What you need to know from the FCA's first Policy Statement on MiFID II implementation

This first Policy Statement for the implementation of MiFID II was published by the FCA on 31 March and highlights some of the key rule changes that will be applicable to firms falling in scope of the new Directive and the Regulation (MiFIR) on 3 January 2018. It is particularly relevant to operators of trading facilities and regulated markets, systematic internalisers, market data providers, commodity derivatives traders and algorithmic / high frequency traders, but of course all firms who interact with these operators should be aware of the changes.

This PS includes some ‘made rules’ that became effective on 2 April, relevant to the new MiFID II application fees. However, it largely contains near-final rules in respect of the areas and issues raised in the relevant consultation papers CP I (15/43) and CP II (16/19), and partly in CP III (16/29) and CP IV (16/43). The FCA will publish its final Handbook rules in June, once the EU and National legislation has been finalised.

The areas covered include the following:
  • handbook perimeter guidance for trading venues, based on ESMA guidelines;
  • deferrals of post-trade transparency;
  • transaction reporting exemptions for portfolio managers and pension funds;
  • use of third parties in reporting transactions;
  • guidance on telephone recording obligations; and
  • implementation of remedies from the asset management review of 2016.
In the relevant consultation papers the FCA had already presented draft Handbook rules on systems and controls and market provisions, and these have been confirmed in the PS17/5.

What do the rules intend to achieve?
The new rules being implemented under MiFID II are designed to create greater transparency by bringing more trading activities on regulated venues and increase the protection for consumers by extending the scope of firms that will be subject to the Directive. The reform essentially adds higher organisational and conduct of business standards and introduces more reporting requirements to allow the National Regulator to have a clearer view of market trends and greater influence on the industry.

Proportionality will be adopted across all new requirements to ensure that firms of different sizes and different types of business are able to comply with the appropriate standards on an ongoing basis.

Some of the changes will be achieved by amending the market conduct sourcebook (MAR) to ensure that all firms and trading venues apply equivalent standards in preventing the risk of market abuse.

Finally, the FCA has proposed the implementation of additional remedies that address directly the issues identified in the asset management review of 2016, all to be consistent with MiFID II.

Scope and impact of the rules
Firms caught by the new rules include:
  • investment banks;
  • interdealer brokers;
  • commodity derivatives traders;
  • algorithmic / high frequency traders (HFT);
  • Multilateral trading facilities (MTF) and organised trading facilities (OTF);
  • regulated market and recognised investment exchanges (RM);
  • data reporting service providers (DRSP);
  • systematic internalisers (SI); and
  • investment managers and investment adviser.
Trading venues and trading facilities
RMs, MTFs and OTFs will have access to the final perimeter guidance from the FCA in June as ESMA is still considering the issues to be addressed in its guidelines and regulatory technical standards around large scale orders, transactions in commodity derivatives, and transparency.

Trading venues and exchanges will need to implement governance arrangements that are sufficient to ensure the effective and prudent management of the trading activities and to maintain the integrity of the market.

Trading venues will not be able to operate as systematic internalisers. SIs will be required to notify the FCA when they become, or cease to be, an SI, which is also meant to apply to branches of non-EEA investment firms dependent on a decision at EEA level.

Investment firm that also operate an MTF will be allowed to trade on a proprietary or matched-principal basis only outside of their own trading facility to prevent conflicts of interests. OTFs will instead be able to trade their own proprietary capital as long as they have received client consent.

For prudential purposes investment firms operating an MTF and an OTF will be categorised as IFPRU 730k firms, and therefore subject to the highest requirements.

HFT
Firms meeting certain conditions will be categorised as HFTs and will therefore be subject to authorisation under MiFID II. The new systems and controls requirements ensure that HFTs are able to mitigate the risks arising from algorithmic trading and offer protection to consumers.

These firms will need to notify the FCA of their membership in trading venues and have written agreements with trading venues, will be subject to new rules around market making arrangements in place, management of conflicts of interest, business continuity and Direct Electronic Access (DEA).

Pre-trade and post-trade transparency
The MiFID II implementation aims at greater transparency from more trading firms and in respect of more financial instruments, including equity and non-equity products. However the FCA has now drafted the basic conditions and guidance for the application for waivers and deferrals, based on the type of firm applying and/or the type of instrument traded. Waivers granted will be reviewed by ESMA in 2020 to assess the continued compatibility of those waivers with the requirements in MiFIR.

Transaction reporting
The requirements in this area are perceived as being the core of the MiFID II reform, not just for the increased volume of data to be reported but also for opening the market to new reporting intermediaries. DRSPs will be allowed to become authorised as an Approved Reporting Mechanism (ARM) and submit transaction reports to the competent authorities on behalf of investment firms.

The FCA has proposed some flexibility in this area by allowing collective portfolio managers and pension funds to be exempt from transaction reporting obligations.

Systems and controls
The SYSC sourcebook will be amended extensively to reflect the new scope of application and final rules covering requirements in areas such as senior management, risk management, outsourcing and remuneration just to mention a few. Major focus will be placed on the adequacy of human resources and firms will be required to maintain a management body with adequate knowledge, skills and experience that commits sufficient time to perform their functions and whose decision making can be monitored regularly.

Higher standards will be expected in the management of conflicts of interests as firms will need to take all ‘appropriate’ steps to prevent or manage conflicts of interest from arising.  This will also be supported with a reform of remuneration measures in SYSC 19.

The recording of telephone conversations has been amended from the original proposal and a specific solution will be offered to retail investment advisers that are exempt under Article 3.

Further changes
Changes have been made to the proportionate application of Principles for Businesses to different client types, further clarification of whistleblowing rules and the appropriate client categorisation of local authorities.

What should firms be considering now?
Despite the ‘near-final’ state of the rules in PS17/5, all firms in scope of MiFID II must ensure to be ready in time. The next Policy Statement with final rules is due in June, and will be a significant step towards full implementation.  Firms that are currently regulated and new operators are all encouraged to start reviewing the scope of application of MiFID II through an early gap-analysis, to determine what application may need to be submitted to the FCA by the cut-off date of 3 July 2017 and start adapting to the new standards as soon as practicable to avoid potential breaches.

Moore Stephens can help all types of firms with a complete assessment of the impact that MiFID II may have on your business, prepare applications for authorisation or variation of permission, and update your compliance manuals and procedures. We welcome all those interested in getting to know more about the current reform, to sign up to our MiFID II Academy, a forum that offers knowledge, clarity and support in your journey to the new regime.

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