MiFID II will come into effect on 3 January 2018 and is widely regarded as one of the most important regulatory initiatives undertaken by the European Union (“EU”) since the onset of the financial crisis in 2008. MiFID II was published together with the Markets in Financial Instruments Regulation (“MiFIR”) in 2014.MiFID II will come into effect on 3 January 2018 and is widely regarded as one of the most important regulatory initiatives undertaken by the European Union (“EU”) since the onset of the financial crisis in 2008. MiFID II was published together with the Markets in Financial Instruments Regulation (“MiFIR”) in 2014.
You can download your copy of the impact of MiFID II on non-EU managers
MiFID II relates to the framework of trading venues/structures in which financial instruments are traded. MiFIR is concerned with regulating the operation of these trading venues and the processes, systems and governance measures adopted by market participants.
In general, MiFID II only applies to investment firms with a physical presence in Europe which are regulated by a European regulator.
Non-European managers (“NEMs”) who exclusively offer services to EU non-natural persons are covered by the so-called “safe harbour” exemption, which frees them from the requirement of obtaining a MiFID authorisation. Following a July 2017 publication by the Irish Department of Finance, this exemption will be maintained, however narrowed down to the provision of wholesale investment services.
Albeit MiFID II may not directly apply to NEMs who wish to provide investment services to EU clients, it is likely to have a secondary impact where they have EU counterparties. This paper shall give an overview over the expected impact on non-EU managers.
The Key Aspects of MiFID II Impacting Non-EU Managers
Ability of Non-EU managers to provide services to EU clients
Under MiFID I, non-EU managers who seek to passport their services across the EU, had to comply with national regulations governing market access in each country. MiFID II introduces a unified “third country regime”. Non-EU managers seeking to provide portfolio management or advisory services to EU professional clients will need to comply with the third country regime and register with the European Securities and Markets Authority (“ESMA”). A non-EU manager will need to comply with a number of conditions to be able to passport its services including:
- The non-EU manager must be authorised and subject to effective supervision in a third country;
- The European Commission must have adopted an equivalence determination for the third country in question;
- There must be cooperation arrangements in place between the EU and the third country.
MiFID II Product Governance
Under the MiFID II rules, investment firms that create products, so called manufacturers will be required to identify a target market for their products and will be required to provide details relating to the target market/investor type to distributors/placement agents. As a result of this, non-EU managers may be asked by EU placement agents/distribution firms to enter into arrangements which enable the EU distributor to fulfil its obligations and to deliver MiFID II compliant information regarding the non-EU managers’ products.
MiFID II Rules on Inducements and Unbundling of Research
MiFID II introduces a general ban on inducements, including commissions and rebates for independent advisors. In addition, MiFID II seeks to unbundle the purchase of research from execution services. From now on, either the investment firm (via the so called P&L method) or the client (via the so-called Research Payment Account (“RPA”) method) will bear the cost of research.
While the new rules are not directly applicable to non-EU managers, they may affect the price of investment research in the EU, as an EU investment firm providing both execution and other (including research) services to clients (including non-EU based managers) will need to identify separate costs for each of the services. The non-EU manager will likely also receive separate invoices for both execution and research services.
Market Infrastructure/Transparency
MiFID II introduces the concept of an Organised Trading Facility (“OTF”) which captures trading in non-equity instruments which previously operated outside the scope of MiFID. The rules around Regulated Markets (“RMs[1]”) and Multilateral Trading Facilities (“MTFs[2]”) have been aligned, and a range of organisational requirements currently applying to RMs and MTFs have been extended to the newly introduced OTFs. Additionally, obligations for SIs[3] have been increased.
There are also new requirements in relation to pre- and post-trade transparency. MiFID I transparency requirements only applied to equities traded on regulated markets. Under MiFID II, the transparency requirements apply to both equities and non-equity like instruments such as bonds and derivatives traded on a trading venue.
With regard to pre- and post-trade transparency, it is likely that all trades concluded through EU trading venues will be affected. While the new transparency requirements will not apply directly to non-EU managers, anonymised information about all transactions they trade through EU trading venues will be made public by EU brokers. Non-EU managers will therefore need to assess the impact of the new transparency regulations on their trading strategies.
MiFID II Transaction Reporting
Under the MiFID II framework, the transaction reporting requirements increased considerably. The scope of products which need to be reported has been extended with transaction reporting now being required for all products traded on EU RMs, OTFs and MTFs. In addition to an increase in the number of products that qualify for reporting, the number of data fields required for MiFID transaction reporting has also greatly increased. New data fields include details of the person executing a transaction and details of the algorithm used to make a decision to trade.
Where non-EU managers are trading on EU trading venues, they may be required by the EU trading venues to collate and send reportable information to the trading venue in question. This is because the EU trading venue has an obligation to transaction report the relevant trades to the relevant local supervisory authority.
Investor Protection/Best Execution
MiFID II requires investment firms to take all sufficient steps to obtain the best possible result for their clients when executing orders. Investment firms will be required to publish data relating to execution quality (i.e. cost, speed, etc.) at least annually and will be required to publish their top five execution venues for the previous year.
EU brokers executing trades for non-EU managers will be required under MiFID II to provide their clients with sufficient information on their order execution policy, including how orders will be executed by the broker for the non-EU manager. The non-EU manager will need to provide its consent to the execution policy before it is shared with clients.
Algorithmic Trading
MiFID II provides that investment firms that engage in algorithmic trading[4] must have in place effective systems and risk controls to ensure that their trading systems are resilient, have sufficient capacity and are subject to appropriate trading thresholds and limits. In addition, firms must have effective business continuity arrangements in place, must ensure appropriate testing and monitoring of their trading systems occurs and must keep records to evidence their compliance with the requirements of MiFID II.
Non-EU managers are not caught directly by the MiFID II rules on algorithmic trading. However where non-EU managers using algorithmic trading access EU trading venues via an EU broker, they will need to analyse what updates will be necessary to their systems and procedures as a result.
Exchange Trading Requirements
Where non-EU managers access EU trading venues directly, they will be affected by the new systems resilience and organisational requirements which apply to EU trading venues. These include detailed due diligence of all members and participants and technical testing of member’s trading systems before accessing the trading venue’s system.
Timeline for MiFID II Implementation
EU member states were required to transpose the provisions of MiFID II into their national legislation by 3 July 2017. Ireland has missed this deadline, as did most other EU member states. Only Cyprus has fully transposed the new regulations, and a mere six other countries have communicated implementing measures as at late July 2017 (Austria, Portugal, Sweden, France, Belgium, and Spain). The new regulations are due to enter into effect on 3 January 2018.
What Should Non-EU Managers Do Now?
Non-EU managers who believe that they may be affected by the changes being introduced under MiFID II should:
- Contact their EU brokers and distributors to discuss required changes;
- Conduct an internal review of any changes to trading systems that may be required;
- Conduct an internal review of any changes to policies and procedures that may be required.
You can download your copy of the impact of MiFID II on non-EU managers
KB Associates’ Services
KB Associates offers a range of services to investment funds and management companies including:
- The provision of UCITS/AIF management company services.
- The provision of designated persons to perform UCITS business plan and AIFMD programme of activity managerial functions.
- The provision of UCITS/AIF operational support.
If you would like to discuss any issues raised in this article or related to KB Associates’ services in general, please feel free to contact Mike Kirby (+353 1 667 1980), Peter Northcott (+44 203 170 8813) or Mike Parton (+1 345 946 4224).
[1] Authorised regulated markets for the purposes of MiFID, e,g. in Ireland the Main Securities Market of the Irish Stock Exchange
[2] Multilateral Trading Facilities are self-regulated trading venues and are an alternative to traditional stock exchanges.
[3] Systematic Internalisers were introduced under MiFID I and are investment firms who execute orders from their clients against their own book or against orders from other clients. They are like mini exchanges and execute orders outside an RM.
[4] Algorithmic trading is trading where a computer algorithm determines individual parameters of orders such as price, quantity and timing.