards which specify the types of indirect clearing arrangements in the scope of MiFIR is very similar to the mandate granted under European Market Infrastructure Regulation (EU) 648/2012. However, it acknowledges that the mandate is not identical and asks stakeholders if it should adopt a different approach.

Interviewed by Neasa MacErlean.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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