The MiFID II requirements are more detailed than those in MiFID I in setting out the role and responsibility of the management body, to ensure good corporate governance.
In common with MiFID I, MiFID II requires competent authorities to ensure that firms comply with requirements around corporate governance, through assessment as part of authorisation.
An investment firm’s management body must define, approve and oversee the firm’s organisation for the provision of investment services. These obligations ensure that the management body sets out the firm’s corporate governance arrangements, and fully considers and scrutinises them at the time of implementation and on an ongoing basis. In setting out the firm’s organisation; the firm must specifically consider the following key issues:
- the skills, knowledge and expertise required by personnel; and
- the resources, procedures and arrangements for the provision of services and activities (taking account of the firm’s nature, scale and complexity and all the requirements the firm must comply with).
Further there are various specific requirements relating to the firm’s organisation, in the context of a firm’s activities. For example, firms providing independent advice or portfolio management should also set up a policy, as part of their organisational requirements, to ensure that third party payments received by the firm are allocated and transferred to the clients.8
MiFID I placed emphasis on the compliance function to ensure internal policies and procedures met the firm’s obligations under the Directive (and elaborated in the MiFID Implementing Directive). These provisions remain and are identical in MiFID II.
Policy of services and products offered which is stress tested
An investment firm’s management body must define, approve and oversee a policy as to services, activities, product and operations offered or provided in accordance with the risk tolerance of the firm and the characteristics and needs of the clients of the firm to whom they will be offered.
The MiFID II requirements in respect of third party payments, commissions and inducements are set out in our conduct of business briefing notes.
Importantly, MiFID II requires management bodies to ensure appropriate stress testing of services or products is conducted, to ensure that the above mentioned policy works and that such services or products accord with the characteristics and needs of the firm’s clients.
The MiFID II requirements in respect of appropriateness and suitability, are also set out in a separate conduct of business briefing note.
MiFID II introduces a new requirement that the management body define, approve and oversee a remuneration policy of persons involved in the provision of services to clients, which must have the following fundamental aims as its objective:
- encouraging responsible business conduct by the firm;
- ensuring the fair treatment of clients; and
- avoiding conflicts of interest in the relationship with clients.
This remuneration policy is widely drawn by the legislation, covering all persons involved in the provision of services.
Management bodies must monitor, and assess the effectiveness of the firm’s governance arrangements and the adequacy of the Policy set out above.
MiFID II makes explicit the link between remuneration of staff and conflicts of interest. Whilst firms had a duty to organise themselves so as to effectively manage conflicts under MiFID I, pursuant to the recast MiFID II firms must “take all appropriate steps to identify and to prevent or manage conflicts
of interest […] including those caused by […] the firm’s own remuneration and other incentive structures”.9
The management body must have adequate access to information and documents which are needed to oversee and monitor management decision-making, as the management body will be held responsible for the firm having governance arrangements that ensure effective and prudent management of a firm. This requirement represents a hard-coded requirement for firms to ensure that good quality management information (‘MI’) is delivered from the business. Proactive engagement by management will be key.
In the UK context, this represents a strengthening of the guidance which the UK regulators have issued in recent years, concerning the provision of ‘MI’.
Members of the management body
In common with MiFID I, members of the management body of the investment firm must be of ‘sufficiently good repute’. Further, such members must possess:
‘sufficient knowledge, skills and expertise’, and
‘commit sufficient time to perform their functions in the investment firm.’
In keeping with current requirements, members of the management body must not obstruct the effective, sound and prudent management of the firm, or the adequate consideration of the interests of clients and the integrity of the market. The firm must also notify the competent authority of any changes to its membership, and provide sufficient information to the competent authority for it to assess the firm’s compliance with the obligations set out above concerning governance arrangements.
The provisions within MiFID II, level 1 build on the ‘clients best interests’ provisions which were an important feature of MiFID as first enacted.
MiFID II, level 1 sets out the higher level requirement for product manufacturers to maintain, as part of their organisational arrangements, appropriate product review processes to ensure investment products are ‘consistent with the needs’ of identified target markets. Product distributors are also required to ensure that their organisational arrangements include provision for access to key information on product which it distributes, from relevant manufacturers.
MiFID II, Level 2 measures will introduce new requirements on product governance and product approval processes to ensure that financial instruments and structured deposits will be offered or recommended only when this is in the interest of the client.
The recitals to MiFID II make clear the objective of the European Commission to prevent investment firms which manufacture and distribute financial instruments (and structured deposits), at an early stage, from failing to meet investor protection standards. Product governance policies and procedures are central to achieving good client outcomes, and represent one of the principal avenues to acting in the clients best interests.
Pursuant to the Level 1 measures, product manufacturers must ensure that products are manufactured to meet the needs of the target market of end clients, within the relevant category of clients, and that such products are distributed to the identified target market. Further, investment firms must ensure that products are reviewed to ensure that they remain consistent with the needs of the identified target market, taking into account events which might materially affect the risks posed by products to that market.
In particular product manufacturers will be under an obligation to maintain, operate and review a process for the approval of each financial instrument and significant adaptations of existing financial instrument before they are marketed or distributed to clients.