MiFID II considerations for less complex firms – 17/23

15th December 2017


As firms should be aware, MiFID II comes into force on the 3rd January 2018. With far-reaching implications for firms across the financial services universe, firms are scurrying to make changes to their business models in order to implement the multitude of organisational, compliance and conduct of business changes the legislation introduces. Do refer to our MiFID II briefing for an overview of its broader implications for all firms in scope.

This Regulatory Bulletin serves as a cautious reminder of the granularities of change in the Financial Industry by virtue of MIFID II, particularly in respect of corporate bodies who previously benefited from a ‘light touch’ regulatory burden from the UK regulator.

As expected, perspicacious firms under the historical scope of MiFID I should already have made arrangements concerning MiFID II. Unassuming less complex firms, such as corporate financiers, investment management firms, other advisor/arrangers and fund managers, may however be in for a shock to learn that they also fall within its ambit, albeit to a limited extent. Please find below a snapshot summary of some particular areas of MiFID II such firms may want to consider.


Recording of telephone and electronic communications

MiFID II obliges investment firms, including corporate finance firms and investment managers, to record relevant telephone conversations and electronic communications. Communications covered relate to transactions concluded not only when dealing on own account, but also for the provision of client order services concerning the reception, transmission and execution of client orders. Firms should also have a written Communication Policy.

All communications intended to result in a transaction must be recorded, even under circumstances in which the communication does not result in a transaction occurring. Face-to-face conversations with a client must also be recorded, for example by using written minutes or notes. The records kept in this manner must be provided to the client upon request, and kept for a minimum of 5 years (extendable to 7 years).

Firms providing underwriting and placing services are not within the scope of the taping requirement unless the firm is involved in providing client order services alongside these. Such client order conversations and communications will be in scope of the taping requirement. As the focus of the recording requirement is on the end of the process, in practice this is likely to be limited to communications in relation to key elements of the final intended transaction, such as price.

In the context of corporate finance business and Recital 44 of MiFID II noted in PERG 13 Q13D, reception and transmission could include negotiating terms for the acquisition or disposal of investments on behalf of a corporate client with a potential buyer or seller, for example as part of a merger or acquisition. Although the FCA would not expect the recording obligation to relate to an investment firm’s internal discussions at board meetings, the MiFID delegated regulation specifically refers to the recording of certain internal telephone conversations. This could include discussions, for example, in relation to key elements of the final intended transaction, notably price, when these discussions take place over the telephone, and the same applies to similar discussions with the client.

The purpose of the new record keeping requirements is to ensure that there is evidence to prove the terms of any orders given by clients and the alignment of correspondence with transactions executed by investment firms. The requirements are also intended to detect any behaviour that may have relevance to or constitute market abuse, offering an audit trail.

The FCA will not extend the MiFID II taping regime to cover all aspects of corporate finance business but communications that occur during corporate finance business would be in-scope when providing client order services that relate to the reception, transmission or execution of client orders, or when dealing on own account. Calls will not fall into this category where the firm is merely feeling its way and reserving its decision.

Telephone recording is required on a best endeavours basis.


Research unbundling

MiFID II requires independent research to be priced separately from execution services. Explicit payments for investment research must now be made by investment firms. Firms will need to have systems in place in order to manage unbundled payments for execution and advisory services, develop a taxonomy of services that are categorised as research and pricing models for these services. Some “quasi” research services may be considered as Non Advisory Services and fall outside this regime. Firms should look closely at their products to ascertain whether classification as Investment Research is correct. There may be VAT issues to address.

Investment Research

MiFID regulations covering Research Services apply to any firm which produces, or arranges for the production of investment research that is intended or likely to be subsequently disseminated to clients of the firm or to the public, under its own responsibility or that of a member of its group.

Investment Research is now deemed an unacceptable “inducement” unless paid for out of a Firm’s “own funds”, or if it has an on-going benefit to the Client and is processed through a Research Payment Account [RPA]. Firms generating in house research must produce and work to a “Research Budget” which must be designed to break-even. Firms buying in research must charge out to its clients/portfolios the cost of buying in that research.

Paying for a Research Service deemed biased or distorted as a result of the Fee is not acceptable. Managers must not receive unpaid for independent research from a third party unless it falls within narrow exceptions.

Fees or Charges

The charges for the provision of research services by providers such as brokers or investment banks, must not be linked to volume or value of transactions executed on behalf of the Clients. A fee, commission or non-monetary benefit should only be paid or received where justified by the provision of an additional or higher level service to the client.  Firms are also committed to a service review on a regular basis.

Managers’ disclosure obligations to clients/portfolios

Policy disclosure to the client will be required and non-monetary benefits shall be priced and disclosed separately. Before the Service is provided, the Manager is required to disclose to the client / fund the amount of research charge paid, and any benefit received, then annually thereafter. The frequency of the charge has to be agreed with the client, and the client’s specific agreement is not required for increases in charge. Monetary benefits deemed “inducements” should be made clear in the policy. New funds are required to disclose full details of research charges in any Prospectus.

Firms receiving research services from third parties

These Regulations apply to portfolio managers, advisory brokers, UCITs and AIFMs. Fees charged to portfolios for management services must be separated into the RPA unless paid from own funds. The RPA is controlled by the manager and funded by a research charge to portfolios / clients.

Operation of a Research Payment Account (RPA)

The RPA is required where payments are received or made for research services which are, in turn, then charged out to recipients/clients/portfolios.

The asset manager is responsible for the operation of the RPA. The FCA or the client can ask for summary of all payments into and out of an RPA, the benefits received, and how the spend compares to budget.

An RPA surplus cannot be used to fund a manager’s own research. A surplus can only be rebated to clients/ portfolios, or carried forward to the following year’s Budget, and put against future charges.

Buy side investment firms will be able to pay for investment research directly from their own account, or should they choose to pay using client commissions, using a Research Payment RPA supported by a Commission Sharing Agreement (CSA), which codifies how execution costs are split into execution costs and research costs, and how commissions are to be shared amongst research providers.

Sell side investment firms will need to unbundle their costs for research from the cost of execution, such that buy side firms can make explicit payments for research received. They will then need to be able to process direct payments for research received. They will then need to be able to process direct payments or commission based payments and attribute those payments appropriately.  Some Firms find that a separate incorporated entity helps address these issues.

Some firms have provided “activities” to their Clients under the guise of Research Services which should more properly have been categorized as Inducements are now banned as inducements, and subject to different Regulations. Examples include travel to exotic locations for conferences, meetings at popular sporting events etc.

Introductory Commission payments

These are generally banned but there are notable exceptions particularly where no added value is given. There are also implied restrictions in the manner in which any related commissions payments are calculated and paid.


Transaction and trade reporting

MiFID II introduces new transaction reporting requirements for investment firms. The purpose of the new reporting requirements is to improve transparency. Transaction reporting requirements under MiFID II do not only concern transmitter firms. Fund managers will also need to make arrangements to have transactions reported. Note that there is an exemption for non-MiFID “collective portfolio management investment firms”.

Receiving and transmitting Orders

You should also be aware that receiving and transmitting orders are deemed as execution for the purposes of MiFID II.

In relation to trade, this is only affected in as much as your firm carries out transactions in financial instruments which are EU listed, and included in the Financial Instruments Reference List issued by ESMA (FIRD). Briefly, such financial instruments are those which are listed on an EU Trading Venue (including Global Depository Receipts [GDR] based on overseas securities). Should this be the case then there will likely be an impact on your firm.


Best execution

Under MiFID II, as under MiFID I, the best execution rules are intended to help boost free competition between trading venues. It states that ‘all sufficient steps’ must be taken rather than ‘all reasonable steps’ to obtain the best possible result for clients, however this change is more cosmetic than substantive.

MiFID II also stipulates that investment firms, which includes fund managers, that execute transactions on behalf of clients must inform them where the order was executed periodically. These reports must include details about price, costs, speed and likelihood of execution for individual financial instruments. Clients must also be given more specific information about their order execution policy in order to allow for them to understand how an order will be executed and to verify the firm’s compliance with their obligation to execute orders on terms most favourable to the client.

Additionally, investment firms that execute client orders must summarise and make public on an annual basis, for each class of financial instruments traded, the top five execution venues. These reports should indicate the top five in terms of trading volumes and where client orders were executed in the preceding year.

Finally, under MiFID II investment firms must publish information regarding the quality of execution. Information published regarding the quality of execution must then be taken into account by investment firms in their order execution policies.


How we can help

Should have any queries concerning MiFID II, CPA Audit’s Compliance Team are at hand to advise and assist you. Contact us to discuss your needs.

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