Anti-money laundering and market abuse trends in the UK
The anti-money laundering (AML) and market abuse landscapes have continued to be turbulent over the last 18-24 months, and this trend is set to continue.
With the implementation deadline of January 3, 2018 starting to loom over the horizon the FCA has started producing a series of consultation papers on MiFID II / MiFIR. The third consultation paper in the series, Consultation Paper 16/29: Markets in Financial Instruments Directive II Implementation – Consultation Paper III, was published on September 29, 2016.
The consultation paper is split into two parts with the first half covering conduct of business issues and the second half focusing on matters not covered by the previous FCA consultations including product governance and additional perimeter guidance. Generally, the deadline for comments on the consultation paper is January 4, 2017.
In this latest ‘10 things you should know’ MiFID II / MiFIR briefing note we pick out some of the hot topics in the consultation paper.
The FCA intends to implement the ban on inducements in MiFID II as is, as far as it applies to firms providing independent investment advice and portfolio management services to professional clients. Importantly, for firms providing investment advice and portfolio management services to retail clients, the FCA proposes to extend MiFID II’s inducement ban in three ways in order to reflect the existing UK policy approach. First, so that it extends to restricted advice as well as independent advice. Second, to prohibit the acceptance of commission and benefits rather than their acceptance and retention (i.e. to ban rebating of inducements to retail clients). Third, to amend the adviser charging rules by applying the ban to the business of providing investment advice rather than only to inducements provided in relation to the provision of a particular personal recommendation to a client.
To retain consistency with its existing approach of applying the use of dealing commission rules (COBS 11.6) to all forms of investment management activity, the FCA proposes to apply the research and inducements requirements in MiFID II to MiFID exempt UK authorised firms carrying out investment management of collective investment schemes. This includes: UCITS management companies; full scope UK alternative investment fund managers (AIFMs); small authorised AIFMs and residual collective investment scheme operators; and incoming EEA AIFM branches.
The FCA’s intention behind extending the requirements to collective portfolio management is to ensure that investors in funds or other forms of collective investment scheme performing economically equivalent activities are subject to the same investor protection standards and that costs and charges are more transparent across different types of portfolios and services. The FCA believes that this is consistent with the commercial models of many asset management firms, whereby individual and collective portfolios are managed side-by-side, with investment decisions taken for groups of portfolios and funds together, and also transactions aggregated across portfolios to create benefits from economies of scale. The FCA argues that the requirements will ensure that where a firm carries out both individual and collective portfolio management, there is no incentive to fund research through dealing commissions charged to their funds, which may also benefit individual portfolios. The FCA feels that this could occur if different standards were applied and firms wished to avoid paying for research themselves or with more explicit charges.
To give effect to MiFID II’s bar on opting-up elective professional clients to eligible counterparty (ECP) status, the FCA is proposing to delete COBS 3.6.4R(1)(b). New text is also proposed for the FCA Handbook that would implement the new procedural notification requirements (written confirmation, investor warnings) for firms who opt-up per se professional clients to ECP status.
Importantly, as elective professional clients will no longer be able to opt-up to ECP status, firms will have to re-categorise their ECP clients who have been opted-up from elective professional client status. Firms will also need to amend their opting-up processes for ECPs to comply with the procedural notification requirements (i.e. in the case of per se professional clients only).
In terms of disclosure MiFID II strengthens the regulatory protections available to professional clients and ECPs. For professional clients, it applies disclosure requirements that previously only applied in relation to retail clients. For ECPs it: requires information disclosure in more circumstances than currently, by effectively reducing the circumstances in which the conduct of business requirements can be dis-applied (as outlined in Article 30(1) of MiFID II); applies the information requirements in Article 24(4) and (5) of MiFID II and the reporting obligations in Article 25(6) of MiFID II; and creates a two-fold obligation on investment firms, in their relationship with ECPs, to act honestly, fairly and professionally and communicate in a way that is fair, clear and not misleading (Article 30(1), second paragraph of MiFID II).
The FCA states that firms doing MiFID business will be subject to more detailed requirements when communicating with professional clients, in line with those currently applying when communicating to retail clients. These firms will need to amend their disclosures accordingly. Such firms will also need to amend their approach to communicating disclosures to ECPs, to comply with the additional requirements that will apply. However, retail clients should notice little difference following the implementation of the new rules whereas professional clients and ECPs will notice changes to the quantity and detail of the disclosure material they receive.
MiFID II expands the existing MiFID suitability provisions in a number of ways. The new requirements are mainly set out in a Delegated Regulation (Delegated Regulation of April 25, 2016 supplementing MiFID II as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive (the Delegated Regulation)) with the exception of that on bundled products and services where the rules are set out in MiFID II. The FCA does not have any discretion to apply requirements that are additional to those set out in MiFID II and the Delegated Regulation. The FCA has therefore copied out the relevant sections of the Delegated Regulation into a new draft of COBS 9A. Article 3.2(b) of MiFID II requires the FCA to have suitability requirements for Article 3 firms1 that are ‘at least analogous’ to those for other firms. The FCA proposes to apply the proposed COBS 9A to Article 3 firms in full.
The FCA proposes to leave the implementation of provisions on appropriateness for products covered by the Insurance Distribution Directive until it has consulted on implementing the Directive. Therefore the FCA’s proposals currently only cover the application of the appropriateness test to MiFID products. As the FCA does not have any discretion to apply requirements that are additional to those set out in MiFID II and the relevant Delegated Regulation (Commission Delegated Regulation of April 25, 2016 supplementing MiFID II as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive) the FCA proposes to copy out the requirements into COBS 10A.
When the final FCA rules are implemented firms will need to carry out the appropriateness test for a wider range of products than at present. When offering bundled products and services, they will need to consider the appropriateness of the overall bundle. They will also need to record the results of a test, including, when a warning has been given but the client wishes to proceed with the transaction, and whether they decided to carry out the client’s request.
Interestingly, the FCA states that non-UCITS Retail Schemes and investment trusts are neither automatically non-complex nor automatically complex. Instead, they need to be assessed against the criteria in the MiFID II Delegated Regulation. The FCA warns that when firms apply such criteria they should adopt a “cautious approach” if there is any doubt as to whether a financial instrument is non-complex.
The FCA is not proposing to apply the new requirements in COBS 10A to Article 3 firms.
The FCA’s proposed approach is to amend the existing rules on best execution set out in COBS 11.2 by transposing the MiFID II requirements into a new COBS 11.2A. In addition, whilst the Delegated Regulation is directly applicable the FCA proposes to copy the relevant provisions into the FCA Handbook. Also, the FCA proposes to retain the existing guidance in COBS 11.2 that stems from the recitals in MiFID as it believes that the substance of this guidance also appears as MiFID II’s recitals and it considers that these will help to explain the purpose and intent behind the operative provisions.
The FCA also sets out certain proposals as regards applying the MiFID II best execution rules to non-MiFID business (Article 3 firms and managers of collective investment undertakings). Such proposals include extending the MiFID II best execution rules to non-MiFID business but with certain modifications that are designed to take into account the specific business models of certain firms.
To meet the new MiFID II requirements firms will be expected to update their existing execution arrangements, execution policies and monitoring procedures.
For investment research the FCA proposes to copy out the provisions of MiFID II into a single new COBS chapter, rather than retaining the current structure of COBS 12.2 and 12.3. To ensure that firms recognise that what the MiFID II text refers to as ‘marketing communication’ is the same as what is currently referred to as ‘non-independent research’ in the FCA Handbook, the FCA proposes to introduce a piece of guidance to clarify at the beginning of the new COBS chapter:
“This chapter applies to both investment research and non-independent research, the latter of which is not presented as objective or independent and is accordingly considered a marketing communication.”
MiFID II specifically identifies firms’ product governance obligations. These obligations require a number things including that firms establish procedures to assess the target market and risks for those new products that it manufactures or distributes. MiFID II contains further specific obligations for firms involved in the manufacture of products (for example that products are designed to meet the needs of the target market) and distribution (for example there are provisions for such firms to gather relevant information from manufacturers).
The FCA proposes to introduce the MiFID II provisions into a new sourcebook for Product Governance and Product Intervention. The sourcebook will also include the Statement of Policy on the FCA’s use of its temporary product intervention rule-making power.
Article 10 of the Delegated Regulation seeks to clarify the scope of derivative contracts relating to currencies which necessitates a change in the scope of UK domestic regulation, notably in regard to forward FX contracts. The FCA proposes to amend its existing guidance on such contracts in PERG 13 Q30 and include new material to help firms understand the scope of the new regulation. The proposed new guidance includes, in particular, several practical examples of the scope of the ‘means of payment’ exclusion in the Delegated Regulation and an explanation of its exclusion for FX spot contracts.
The FCA proposes to apply the MiFID II taping regime to a wider range of activities than those required by the Directive. This includes corporate finance business. The FCA believes that its proposal to require firms to record corporate finance business aligns with the outcomes of Fair and Effective Markets Review, which highlighted the benefits of technology to help reduce the scope for poor misconduct in wholesale markets, and its operational objective to protect and enhance market integrity. In addition the FCA saw from its recent thematic review, Thematic Review 15/13: Flows of confidential and inside information, poor systems and controls in respect of the handling of confidential and inside information within these firms. The FCA believes that records of telephone conversations and electronic communications could help it assess how these firms are complying with their wider regulatory requirements including the management of conflicts of interest which are inherent in the provision of corporate finance business, particularly in respect of underwriting and placing.
Under Article 3 of MiFID II, Member States can exempt from authorisation as MiFID investment firms, firms that provide investment advice and/or receive and transmit client orders in relation to a restricted range of financial instruments, which do not hold client assets or money and do not do business outside of the UK. MiFID II requires that such firms are subjected to ‘at least analogous’ requirements to each of the individual organisational and conduct requirements listed in Article 3(2)(a) to (c) of MiFID II and their corresponding implementing measures.
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