MiFID II / MiFIR series

Navigating the ESMA May 2014 Consultation Paper

Publication June 2014


The final legislative texts of the Markets in Financial Instruments Directive (recast) (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) were approved by the European Parliament on 15 April 2014 and by the European Council on 13 May 2014. Both will enter into force on the twentieth day following their publication in the Official Journal of the European Union (estimated in June 2014).

The European Securities and Markets Authority (ESMA) has listed 106 separate implementing measures for MiFID II and MiFIR. The implementing measures will take the form of delegated acts and technical standards. Delegated acts are drafted by the European Commission on the basis of advice by a European Supervisory Authority (ESA) and technical standards are drafted by an ESA and adopted by the Commission. With MiFID II and MiFIR the ESA will generally be ESMA.

On 23 April 2014, the Commission issued a request for ESMA to provide it with technical advice on possible delegated acts and technical standards. On 22 May, ESMA begun the formal process of producing its technical advice by publishing a discussion paper and a consultation paper. The purpose of the discussion paper is to seek views on key elements of future ESMA technical standards. The purpose of the consultation paper is to consult interested parties in order to produce technical advice to the Commission which will allow it to formulate delegated acts.

The consultation paper is 311 pages long. The time frame in which investment firms can digest and comment on the consultation paper is very limited with comments due in just over two months on 1 August 2014. Before the deadline ESMA will be holding a public hearing in Paris on 7 and 8 July.


The consultation paper is structured around 7 key topics, these being investor protection, transparency, data publication, micro-structural issues, requirements applying on and to trading venues, commodity derivatives and portfolio compression.

A key point made in the consultation paper is that ESMA is advising the Commission, inter alia, on MiFID II implementing measures with regard to organisational requirements and operating conditions for investment firms. Under MiFID these implementing measures are included in the MiFID Implementing Directive. ESMA considers that several existing requirements of the MiFID Implementing Directive are in line with the MiFID II framework and are still adequate in the new regulatory framework. In light of this the consultation paper focuses on areas where new requirements or modifications to the MiFID Implementing Directive are proposed. Where additions or amendments to the MiFID Implementing Directive are not proposed ESMA believes that the existing requirements should be confirmed in the MiFID II implementing measures.

Investor protection: overview

The investor protection section (section 2) is the longest part of the consultation paper comprising some 150 odd pages (pages 13 to 166). It covers a wide range of issues:

  • exemption from the applicability of MiFID for persons providing an investment service in an incidental manner;
  • investment advice and the use of distribution channels;
  • compliance function;
  • complaints handling;
  • product governance;
  • record keeping;
  • safeguarding client assets;
  • conflicts of interest;
  • remuneration;
  • fair, clear and not misleading information;
  • information to clients about investment advice and financial instruments;
  • the legitimacy of inducements to be paid to/by a third person;
  • investment advice on an independent basis;
  • suitability;
  • appropriateness;
  • best execution;
  • client agreement;
  • reporting to client;
  • client order handling;
  • transactions executed with eligible counterparties; and
  • product intervention.

Investor protection: examples of ESMA’s approach

Exemption from the applicability of MiFID for persons providing an investment service in an incidental manner

The section on investor protection begins with a brief discussion on the exemption from the applicability of MiFID II for persons providing an investment service in an incidental manner. This exemption is contained in article 2(1)(c) of MiFID II. The wording of the exemption is identical to that contained in MiFID.

Interestingly, ESMA states that common criteria for the exemption should be developed noting that the word “incidental” should not solely be defined through temporal criteria (i.e. frequency or duration of services) but rather that the provision of the investment service should have an inherent connection to the main area of the professional activity and be of minor and subordinated scope in comparison. In addition, ESMA states that an investment service would not be considered as being provided in an incidental manner if the person who provides the investment service markets its ability to provide investment services. A positive and negative example of how the exemption could apply are given by ESMA.

Compliance function

Article 16(2) of MiFID II consists of an identical recast of article 13(2) of MIFID. It provides that:

“An investment firm shall establish adequate policies and procedures sufficient to ensure compliance of the firm including its managers, employees and tied agents with its obligations under this Directive as well as appropriate rules governing personal transactions by such persons.”

In September 2012, ESMA published guidelines on certain aspects of the MiFID compliance function which focused on, among other things, the organisational requirements of the compliance function for the standards of effectiveness, permanence and independence. In the consultation paper ESMA states that improvements could be made to the MiFID Implementing Directive by implementing some of the principles set out in the guidelines.

Record keeping (other than recording of telephone conversations or other electronic communications)

MiFID II does not make any substantial changes to MiFID in respect of general record keeping obligations, other than emphasising that records should enable national competent authorities (NCAs) to fulfil supervisory tasks and perform enforcement actions.

The MiFID Implementing Directive and the MiFID Implementing Regulation currently provide for a number of record-keeping requirements. ESMA acknowledges this and states in the consultation paper that article 51 of the MiFID Implementing Directive and articles 7 and 8 of the MiFID Implementing Regulation should be confirmed in the implementing measures of MiFID II. However, ESMA also advocates transposing a list of minimum records into the MiFID II implementing measures. This list would be largely based on the 2007 CESR Level 3 recommendations that list the minimum records that NCAs need to draw up according to article 51(3) of the MiFID Implementing Directive.

Recording of telephone conversations and electronic communications

ESMA discusses article 16(7) of MiFID II which introduces organisational requirements for investment firms, which requires them to record telephone conversations or electronic communications relating to the following investment services: reception and transmission of orders, execution of orders on behalf of clients, and dealing on own account.

The specific conversations and communications that should be recorded in relation to these investment services are: (i) the receipt of an order from a client; (ii) the transmission of an order (both where the investment firm will transmit the order, and where it will execute it); (iii) the conclusion of a transaction when executing orders on behalf of clients; and (iv) the conclusion of a transaction when dealing on own account regardless of whether a client is involved in the transaction.

Among the many points that ESMA makes on this obligation is one concerning internal calls. ESMA states that some internal calls will be subject to the MiFID II recording requirement where the internal call in question “relates to or is intended to result in transactions” in the provision of investment services subject to the telephone recording requirement. According to ESMA this view aligns with recital 57 of MiFID II.

Product governance

In the consultation paper ESMA discusses the relevant product governance provisions in MiFID II, being recital 71 and articles 16 and 24. In its analysis ESMA proposes to introduce two sets of policy proposals for product governance arrangements for:

  • investment firms to adopt when manufacturing products (product governance obligations for manufacturers); and
  • investment firms to adopt when deciding the range of products and services they intend to offer to clients (product governance obligations for distributors).

ESMA proposes that where an investment firm acts as both a manufacturer and a distributor of investment products it should be required to fulfil all the relevant obligations set out for both manufacturers and distributors. In a group context, where the product is developed by one entity and distributed by another, the product governance requirements for manufacturers and distributors apply to each entity depending on the activities undertaken.

Also, ESMA proposes to impose on investment firms a positive duty to check that products function as intended rather than only requiring them to react when detriment becomes apparent or at issuance or re-launch of the same product. The frequency of the review is considered further in the consultation paper.

Safeguarding client assets

Article 16 of MiFID II concerns the safeguarding of client assets. Articles 16 to 20 of the MiFID Implementing Directive also deal with the safeguarding of client assets. Having reviewed these articles ESMA sets out draft advice on a number of related issues including the indiscriminate use of Title Transfer Collateral Arrangements (TTCA), segregation of client financial instruments in third country jurisdictions and securities financing and TTCA and collateralisation.

Noticeably ESMA proposes to introduce additional requirements in respect of both client instruments and client funds. ESMA proposes that investment firms should have proper and specific governance in place to ensure the safeguarding of client assets. More specifically, ESMA proposes addressing concerns around inappropriate lending of, and liens over, client assets; and restricting any inappropriate activity in this area; increasing disclosure to clients; and addressing, through diversification, the contagion risk to client funds that occurs when held exclusively in group banks.

Conflicts of interest

The requirement that investment firms should not over-rely on disclosure or use it as a self-standing measure to manage conflicts is, according to ESMA, implicit in article 22 of the MiFID Implementing Directive. To address any uncertainty over interpretation ESMA proposes to make this principle explicit. ESMA considers that before relying on disclosure, investment firms should first consider whether other reasonable measures effectively mitigate the conflict of interest and prevent potential detriment. It believes that in this regard it would be reasonable for NCAs to request evidence from investment firms to demonstrate compliance with this requirement.

ESMA also notes that under MiFID whilst there is no explicit obligation requiring investment firms to periodically review conflicts of interest policies it is normal business practice for them to do so. ESMA proposes to formalise this process by requiring investment firms to assess and periodically review at least annually their conflicts of interest policy.


Whilst MiFID and its implementing measures do not specifically mention remuneration issues MiFID II changes the position by inserting a new explicit requirement in article 9(3)(c) that management bodies of investment firms:

“define, approve and oversee [….] a remuneration policy of persons involved in the provision of services to clients aimed at encouraging responsible business conduct, fair treatment of clients as well as avoiding conflicts of interest in the relationships with clients.”

The basis of ESMA’s draft advice are the principles contained in its 2013 guidelines on remuneration (in particular the definition of remuneration). ESMA believes that MiFID II should specify requirements in the following areas:

  • governance – before approving remuneration policies, management bodies should seek advice from the compliance function;
  • general criteria for the design of remuneration policies – such criteria should avoid creating incentives for relevant persons to favour their own interest or the firm’s interest over the interest of clients; and
  • variable remuneration – an appropriate balance between fixed and variable remuneration to be maintained at all times and variable remuneration to be based on qualitative criteria.

Legitimacy of inducements to be paid to/by a third person

MiFID contains requirements for third party payments in the context of article 26(b) of the MiFID Implementing Directive. Article 24 of MiFID II seeks to strengthen these requirements by distinguishing between rules that apply to: (i) the investment services of portfolio management and investment advice on an independent basis; and (ii) all other investment services.

In the consultation paper ESMA considers the following areas which were set out in the Commission’s mandate:

  • the conditions under which investment firms providing investment advice on an independent basis and portfolio management fulfil the requirement to not accept and retain any monetary or non-monetary third party payments;
  • the definition and conditions for ‘minor non-monetary benefits’ that can be received when providing independent advice or portfolio management;
  • the use of payments and non-monetary benefits that meet the requirement of enhancing the quality of the relevant service to the client; and
  • requirements for the disclosure to the client in relation to the existence, nature and amount of the third party payment or benefit.

In relation to minor non-monetary benefits ESMA believes that this exemption should be strictly interpreted, such that non-monetary benefits likely to influence the behaviour of the recipient should not be allowed. ESMA also discusses the potential for research to be permissible as a minor non-monetary benefit. In particular ESMA proposes that for financial analysis to come within the exemption it would need to be intended for distribution so that it is, or is likely to become, accessible by a large number of persons, or for the public at the same time. The simultaneous widespread distribution of research on a single financial instrument or issuer of financial instruments, or generic economic commentary, is given as an example that may meet the requirement. In contrast ESMA states that it considers any research which involves a third party allocating valuable resources to a specific portfolio manager would not constitute a minor non-monetary benefit and could be judged to impair compliance with the portfolio manager’s duty to act in their client’s best interest.


ESMA’s draft advice covers the general suitability provision in article 25(2) and the contents of the suitability report in article 25(6) of MiFID II.

ESMA considers that the suitability provisions in article 35 of the MIFID Implementing Directive are a good basis for the development of the MiFID II implementing measures and proposes to leave them as drafted except for article 35(1). This provision is to be updated to reflect that MiFID II explicitly requires investment firms, when undertaking a suitability assessment, to assess both a client’s ability to bear losses and a client’s risk tolerance. ESMA’s advice also covers the position that MiFID II requires investment firms to provide a client with a suitability report specifying how the advice given meets the retail client’s circumstances and needs.


ESMA’s draft advice on appropriateness covers article 25(3) and (4) of MiFID II, which includes the definition of a non-complex financial instrument. This includes advice in relation to the criteria to assess non-complex financial instruments for the purposes of article 25(4)(a)(vi) of MiFID II.

ESMA considers that the criteria in article 38 of the MiFID Implementing Directive and the 2009 CESR Q&A statement on MiFID complex and non-complex instruments to be a useful starting point when analysing “other non-complex financial instruments” but has added additional criteria.

Best execution

MiFID II does not set out major changes to the best execution requirements although ESMA’s advice provides a few additional requirements and clarifications covering:

  • detail of execution policies;
  • disclosure and consent;
  • content of disclosure;
  • third party payments;
  • transparency of venue selection;
  • factors that may constitute a ‘material change’; and
  • use of a single venue or entity for execution.

In relation to material change ESMA states that what is material will depend on the nature and scope of any change and the nature and size of a firm’s business. Nevertheless, ESMA also states that a material change could be understood as a significant event of internal or external change that could impact parameters of best execution (cost, price, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order).

Transparency: overview

Section 3 of the consultation paper covers transparency (pages 174 to 208). It is divided into eight sub-sections covering:

  • liquid market for equity and equity-like instruments;
  • delineation between bonds, structured finance products and money market instruments;
  • the definition of systematic internaliser;
  • transactions in several securities and orders subject to conditions other than the current market price;
  • exceptional market circumstances and conditions for updating quotes;
  • orders considerably exceeding the norm;
  • prices falling within a public range close to market conditions; and
  • pre-trade transparency for systematic internalisers in non-equity instruments.

Transparency: examples of ESMA’s approach

Liquid market for equity and equity-like instruments

Article 2(1)(17)(b) of MiFIR defines “liquid market” for the purposes of applying transparency measures to equity and equity-like instruments. It provides that ‘liquid market’ means:

“for the purposes of articles 4, 5, and 14, a market for a financial instrument that is traded daily where the market is assessed according to the following criteria:

  1. the free float
  2. the average daily number of transactions in those financial instruments
  3. the average daily turnover for those financial instruments.”

In the consultation paper ESMA sets out its findings from data collection exercises and analysis which illustrate a significant amount of work that the ESA has already undertaken behind the scenes. Following these exercises and analysis ESMA proposes:

 Free floatAverage daily number of transactionsAverage daily turnover (€)
Depositary receipts€100,000,0002501,000,000
Exchange traded funds100 (number of units issued for trading)20500,000
Certificates (as defined in article 2(1)(27) of MiFIR1,000,000 (issuance size in euro)20500,000

Definition of systematic internaliser

The current definition of systematic internaliser contained in article 4(1)(7) of MiFID is updated in article 4(1)(20) of MiFID II. The revised definition in MiFID II is based on quantitative criteria for assessing when the activity of dealing on own account by executing client orders is sufficiently frequent, systematic and substantial. The new definition also allows an investment firm to choose to opt-in under the systematic internaliser regime even where it does not meet all or any of the quantitative criteria.

Separately MiFID II extends the systematic internaliser regime so that it no longer just applies to shares but a broader range of equity-like instruments (depositary receipts, ETFs, certificates and other similar financial instruments) and non-equity instruments (derivatives, bonds, structured finance products and emission allowances).

ESMA discusses the meaning of “sufficiently frequent, systematic and substantial” generally and then in the context of both equities and equity-like instruments and non-equity instruments. In relation to “frequent and systemic” ESMA proposes for liquid instruments to set a threshold as a percentage of the total number of trades calculated for each financial instrument. For illiquid instruments ESMA proposes setting an absolute number of transactions. The discussion regarding “substantial” focuses on the determination of two thresholds.

Transactions in several securities and orders subject to conditions other than the current market price

In relation to execution in several securities ESMA states that the current definition of portfolio trade (i.e. a transaction in more than one financial instrument where those financial instruments are traded as a single lot against a specific reference price) involving 10 or more financial instruments remains valid. ESMA also adds that a portfolio trade should also be considered as a transaction subject to conditions other than the current market price for the purpose of the execution of orders at prices different to the quoted ones.

Exceptional market circumstances and conditions for updating quotes

ESMA proposes a non-exhaustive list of exceptional market circumstances which includes where an NCA prohibits short sales according to article 20 of the Regulation on short selling.

Orders considerably exceeding the norm

ESMA is not proposing to prescribe for all investment firms acting as systematic internalisers the number and/or volume of transactions exceeding the norm. Instead, each investment firm is to determine in advance, in an objective and non-discriminatory way and consistently with its risk management policy, when the number or volume of orders shall be regarded as considerably exceeding the norm.

Data publication: overview

Section 4 of the consultation paper covers data publication (pages 209 to 229). It is divided into three sub-sections covering:

  • access to systematic internalisers’ quotes;
  • publication of unexecuted client limit orders on shares traded on a venue; and
  • reasonable commercial basis.

Data protection: examples of ESMA’s approach

Publication of unexecuted client limit orders on shares traded on a venue

ESMA states that the submission of clients’ limits orders to trading venues should be adapted to MiFID II by adding Organised Trading Facilities (OTFs) to the venues to which an investment firm can transmit a non-executed order.

Reasonable commercial basis

The section on reasonable commercial basis in relation to the provision of data forms the longest part of the data protection section of the consultation paper. MiFID II and MiFIR contain numerous references to this term and there are five separate powers for the Commission to clarify what the phrase means through delegated acts.

ESMA notes that the main element of reasonable commercial basis relates to the prices charged for data and most of the section covers this. However, ESMA also acknowledges that there is the question of unbundling.

ESMA states that reasonable commercial basis should include a measure of non-discrimination. Suppliers should offer the same prices, and other terms and conditions, to all customers who are in the same position according to published, objective criteria. Such criteria should, however, allow suppliers to discriminate between different types of customers where it is reasonable to do so.

In the consultation paper ESMA discusses possible options for determining reasonable commercial basis. One option provides that for a service to be supplied on a reasonable commercial basis, the supplier should set prices to be fair, reasonable and non-discriminatory. Suppliers’ price lists should be subject to full transparency, alongside other key metrics. Another option considers imposing certain high-level limits. For example, market data services as a proportion of total revenues should not exceed a certain percentage.

Micro-structural issues

Section 5 of the consultation paper covers micro-structural issues and is short consisting of only six pages (pages 230 to 236). It deals with two issues: algorithmic and high frequency trading (HFT) and direct electronic access.

The concepts of algorithmic trading and HFT are defined in article 4(1)(39) and (40) of MiFID II. In line with the Commission’s mandate ESMA focuses on further clarification of the HFT definition. In this regard ESMA considers two options. The first option focuses on “infrastructure intended to minimise network and other types of latencies” whilst the second, and preferred, option focuses on the “high frequency nature of the message intraday rate”.

Whilst discussing both options ESMA notes that where a market has concluded that an activity amounts to HFT the same approach should be extended to all trading venues in the EU.

Requirements applying on and to trading venues

Section 6 of the consultation paper covers requirements applying on and to trading venues (pages 237 to 277). It is divided into five sub-sections covering:

  • SME growth markets;
  • suspension and removal of financial instruments from trading;
  • substantial importance of a trading venue in a host Member State;
  • monitoring of compliance – information requirements for trading venues; and
  • monitoring of compliance with the rules of a trading venue – determining circumstances that trigger the requirement to inform about conduct that may indicate abusive behaviour.

Most of ESMA’s comments in this section are reserved for SME growth markets. ESMA sets out draft advice on options as regards each of the requirements that an SME growth market will need to meet in accordance with article 33(3) of MiFID II. ESMA also provides draft advice in relation to article 33(3)(a) of MiFID II which requires that at least 50% of the issuers whose financial instruments are admitted to trading on the multilateral trading facility (MTF) are SMEs at the time when the MTF is registered as an SME growth market and in any calendar year thereafter.

Commodity derivatives: overview

Section 7 of the consultation paper covers commodity derivatives (pages 278 to 307). It is divided into three sub-sections covering:

  • financial instruments definition – specifying section C6, 7 and 10 of Annex I of MiFID II;
  • position reporting thresholds; and
  • position management powers of ESMA.

Commodities derivatives: examples of ESMA’s approach

Financial instruments definition

ESMA begins by setting out its understanding of the MiFID II text in relation to the definition of C6 of Annex I. In particular it notes that the definition of section C6 of Annex I under MiFID has been significantly changed under MiFID II by classifying options, futures, swaps and other derivative contracts relating to commodities that can be physically settled and are traded on an OTF as financial instruments, in addition to those instruments that trade on MTFs and regulated markets.

In relation to C6 energy contracts ESMA notes that these are defined as options, futures, swaps and any other derivatives with coal or oil as an underlying and which are traded on an OTF and must be physically settled. However, whilst stating that derivative contracts with coal as an underlying appear to be an easily identifiable section of instruments ESMA believes that the same does not hold for contracts with oil as an underlying. Here the question arises whether only different grades of crude oil would qualify as C6 energy derivatives contracts or whether other contracts where the underlying is derived from crude oil are within scope. In the consultation paper ESMA states that at this stage it has yet to decide on exactly where the line should be drawn and calls for input from stakeholders.

ESMA also sets out draft advice designed to clarify the notion of “must be physically settled”. In particular it considers that the existence of force majeure provisions should not prevent a contract from being characterised as “must be physically settled” for the purposes of further specifying wholesale energy products under section C6 and C6 energy derivative contracts.

Position reporting thresholds

Article 58(6) of MiFID II requires ESMA to advise the Commission on the minimum thresholds that are referred to in article 58(1). These thresholds are the levels above which the aggregate Commitment of Trader Reports that have been prepared by trading venues and also collected by ESMA will be published. When determining the appropriate thresholds for publication, the Commission will have regard to:

  • the total number of persons that hold a position in the relevant instrument; and
  • the total size of their positions.

ESMA proposes that a Commitment of Trader Report would only need to be published for a commodity derivative, emission allowance, or a derivative thereof traded on a trading venue when:

  • 30 or more persons hold a position in that commodity derivative; and
  • when the value of the gross long or short volume of total open interest of their positions for that commodity derivative exceeds four times the deliverable supply in that commodity derivative.

Position management powers of ESMA

MiFID II and MiFIR introduce for the first time, mandatory position limits and position reporting across the EU. NCAs who will supervise the adherence to the position limits will be granted a minimum set of powers in relation to: requiring information on commodity derivative positions, requesting a person to reduce the size of a position and having the ability to limit a person from entering into a commodity derivative.

Under article 45 of MiFIR ESMA has comparable position management powers to NCAs and article 45(1) of MiFIR gives ESMA, in certain circumstances, powers to: request information from any person on their derivative positions, require the reduction or elimination of those positions and, as a last resort, limit the ability of a person from entering into a commodity derivative.

ESMA’s position management powers can only be used in exceptional circumstances and only where there is both an emergency situation and a failure or inability of an NCA to take appropriate action. In the consultation paper ESMA sets out a non-exhaustive list of those emergency scenarios.

ESMA also provides draft advice on the criteria and factors that will be used to determine the appropriate reduction of a position or exposure entered into via a derivative.

Portfolio compression

The final section of the consultation paper, section 8, is short (pages 308 to 311) and covers portfolio compression.

MiFIR defines portfolio compression, and the rules that should apply to the investment firms when providing compression. In the consultation paper ESMA discusses the elements of portfolio compression and the information that should be published by investment firms and market operators providing compression. ESMA notes that the elements of portfolio compression to be developed will need to take into consideration that it can be performed on a bilateral or on a multilateral basis.


MiFID II and MiFIR are expected to enter into force in June 2014, in which case ESMA’s technical advice would be due in December 2014. On that basis, Member States would need to adopt and publish the domestic legislation necessary to transpose MiFID II by June 2016, such legislation and MiFIR would then apply from December 2016.

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