MiFID II / MiFIR series

Investor Protection (Conduct of business)

Publication May 2015


The Markets in Financial Instruments Directive (MiFID) is one of the cornerstones of EU financial services law, setting out which investment services and activities should be licensed across the EU and the organisational and conduct standards that those providing such services should comply with.

Following technical advice received from the European Securities and Markets Authority (ESMA) and a public consultation, the European Commission (the Commission) published legislative proposals in 2011 to amend MiFID by recasting it as a new Directive (MiFID II1) and a new Regulation (MiFIR2). The legislative proposals were the subject of intense political debate between the European Parliament, the Council of the EU, and the Commission. However, informal agreement between the EU institutions was finally reached in February 2014. The final MiFID II and MiFIR texts were published in the Official Journal of the EU on July 12, 2014 and entered into force 20 days later on July 2, 2014. Entry into application will follow 30 months after entry into force on January 3, 2017.

The implementing measures that will supplement MiFID II and MiFIR will take the form of delegated acts and technical standards. On May 22, 2014, ESMA released a consultation paper (the CP) setting out ESMA’s proposed advice to the Commission regarding delegated acts and on December 19, 2014 ESMA issued its final report to that consultation paper providing its draft advice to the Commission. The Commission will implement the resulting legislative proposals during 2015, taking into consideration ESMA’s final advice as well as the views of the European Parliament and Council of the EU. The Parliament and Council have three months to formally scrutinise and object to the Commission’s adopted legislation (extendable by up to a further three months) before it is finalised.

On May 22, 2014, ESMA also issued a discussion paper (the DP) setting out ESMA’s proposals for technical standards. On December 19, 2014, ESMA responded on the DP with a consultation paper setting out draft technical standards. The period for responding in relation to these draft technical standards was 2 March 2015.

While the headline changes to the MiFID regime center on market infrastructure, there are many changes being made to investor protection requirements. The overall theme is one of a small number of macro changes but a large number of micro changes which, together, will represent significant regulatory reform in this area. What is developing is a thick layer of additional EU requirements applicable to investment firms, some of which is clearly post-crisis reaction (for example, new product intervention powers, full prohibitions on some inducements, a tougher stance on execution-only business and a tighter client categorisation regime).

Conflicts of interest

What are the current requirements?

MiFID currently requires firms to:

  • consider and identify where conflicts may arise in the course of their business between: (a) the firm (including its managers, employees and tied agents) or any person directly / indirectly linked to the firm, and its clients; and (b) between different clients;
  • keep (and regularly update) a record of these actual and potential conflicts;
  • put in place organisational and administrative structures to prevent such conflicts from adversely affecting the interests of clients, and document this in a conflicts of interest policy; and
  • where these organisational / administrative measures do not allow a firm to have reasonable confidence that the risk of damage to clients’ interests will be prevented, to make adequate disclosure to clients. The disclosure must be in a durable medium and contain sufficient detail of the general nature and / or sources of the conflicts that may arise and the steps taken to mitigate / manage them so clients can make an informed decision before conducting business with the firm.

What is new in MiFID II Level 1?

There are no substantive changes made to these requirements in MiFID II (Level 1). There is an express statement that conflicts can arise from inducements and remuneration structures.

What is ESMA’s advice for Level 2?

Following its summer 2014 consultation, ESMA has now finalised its draft advice to the Commission which recommends significant changes as follows (these changes will apply in addition to the current requirements):

  • due to a perception that firms over-rely on disclosure, ESMA is proposing to make explicit the principle that disclosure is to be a ‘last resort’. By this ESMA means that disclosure can only be used where a firm’s organisational / administrative measures are not sufficient to ensure, with reasonable confidence, that the risks of damage to clients’ interests will be prevented;
  • coupled with the above perception that firms over-rely on disclosure, there is also a perception that the disclosures that are currently made are too generic. ESMA is proposing that disclosure should be tailored to the clients to whom they are addressed – i.e. disclosure should mention the specific conflict(s) that arises for that client type / category of service, as opposed to listing all conflicts that generally arise from the firm’s business across all client types and in respect of all services;
  • in the disclosure, ESMA is proposing that firms must clearly state that the organisational / administrative arrangements established by them to prevent or manage that conflict are not sufficient to ensure, with reasonable confidence, that there will not be a risk of damage to the interests of the client;
  • conflicts of interest policies must be reviewed and updated periodically (at least annually); and
  • over-reliance on disclosure is to be considered a deficiency in the firm’s conflicts of interest policy, which ought to be addressed when the policy is periodically reviewed.

Although not items consulted upon last summer, ESMA has decided to clarify two points in the MiFID Implementing Directive which have quite far reaching consequences.

  1. ESMA is clarifying that Article 25(1) of the MiFID Implementing Directive not only applies to ‘investment research’ but also to ‘recommendations’. ‘Recommendation’, for these purposes, is a broader category than ‘investment research’. Like ‘investment research’ it refers to research or other information recommending or suggesting an investment strategy, and which is intended for distribution channels or for the public. But there is no requirement for it to be labeled as investment research or presented as objective, nor need a ‘recommendation’ fall short of being a personal recommendation if it were made by an investment firm to its client.

    As proposed, this would require firms to apply measures to ensure the independence and operational separation of staff preparing marketing material / recommendations which does not amount to investment research, in the same way that they do for staff who prepare investment research.
  2. ESMA is further clarifying the requirements for analysts that prepare investment research so that they need to be physically separated from those other persons whose interests may conflict with those of the persons to whom that research is disseminated (unless this is disproportionate – in which case there need to be alternative information barriers).


What are the current requirements?

There are no specific restrictions under MiFID in relation to remuneration although, as noted above, there are general requirements in relation to managing conflicts of interest. In 2013 ESMA did, however, publish Guidelines on remuneration policies and practices for investment firms.

What is new in MiFID II Level 1?

MiFID II proposes restrictions on incentive schemes, internal rewards and sales targets for those firms operating in both the retail and professional markets as follows:

  • it requires a formal remuneration policy to be approved and overseen by senior management;
  • this policy should be aimed at the alignment of remuneration structures to encourage responsible business conduct, fair treatment of clients and to avoid conflicts of interest; and
  • it prohibits firms remunerating or assessing the performance of staff in a way that conflicts with the clients’ best interests rule or which incentivises staff to sell particular products or services.

What is ESMA’s advice for Level 2?

Following its summer 2014 consultation, ESMA has now finalised its draft advice to the Commission which follow ESMA’s principles in its Guidelines on remuneration (mentioned above):

  • to use the same definition of ‘remuneration’ as contained in those Guidelines, which includes as remuneration non-financial remuneration such as in-kind benefits and career progression;
  • to require management bodies to seek advice from compliance before approving remuneration policies and for senior management to be responsible for the day-to-day implementation of the policies;
  • to specify the design criteria for the remuneration policies, in particular to tackle the risk of staff being incentivised to favour their own interests or the firm’s to the potential detriment of clients; and
  • for there to be an appropriate balance between fixed and variable remuneration at all times, with variable remuneration to take account of criteria reflecting compliance with applicable regulations, fair treatment of clients and the quality of client service (and not solely or predominantly on quantitative commercial criteria).

Communications – fair, clear and not misleading

What are the current requirements?

MiFID requires all information addressed to clients or potential clients to be fair, clear and not misleading and for marketing communications to be addressed as such. There are specific conditions that communications need to meet in order to be fair, clear and not misleading, which currently only apply to retail clients.

What is new in MiFID II Level 1?

MiFID II is not proposing any direct changes to the current regime. However, it does reinforce in the recitals that eligible counterparties are clients. Consistent with this, MiFID II is proposing a new obligation on firms to communicate with eligible counterparties in a way that is fair, clear and not misleading.

What is ESMA’s advice for Level 2?

Bearing in mind that one of the objectives of MiFID II is to improve, where appropriate, the treatment of non-retail clients, ESMA has confirmed the proposals from its summer 2014 consultation to: (1) make targeted improvements to the current regime applicable to retail clients; and (2) extend some ‘retail like’ obligations to communications with professional clients.

Retail clients

ESMA’s advice strengthens the conditions with which information must comply in order to be fair, clear and not misleading as follows:

  • information must be consistently presented in the same language throughout all client facing material. In its December report, ESMA has confirmed that ‘same language’ means spoken language (i.e. German) as opposed to referring to the style of communication. Further, that client should be able to consent to being communicated with in more than one language;
  • to always include a fair and prominent indication of any risks where potential benefits are referenced, which must be in a font size at least equivalent to the predominant font size used throughout the communication;
  • information should always be up-to-date bearing the communication method in mind (e.g. online information should always be up-to-date, printed material should be updated when next printed); and
  • information on future performance should be based on performance scenarios in different market conditions and should reflect the nature and risks of the specific types of instruments covered by the analysis.

Professional clients

ESMA’s summer 2014 consultation proposed to extend some of the detailed requirements on communications to retail clients (both from the existing regime under MiFID and as discussed above) to apply to communications with professional clients. In its final advice, ESMA has confirmed that the only ‘retail-like’ obligations which it is extending to communications with professional clients are the following three items:

  • information must not reference potential benefits without a fair and prominent indication of relevant risks;
  • information must not disguise, diminish or obscure important items, statements or warning; and
  • information must be accurate and up-to-date, taking account of the communication method used.

Eligible counterparties

ESMA has confirmed that its technical advice does not apply to eligible counterparties. Accordingly, firms have greater flexibility to determine how to comply with the Level 1 requirement for all communications with eligible counterparties to be ‘fair, clear and not misleading’ and need not be constrained by ESMA’s proposals for retail and professional clients.

Dealings with eligible counterparties

What are the current requirements?

Under MiFID, “eligible counterparty business” is essentially excluded from the majority of investor protection requirements. Eligible counterparties are, broadly speaking, financial institutions, insurers, pension funds and governments. Eligible counterparty business refers to arranging and dealing activities when carried out by eligible counterparties.

What is new in MiFID II Level 1?

MiFID II extends some existing investor protection requirements to eligible counterparties. The recitals note that “the financial crisis has shown limits in the ability of non-retail clients to appreciate the risk of their investments. While it should be confirmed that conduct of business rules should be enforced in respect of those investors most in need of protection, it is appropriate to better calibrate the requirements applicable to different categories of clients. To that extent, it is appropriate to extend some information and reporting requirements to the relationship with eligible counterparties. In particular, the relevant requirements should relate to the safeguarding of client financial instruments and funds as well as information and reporting requirements concerning more complex financial instruments and transactions.”

“New” obligations

MiFID II introduces the following express obligations on firms when dealing with eligible counterparties:

  • to act honestly, fairly and professionally in their dealings with eligible counterparties;
  • to communicate in a way which is fair, clear and not misleading;
  • to provide certain information to eligible counterparties (see ‘Information to clients’ discussed in this note); and
  • to provide certain reports to eligible counterparties (see ‘Reporting to clients’ discussed in this note).

While these obligations are not new concepts for firms generally (i.e. they currently apply to their dealings with retail and professional clients), they have not been applied to eligible counterparties before.

What is ESMA’s advice for Level 2?

ESMA has not provided any technical advice on any additional requirements in relation to the obligation to act honestly, fairly and professionally, or to communicate in a manner that is fair, clear and not misleading with eligible counterparties.

In relation to the information to be provided to eligible counterparties, ESMA’s final advice is that eligible counterparties can ‘opt-out’ of receiving certain disclosures (for instance, post-sales periodic disclosures) in certain circumstances. These circumstances exclude situations the eligible counterparty is on-selling products to its clients, or the relevant financial instruments embed a derivative. In addition, firms can agree with eligible counterparties different standards for the content and timing of reports than those required for professional and retail clients.


What are the current requirements?

MiFID currently prohibits the payment of fees or commissions and receipt of other non-monetary benefits between firms and persons other than their clients (e.g. advisory firms and distributors), unless certain criteria are met. This prohibition is intended to ensure such payments and benefits are not inducements and, as such, do not introduce conflicts with clients’ interests.

Payments and non-monetary benefits are required to be assessed to ensure that they do not impair the firm’s duty to act in the best interests of the client, that they are “designed to enhance the quality” of the service being provided to the client and that they are disclosed to the client.

What is new in MiFID II Level 1?

With the introduction at an EU level of the new concept of ‘independent advice’ (discussed later in this note) and with historic concerns about potential conflicts of interest with firms receiving third party payments, MiFID II strengthens the current inducement rules and introduces the following changes:

  • firms providing independent investment advice or portfolio management are prohibited from receiving and retaining any fees, commission, or monetary or non-monetary benefits from third parties – these payments / benefits can be received but they must be passed on in full to clients as soon as possible following receipt;
  • minor non-monetary benefits are excluded from the prohibition but they must not impair a firm’s duty to act in the best interests of its clients, must be capable of enhancing the quality of client service and must be disclosed;
  • firms not providing independent investment advice or portfolio management must comply with the existing inducement rules from MiFID for all types of third party payments;
  • firms are unable to set off any payments from fees owed to them by clients;
  • clients need to be accurately and, where relevant, periodically informed about all the fees, commissions and benefits the firm has received in connection with the investment services provided; and
  • where applicable, firms must inform clients on how the fee / commission / non-monetary benefit can be transferred to them – and portfolio managers and independent advisers should have a policy for this.

What is ESMA’s advice for Level 2?

Following last summer’s consultation, ESMA’s technical advice confirms its original proposals with some important retractions as follows:

Ban on independent advisers / portfolio managers receiving commission

  • ESMA has confirmed that advisers / managers can still consider financial instruments that pay commission provided that any monetary benefits received in relation to those financial instruments are paid over to clients. There are no strict timelines for paying over the commission but ESMA has confirmed that the transfer must occur ‘as soon as reasonably possible’.
  • Clients can be informed about what payments have been received and paid over to them as part of their regular periodic reporting statements.

Interpretation of minor non-monetary benefits (which are excluded from the ban)

  • ESMA has confirmed that the ability for independent advisers and portfolio managers to receive minor non-monetary benefits should be read strictly and interpreted narrowly – i.e. the benefits should be reasonable and proportionate and should not be likely to influence the behaviour of the adviser / manager.
  • Despite substantial market push-back to the summer 2014 consultation, ESMA’s advice confirms that the Commission should adopt an exhaustive list of what constitutes a minor non-monetary benefit to prevent regulatory arbitrage amongst Member States. ESMA advises that this list should include: (1) information or documentation relating to financial instruments (including research, but see further discussion below); (2) participating at conferences / seminars / training on specific financial instruments / services; and (3) reasonable hospitality of a de minimis value. In a small retraction, ESMA has acknowledged that it needs to be flexible so is proposing that the list can be supplemented by ESMA guidelines.

Treatment of research

  • In its summer 2014 consultation, ESMA had proposed quite detailed requirements in relation to how research could amount to a ‘minor non-monetary benefit’. Its proposals effectively meant that, in practice, firms would be prevented from their current practices of receiving all but the most generic or widely distributed ‘free research’ and would have to start to pay for it.
  • Although ESMA has retracted some elements of its summer 2014 consultation, the main principle has been retained. ESMA is advising the Commission that portfolio managers and independent advisers can only receive research (that does not fall within the parameters of being ‘minor’) by paying for it either directly or from a separate research fund (paid for by a fee charged to clients).
  • Further, that the payment for research should not be linked to payments made for executing transactions.
  • In addition, ESMA has also indicated that it considers an extension of similar requirements to undertakings for collective investment of transferable securities (UCITS) and alternative investment funds (AIF) managers to be appropriate.

Quality enhancement and disclosure requirements

  • ESMA has confirmed its earlier proposals that inducements need to be comprehensively disclosed and that summary disclosure is not sufficient. ESMA has, however, gone further than its summer 2014 proposals by advising the Commission that inducements should be separately disclosed and priced albeit that minor non-monetary benefits can be disclosed in a generic way (and are, unlike other inducements, not required to be disclosed to clients on an annual basis).
  • ESMA has confirmed its proposals to clarify how the quality of a service can be enhanced by advising the Commission to adopt a non-exhaustive list of the circumstances and situations to determine when the quality enhancement test is not met. ESMA largely confirmed the list from its summer 2014 proposals, and specified that the test would not be met where the fee, commission or non-monetary benefit:
    • does not result in an additional or higher quality service to the client (above regulatory requirements);
    • directly benefits the firm / shareholders / employees without tangible benefit / value to the end client; and
    • if it is an ongoing inducement, there is no ongoing client benefit to which it is related.
  • ESMA proposes to develop further Guidelines and Recommendations to supplement the list above over time.
  • ESMA’s advice to the Commission is to place an additional obligation on firms to prove that the services enhance quality by requiring them to record each payment and note how it is used to enhance the quality of the service.

Investment advice – definition and independence

What are the current requirements?

Under MiFID, investment advice is given when a personal recommendation is made to an investor. However, a personal recommendation is not made when it is given exclusively through distribution channels or to the public. Under MiFID, there is no distinction between different types of advice (e.g. independent or non-independent).

What is new in MiFID II Level 1?

MiFID II makes no changes to the definition of ‘investment advice’ from that contained in MiFID.

It does, however, introduce the concept of ‘independent advice’ (as opposed to non-independent (i.e. restricted) advice although the term ‘restricted advice’ is not used in MiFID II). MiFID II requires the following to be satisfied in order for advice to be considered to be ‘independent’:

  • a sufficiently wide range of financial instruments available on the market must be considered;
  • a sufficiently diverse range of financial instruments must be considered (e.g. by type, issuer, product provider);
  • the financial instruments considered should not be provided solely by the firm or other entities that have close links with the firm, or entities with close legal / economic relationships (such as contractual relationships) such that independence is at risk of being impaired; and
  • the firm should not receive and keep any inducements / commission / monetary or non-monetary benefits from any third party (e.g. product providers) - minor non-monetary benefits are permitted to be received / kept – see ‘Inducements’ discussed in this note.

What is ESMA’s advice for Level 2?

Definition of investment advice

ESMA has, since 2010, considered that there was a risk that firms would misinterpret the exclusion set out in Article 52 of the MiFID Implementing Directive to mean that advice could never be given when made through distribution channels. This exclusion operates so that a personal recommendation is not made when it is given exclusively through distribution channels or to the public. In addition, ESMA has found that intermediaries do provide personal recommendations through the use of distribution channels (e.g. the internet). As a result, ESMA originally consulted, and has now confirmed, that its advice is to delete the reference to ‘through distribution channels’ from the exclusion as currently drafted. This still leaves the exclusion for advice addressed ‘to the public’ generally, but it may mean that where firms may have viewed that they do not give advice if they use particular distribution channels, they may now need to accept that they could be giving investment advice (i.e. through a restricted-access website, not available to the public generally). ESMA has noted that it may develop further guidelines as part of its work on Level 3.

Independent advice

ESMA proposed last summer, and has now confirmed, a number of additional requirements to those contained in MiFID II.

ESMA’s advice is that firms providing independent advice should define and implement a selection process to assess and compare a range of sufficiently diverse financial instruments, which must contain the following elements (only slightly tweaked from the summer 2014 consultation):

  • a diversified selection of instruments (by type, issuer or product provider), and which is not limited to instruments provided by the firm or entities closely linked to it (including by contractual relationships, for example), should be considered;
  • the number and variety of instruments considered should be proportionate to the scope of services offered and should be adequately representative of those available in the market;
  • the quantity of financial instruments issued by the firm or entities closely linked to it should be proportionate to the total amount of instruments considered; and
  • the criteria for comparing various financial instruments should include all relevant aspects, and should ensure that neither the selection of instruments that may be recommended nor the recommendations are biased.

For firms that provide independent advice, but who focus on certain classes or a specified range of financial instruments, ESMA advises additional restrictions (e.g. marketing restrictions to ensure only relevant investors are attracted; to allow investors to easily identify a preference for the specified classes / specified range of financial instruments; clients must indicate that they only want these specified classes / specified range of financial instruments; the firm must be able to easily confirm whether its service is appropriate for each new client).

For firms providing both independent and non-independent advice, ESMA has confirmed that its advice is that these firms must:

  • inform retail clients, in good time before providing services, and in a durable medium, whether advice will be independent or non-independent;
  • not describe their business as a whole as ‘independent’; and
  • have organisational controls so that both types of advisory service and advisers are separated (including that the same adviser does not provide both types of advice), and to ensure that clients are not confused about which type of advice they are receiving.

Product intervention

What are the current requirements?

MiFID does not currently contain any EU-wide specific product intervention powers, although different Member States have their own national measures.

What is new in MiFID II Level 1?

In a clear post-crisis reaction, MiFIR sees the introduction of formal product intervention powers at an EU level, which complement the new product governance regime (see below in this note). The intervention powers appear to be based on the UK’s existing product intervention regime although there are some differences. MiFIR gives these powers to ESMA (in relation to financial instruments), to the European Banking Authority (EBA) (in relation to structured deposits) and to the national regulator of each Member State.

National powers

The national regulator of a Member State may prohibit or restrict: (1) marketing or distribution of a particular instrument (including structured deposits); or (2) any type of financial practice, in or from that Member State. The Member State national regulator may only take action if it is satisfied on reasonable grounds:

  • that there is a significant investor protection concern or a threat to the orderly functioning and integrity of financial or commodity markets or stability of the whole or part of the financial system in at least one Member State or a derivative has a detrimental effect on price formation in the underlying market;
  • existing regulatory requirements do not sufficiently address the risks and the issue would not be better addressed by improved supervision or enforcement of existing requirements; and
  • the action is proportionate given the risk, sophistication of investors or market participants and the effect of the action on investors and the market participants.

Before exercising such power, the Member State national regulator must consult with the national regulators in other Member States that might be significantly affected by the intervention and take into account whether any action will have a discriminatory effect on services or activities provided from another Member State.

This represents a major impact in those Member States that do not already have national measures that permit their local regulator to ban products. All Member State national regulators, regardless of whether they are a principles-based, light touch regulator, will now have a relatively heavy-handed power to supplement their enforcement tools.

Powers to ESMA and the EBA

Both the EBA and ESMA have similar powers to those described above for Member State national regulators. Any product ban / restriction can be exercised on an EU-wide basis or can be exercised in relation to a particular Member State. This power can only be used in certain circumstances, namely where:

  • there is a significant investor protection concern (or a threat to the orderly functioning of the market or stability of the financial system generally);
  • existing regulatory requirements are not sufficient to address the issue;
  • Member State national regulators have failed to address the issue; and
  • ESMA / EBA ensures that the action will not detrimentally affect the efficiency of the market or detrimentally affect investors in a disproportionate manner to the benefits of exercising the power or create a risk of regulatory arbitrage.

Each ban / restriction lasts for a maximum of three (3) months but can be renewed (if it is not renewed, it expires) and will be published on the website of ESMA or the EBA (as the case may be).

Any action taken by ESMA / EBA will apply instead of action taken by a Member State national regulator.

Additional product intervention introduced by other measures

While these powers apply to instruments caught by MiFID II, they mirror product intervention powers being introduced in relation to insurance-backed investments under the Insurance Mediation Directive (IMD) as contained in the new EU Regulation for a key investor document in relation to packaged retail and insurance-backed investment products.

What is ESMA’s advice for Level 2?

ESMA and the EBA worked together to set out the factors which Member State national regulators should consider when determining if there are circumstances which require the use of product intervention powers. The EBA carried out its own consultation in relation to structured deposits, so these have been excluded from ESMA’s technical advice. While acknowledging that these factors are intended to limit the otherwise relatively wide discretion of Member State national regulators to use the powers, ESMA’s aim appears to be for the factors to be sufficiently flexible so as not to restrict a regime that needs to remain relatively dynamic. ESMA’s technical advice made certain changes from the summer 2014 proposals, in particular to clarify some aspects in relation to the criteria.

Therefore, ESMA’s technical advice sets out a list of factors for each of the items below but, for flexibility, intends the list to be general in nature, non-exhaustive and to not include quantitative thresholds. In addition, ESMA re-emphasises that the primary focus should be on using the powers in a proportionate way.

The factors include the following the:

  • degree of complexity of the financial instrument or type of financial activity or practice;
  • size of the potential problem or detriment;
  • type of clients involved in an activity or practice or to whom a financial instrument is marketed or sold;
  • degree of transparency of the financial instrument or type of financial activity or practice;
  • particular features or underlying components of the financial instrument or transaction including any leverage a product or practice provides;
  • degree of disparity between expected return or benefit for investors and risk of loss in relation to the financial instrument, activity or practice;
  • ease and cost for investors to switch or sell an instrument;
  • pricing and associated costs;
  • degree of innovation of a financial instrument, activity or practice;
  • selling practices associated with the financial instrument; and
  • situation of the issuer of a financial instrument.

Further to a recent ECJ court case, ESMA’s commentary advises the Commission to consider whether the list of criteria should be exhaustive when ESMA is proposing to exercise the power, but makes clear its view that the list should be non-exhaustive for national regulators.

As these powers are new, it remains to be seen how Member State national regulators will use them (if at all) and whether there may be inconsistent use of the powers in relation to the same or similar products (i.e. whether it may be banned in one Member State but not in another due to the different views of the Member State national regulators). Conscious of this, ESMA proposes to undertake further work (including sharing information across Member State national regulators) to encourage a common understanding on the use of the powers.

Product governance and sales processes

What are the current requirements?

There are no existing detailed provisions addressing product governance or sales processes in MiFID, although high level organisational requirements do exist.

What is new in MiFID II Level 1?

MiFID II introduces a new EU-wide product governance regime which applies to both sides of the product development and sales process, namely to: (1) product manufacturers; and (2) product distributors (if different).

For product manufacturers, there are new requirements to maintain appropriate product governance policies and procedures as part of their organisational arrangements, including product approval processes, to ensure investment products are designed appropriately, ‘consistent with the needs’ of identified target markets, distributed appropriately to the target market, the relevant risks are assessed, appropriate information is made available to distributors, and investment products are regularly reviewed to ensure that they are being sold appropriately and remain consistent with the identified target market.

For product distributors, there are new requirements to ensure that the firm’s knowledge and understanding of the products allows them to match these to the needs of their clients which are primarily linked to training from product manufacturers on products and access to all information (including from product manufacturers) necessary to enable the distributor to sell the product appropriately. Product distributors must also regularly review the products they market to assess whether they remain consistent with the needs of the identified target market and whether the distribution strategy remains appropriate.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation proposed a quite detailed extension of the MiFID Level 1 requirements as follows:

  • more prescriptive requirements aimed at reducing the risks of mis-selling risks at an early stage;
  • a statement that the new regime should not only apply to products but also to investment services; and
  • ensuring the measures can be applied to different Member State legal / economic models so that they are proportionate.

These have been confirmed in the technical advice with clarificatory tweaks to confirm:

  • that the obligations apply in an appropriate and proportionate manner, taking into account the nature of the investment product, the investment service and the target market for the product;
  • that one criterion to consider in developing a product is the threat it may represent to the orderly functioning or the stability of financial markets;
  • some additional potential steps that may be appropriate for manufacturers to take when an event affecting the potential risk / return expectations of a product occurs (i.e. terminating distributor relationships, or liaising with the distributor to modify the distribution process, and informing the relevant national competent authority); and
  • oversight by compliance over the product development / governance process.

Therefore, ESMA’s advice is for there to be two different policies, those that apply specifically to product manufacturers and those that apply specifically to distributors (firms that both manufacture and distribute will be required to comply with both sets of proposals). Importantly, ESMA has confirmed that firms which create, develop, issue and / or design products (including investment firms that advise corporate issuers on the launch of new securities) are, themselves, manufacturers.

The obligations on manufacturers and, separately, on distributors are relatively extensive and detailed and relate to: (i) governance and oversight of the product design and manufacturing process; (ii) managing conflicts of interest; (iii) identifying the target market; (iv) risk assessment; (v) charging structures; (vi) information to distributors; and (vii) regular review of products.

Some of the more interesting items are as follows:

  • that firms be proactive in checking that their products function as intended, rather than being reactive and waiting for detriment to occur;
  • firms who both manufacture and distribute products are only required to conduct a single assessment of the needs and characteristics of the target market for whom relevant products will be manufactured, and to whom they will be distributed. In this regard, in its technical advice, ESMA has clarified that manufacturers who create products to be distributed by others, should identify the target market ‘on a theoretical basis’;
  • that the obligations on distributors should apply to all distributors in a chain albeit that the distributor with the client relationship will have the ultimate responsibility to comply with the obligations. ESMA has confirmed lesser requirements (but still some requirements) on intermediate distributors in a distribution chain; and
  • that distributors of products manufactured by non-MiFID II entities are not excused from the requirement themselves to determine the relevant target market, just because the manufacturer was not required to do so.

ESMA has confirmed that UCITS / AIFs firms will need to comply with these product governance / sales process requirements when they carry out MiFID II activities but not when they carry out UCITS / AIF management. ESMA has noted that the requirements across the different pieces of legislation might be harmonised over time.

Best execution

What are the current requirements?

Investment firms must already comply with an obligation of ‘best execution’ under MiFID, namely to take all reasonable steps to obtain the best possible result for their clients (taking account of factors such as price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order).

Where retail clients are concerned, best execution is considered in terms of the ‘total consideration’ (being the price paid for the instrument and all associated costs including costs / commission charged by the firm).

What is new in MiFID II Level 1?

MiFID II imposes new requirements on firms and trading venues to produce public data about executed transactions. Firms must summarise and publish annually their top five execution venues by trading volume for each class of financial instrument, as well as information on the quality of execution obtained. Trading venues and systematic internalisers must also publish information annually on quality of execution for certain types of financial instrument.

MiFID II also strengthens the current requirements in a number of ways:

  • whereas before firms had to take ‘all reasonable steps’ to obtain best execution, firms must now adhere to a stricter standard – i.e. take ‘all sufficient steps’ to obtain best execution;
  • the requirement to notify clients of material changes to a firm’s execution policy expressly applies only in respect of clients with whom a firm has an ongoing client relationship;
  • firms must be able to demonstrate best execution not only (as is currently the case) to their clients, but also to their Member State national regulator on request; and
  • following concerns about the generic and standardised nature of many firms’ order execution policies, firm’s order execution policies must now be clear, easily comprehensible and sufficiently detailed so that clients can easily understand how firms will execute client orders.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation proposed, and its final report now confirms (with slight retractions), a number of additional requirements and clarifications to contribute to improving investor protection and the transparency of firms’ policies and procedures.

ESMA’s advice to the Commission includes:

  • additional obligations in relation to the detail of execution policies and policies for firms that receive and transmit orders or place them with other firms to execute – the overriding obligation is that these policies need to be customised depending on the class of instrument and the service provided, as opposed to being generic. ESMA has extended the requirement to publish annually the top five execution venues to reception and transmission of orders (RTOs) / firms placing orders with third parties for execution. While ESMA’s summer 2014 consultation proposed that all venues or entities used for execution should be listed in the policies, its final advice has retracted from this. ESMA has now confirmed that this information should be provided, but it is not required to be listed in the policy. ESMA has also removed the requirements on firms charging both participants in a transaction to indicate this in their execution policy and specify the fees charged on each leg (potentially via a range or by specifying a maximum level of such fees);
  • for retail clients, a separate sheet that summarises the best execution policy, focusing on the total known costs for execution, is to be provided;
  • additional disclosure obligations on firms namely: (i) to provide clients with additional information about a firm’s policy when requested; (ii) to clearly indicate in the policy if the client’s order may be executed outside a regulated market, multi-lateral trading facility or an organised trading facility; (iii) to include information in the policies about any third party payments received by firms in connection with the execution of orders; and (iv) to present the costs of any execution venues alongside other features of those venues so that the focus of the client is not solely on the cheapest venue;
  • for the review of policies (annually or where there has been a material change), ESMA is proposing to clarify what constitutes a ‘material change’ to ensure consistent interpretation by Member State national regulators, namely a significant event of internal or external change that could impact the parameters of best execution;
  • to clarify how firms can satisfy best execution requirements when using a single venue or entity for execution; and
  • a new requirement on firms to provide information addressing how the execution and other factors are considered as part of all sufficient steps to obtain best execution.

In relation to the new requirement that firms take ‘all sufficient steps’ to obtain best execution, it had been hoped that ESMA would clarify the extent to which taking ‘all sufficient steps’ is more onerous than the current MiFID requirement of taking ‘all reasonable steps’. However, ESMA has refrained from doing this expressly in its technical advice but has noted that ‘all sufficient steps’ should result in the ‘best possible result’ being received by the client.

Client order handling

What are the current requirements?

MiFID currently requires firms authorised to execute client orders to implement procedures and arrangements which provide for the prompt, fair and expeditious execution of client orders, relative to other client orders or the trading interests of the firm. There are also general principles that firms have to satisfy when carrying out client orders, on aggregation and allocation of client orders.

What is new in MiFID II Level 1?

MiFID II has not introduced major changes to the client order handling rules. The existing requirement to disclose unexecuted client limit orders to the public is being extended to capture additional trading venues (e.g. OTFs) but this is being consulted upon by ESMA under data publication requirements which are covered in a separate note.

What is ESMA’s advice for Level 2?

ESMA did not consult on any changes aside from those relating to data publication (see our separate note).  As it was already implemented in the MiFID II Level 1 text, the existing requirement to disclose unexecuted client limit orders to the public has been extended to capture the additional trading venues created by MiFID II. ESMA has made no additional technical advice.

Client categorisation

What are the current requirements?

Under MiFID, clients can be categorised as eligible counterparties, professional clients or retail clients. The category of retail clients captures every client that is not a professional client or eligible counterparty.

What is new in MiFID II Level 1?

MiFID II does not change the categories of clients, nor the various monetary thresholds and experience levels that eligible counterparties and professional clients are required to meet.

However, a few bespoke changes are being made.

Municipalities and local public authorities

Due to a number of mis-selling concerns in connection with the sale of complex products to local authorities, some changes have been made to how municipalities and local public authorities are able to be classified. They are no longer permitted to be eligible counterparties or per se professional clients, so they are, in effect, deemed to be retail clients. They are still able to elect to be treated as elective professional clients and ‘opted up’ from retail client status.

MiFID II also allows Member States the discretion to adopt specific criteria for the assessment of the knowledge and expertise of municipalities and local public authorities requesting to be treated as professional clients. These criteria can be alternative or additional to the criteria normally required to be satisfied by firms when opting up clients to elective professional client status. In principle, a Member State could adopt less strict criteria for the opting up of municipalities and local authorities.

Elective eligible counterparties

MiFID II is proposing no changes to the various categories of clients that can elect to be eligible counterparties.

What is ESMA’s advice for Level 2?

Municipalities and local public authorities

ESMA was not requested to provide any technical advice or recommend any delegated acts in relation to this point.

Elective eligible counterparties

Bearing in mind that the objective of MiFID II is to increase the protection of investors and reduce the areas of exemption, including strengthening the treatment of eligible counterparties ESMA proposed in its summer 2014 consultation, and has confirmed in its technical advice that the types of investors who can qualify as an elective eligible counterparty is to be restricted. ESMA’s advice is to remove the ability for investors who have elected to be professional clients to then also elect to be eligible counterparties.


Although not consulted upon last summer, ESMA’s technical advice also introduces a specific procedure to apply when eligible counterparties request treatment as such. This procedure will mean that eligible counterparties will need to be warned that they are losing protection and they must provide written confirmation that they are requesting this status (either generally or in relation to one or more specific trades / services / products) and acknowledge that they are aware of the consequences of the protections they may lose.


Likewise, for the reverse, ESMA’s advice is that eligible counterparties who wish to be reclassified as either a professional client or retail client must do so in writing and with an indication of whether it is requested on a general basis or in relation to one or more specific trades / services / products.


What are the current requirements?

Firms providing advice (whether independent or not) or providing portfolio management services to clients must obtain the necessary information regarding the client's knowledge and experience, their financial situation and investment objectives so as to enable the firm to (in the case of advice) provide suitable personal recommendations to clients or potential clients or (in the case of portfolio management) to make suitable investment decisions on their behalf.

What is new in MiFID II Level 1?

MiFID II does not introduce any major changes to the current regime but incorporates into the Level 1 text obligations (similar to those already in the current MiFID Implementing Directive) requiring firms to obtain information about the client’s ability to bear losses and their risk tolerance. It also makes explicit that, where products are packaged or bundled, there is an obligation to ensure the overall package or bundle is suitable.

MiFID II introduces a new requirement that firms must, before the relevant transaction, provide retail clients receiving an advisory service with a suitability report specifying how the advice given meets the client’s circumstances. For retail portfolio management clients, the suitability report can form part of periodic reporting to the client.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation proposed, and its final report confirms these proposals (with some tweaks), to enhance both the suitability assessment and suitability report requirements.

Suitability assessment

ESMA’s advice consists of the following:

  • confirming that the responsibility to undertake the suitability assessment lies with the firm and that firms should not create any ambiguity about this;
  • confirming that the suitability assessment does not just relate to recommendations to buy investments but also whether or not to hold or sell an investment;
  • requiring firms to adopt policies and procedures to ensure that they understand the nature, features (including costs and risks) of instruments selected for clients and that they assess whether equivalent financial instruments could meet the client’s profile. Although ESMA originally consulted that firms should also consider whether lower cost or less complex products are more suitable, its final advice does not include this;
  • for non-independent advisory firms, requiring that they should not make a recommendation in relation to their range of non-independent financial instruments if they are not suitable for clients;
  • requiring firms to assess any switching of products to ensure that the benefits of switching outweigh the costs;
  • in on-going advisory relationships or in portfolio management, requiring firms to have procedures for ensuring they maintain up-to-date information about the client;
  • clarifying that it is up to firms to determine the extent of the information to be obtained from clients and to ensure the information is reliable; and
  • guidance on determining who should be subject to the suitability framework if the client is a legal person or a group of persons.

Suitability reports

ESMA’s advice is that:

  • suitability reports should include prescribed content, namely an outline of the advice and an explanation of how the recommendation is suitable for the retail client. Although originally a proposal, ESMA has decided not to include advice that suitability reports should also outline the disadvantages of acting on the advice (as this information should already be considered in the suitability assessments);
  • clients should be alerted where they may need to seek a periodic review of their arrangements (e.g. where advice might be needed on the rebalancing of a portfolio); and
  • where reports are provided on a periodic basis, any subsequent report needs to only address what has changed (in either the client’s circumstances or the financial instruments) since the last report.

In the commentary to its technical advice, ESMA has also expressly clarified the applicability of suitability assessments to simplified advice type scenarios (i.e. where advice is provided through automated systems).

Appropriateness and execution-only business

What are the current requirements?

MiFID currently requires firms, when providing investment services other than investment advice or portfolio management, to obtain information regarding their existing or potential clients’ knowledge and experience relevant to a specific service or product, to enable the firm to assess whether it is appropriate for the client. (Professional clients are assumed to have sufficient knowledge and experience.)

Firms are not required to carry out this appropriateness assessment where the service being provided is ‘execution only’ and the financial instruments are either listed shares, money market instruments, bonds or other forms of securitised debt, UCITS funds or other non-complex financial instruments.

The MiFID Implementing Directive set out four criteria for assessing when a financial instrument is non-complex, and ESMA’s predecessor (CESR) provided guidance in a Q&A in 2009 on the distinction between complex and non-complex products.

What is new in MiFID II Level 1?

MiFID II modifies the existing list of financial instruments where no appropriateness analysis is required as follows (which narrows the scope of execution-only business):

  • shares admitted to trading on a regulated market, an equivalent third country market or a multi-lateral trading facility, where these are shares in companies (except shares in non-UCITS collective investment undertakings and shares that embed a derivative);
  • bonds and other forms of securitised debt admitted to trading on a regulated market, an equivalent third country market or a multi-lateral trading facility and money market instruments (except those that embed a derivative or incorporate a structure which makes it difficult for the client to understand the risk involved);
  • shares or units in UCITS (except structured UCITS);
  • structured deposits (except those that incorporate a structure which makes it difficult for the client to understand the risk of return or the cost of exiting the product before term); and
  • other non-complex financial instruments.

In addition, it clarifies that where credit is provided (i.e. discussions on existing credit facilities, overdrafts and current accounts), an appropriateness analysis will always be required.

Further, where a package of services or products is provided and a suitability assessment is not required, the overall bundled package must be assessed as appropriate.

What is ESMA’s advice for Level 2?

ESMA’s advice confirms the four criteria set out in the existing MiFID Implementing Directive as being appropriate to determine when a financial instrument is non-complex and adds  two additional criteria, namely the:

  • instrument does not incorporate a clause, condition or trigger that could fundamentally alter the nature or risk of the investment or pay out profile (i.e. investments that incorporate a right to convert the instrument into a different investment); and
  • instrument does not include any explicit or implicit exit charges that have the effect of making the investment illiquid.

ESMA’s advice also confirms that instruments explicitly excluded from the (narrowed) list of non-complex products in the above bullet point list should be automatically deemed to be complex. Further, that these expressly excluded products should then not be able to be considered to be non-complex by going through the MiFID Implementing Directive criteria (set out above).

ESMA has not given any advice in relation to what information needs to be obtained in order to carry out the appropriateness assessment.

Although not consulted upon last summer, ESMA is advising new recording-keeping requirements in relation to the assessment of appropriateness including where the assessment concluded the product was appropriate, was not appropriate, where the assessment could not be carried out due to insufficient information, etc.

ESMA has confirmed that units in a structured UCITS and shares that embed a derivative should automatically be considered complex as well as certain debt and money market instruments and structured deposits. Further, shares or units in AIFs should automatically be considered to be complex.

ESMA may develop additional guidelines particularly around the warning that is given to customers when an appropriateness assessment concludes that a product or service may not be appropriate.

Reporting to clients

What are the current requirements?

MiFID requires various reports to be provided to clients in a durable medium, namely:

  • occasional reporting (other than for portfolio managers);
  • reporting obligations in respect of portfolio management;
  • additional reporting obligations for portfolio management or contingent liability transactions; and
  • statements of client financial instruments or client funds.

What is new in MiFID II Level 1?

MiFID II does not propose any significant changes to the current regime. It confirms the above, but extends the reporting requirement to also include ‘periodic communications… taking into account the type and the complexity of financial instruments involved and the nature of the service provided to the client’.

What is new is that these reports may also now need to go to eligible counterparties.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation made certain proposals in relation to the reporting requirements and these have been confirmed in its technical advice with some tweaks.

Reporting to eligible counterparties

  • ESMA has confirmed its original proposals, namely that the reporting obligations apply to all clients (including professional client and eligible counterparties). However, firms are able to agree with eligible counterparties different standards for the content and timing of reports than those applicable for professional and retail clients.

Reporting to professional clients

  • Trade confirmations are to be sent to professional clients on T+1 (the same as it is currently for retail clients).
  • Professional clients should get the same confirmations (in terms of content) as retail clients receive.

Content of reports for portfolio management

  • The reports should be quarterly at a minimum (not bi-annually – to align the timing with reports to retail clients) and include the activities undertaken and the performance of the portfolio during that period (this harmonises the requirements with those under AIFMD to report on fund performance).
  • ESMA has clarified that where clients have access to an online system which qualifies as a durable medium and where the firm can prove that clients access it in practice, the firm does not also need to provide periodic statements.
  • ESMA has clarified that these reports are also required for professional clients and need to give a ‘fair and balanced’ review of the activities undertaken.

Reporting obligations re: portfolio management or contingent liability transactions

  • Portfolio managers will need to report to the client where the value of the portfolio depreciates by 10%, and by further multiples of 10%.
  • Firms holding a retail client account that includes / is likely to include leveraged financial instruments or other contingent liability transactions, must report to the client when an instrument depreciates by 10% or multiples of 10% from its initial value.

Statements in respect of client assets and funds

  • Statements are to be provided at a minimum of quarterly intervals (not annually) and can be requested more frequently.
  • Statements must include: (i) a clear indication of which assets are subject to client asset protection and which are not (i.e. those subject to title transfer collateral arrangements); (ii) a clear indication of which assets are affected by peculiarities in their ownership status (e.g. if they have a security interest over them); and (iii) the market (or where the market value is not available, estimated) value of the instruments together with a clear indication that the absence of a market price is likely to be indicative of a lack of liquidity. Further, ESMA has added that where an estimated value is provided, it shall be done on a ‘best efforts’ basis.

Reporting on costs and charges

  • See ‘Information to clients’ discussed in this note.

Information to clients

What are the current requirements?

MiFID requires investment firms to provide certain information to clients or potential clients, such as information on its services, on financial instruments, on costs and charges, and its terms of business (in a client agreement).

What is new in MiFID II Level 1?

MiFID II retains the existing measures but given that it introduces new measures (e.g. the new concept of ‘independent’ investment advice), the information requirements imposed also need to be extended.

Information on investment advice

Before advice can be given (see ‘investment advice’ discussed in this note), firms must inform clients of the following:

  • whether the advice to be provided is independent or non-independent;
  • whether advice is based on a broad or restricted range of financial instruments (and whether those instruments are issued by entities linked or tied in some way to the firm); and
  • whether it will provide the client with a periodic assessment of the suitability of the financial instruments recommended to that client.

Information on financial instruments

Information on financial instruments which, from existing measures, must contain appropriate guidance on, and warnings of, the risks associated with investment in the instruments, must now indicate whether the instrument is intended for retail or professional clients, and must take account of any target market identified in accordance with the new product governance requirements (see ‘product governance’ discussed in this note).

Information on costs and charges

MiFID II reinforces the existing requirements but clarifies them in places and sets additional requirements. Information on all costs and associated charges, including charges related to investment and ancillary services, the cost of advice and the cost of financial instruments must be disclosed; the method of payment stated, and details of any third-party payments. All costs and charges should be aggregated so the client understands the overall cost as well as the cumulative effect on the return of the investment (with an itemised breakdown should a client request it). Information about costs and charges is to be provided, where applicable, at least annually post-sale.

What is ESMA’s advice for Level 2?

Information on investment advice

ESMA’s advice confirmed its summer 2014 consultation, such that firms must properly explain the scope and the features of the advice given. This includes requirements to:

  • explain whether or not, and why, investment advice qualifies as independent in a clear and concise way - and the type and nature of any restrictions that apply;
  • explain the range of financial instruments that may be recommended, as well as the firm’s relationship with issuers or providers of the instruments;
  • if a firm provides a periodic assessment of suitability, the firm must explain to its client the:
  • frequency and extent of such assessment, and what will trigger it;
  • extent to which previously collected information will be subject to reassessment; and
  • way in which the updated recommendation(s) will be communicated.

ESMA has confirmed that this applies to advice provided to both retail and professional clients.

Information on financial instruments

ESMA’s advice includes that the following additional information is disclosed on financial instruments:

  • how the instruments function and perform in both positive and negative market conditions;
  • information in relation to any restrictions or impediments on disinvestment (e.g. illiquid assets);
  • an adequate description of the legal nature of financial instruments which are comprised of two or more different financial instruments, their components and how their interaction affects their risks; and
  • the scope and nature of any guarantee or capital protection incorporated in financial instruments, and information about any third party guarantor.

Information on costs and charges

ESMA considers that cost disclosure, together with the disclosure about risk, is an important element to improve the ability of investors to assess the products that are offered to them. Due to concerns that the current MiFID II requirements could still result in different application by investment firms due to certain ambiguities in the drafting, ESMA’s advice is that there should be a significant level of detail in the information provided on costs and charges, including the following:

  • the requirements apply in respect of all categories of clients (including eligible counterparties);
  • limited application can, however, be agreed with professional clients - except where the relevant financial instruments embed a derivative or in the case of portfolio management or advisory services;
  • limited application can also be agreed with eligible counterparties, except where the relevant financial instrument embeds a derivative and the eligible counterparty is on-selling to its own clients;
  • full ‘point of sale’ disclosures must be provided when: (i) the firm recommends or markets financial instruments to clients (which shall be interpreted broadly and include distribution arrangements); or (ii) if the firm is required to provide a key investor document (KID) under packaged retail investment and insurance-based investment products (PRIIPS) or a key investor information document (KIID) under UCITS;
  • in other cases, firms only need to provide information about the costs and charges relating to their service (and not the underlying financial instruments);
  • firms must provide information about the costs of the services they provide, but also the costs of services provided by other firms that they market or recommend to the client;
  • firms should also provide, at the point of sale, an illustration showing the cumulative effect of costs on the client’s return;
  • calculations of costs for point-of-sale disclosure should be based on actually incurred costs (or, if these are not available, a reasonable estimation);
  • annual post-sale information must be provided where firms have recommended or marketed a financial instrument or provided the client with a KID / KIID, provided there is or has been an ongoing client relationship during the year;
  • post-sale information should be based on costs incurred and personalised;
  • costs and charges should be aggregated for both point-of-sale and post-sale disclosures, though firms may separate out aggregated figures for: (a) initial costs and charges; (b) on-going costs and charges; and (c) exit costs;
  • the types of costs that need to be disclosed are set out in an Annex to the final report; and
  • periodic post-sale disclosure does not apply to firms that provide a ‘one-off’ service.

ESMA has set out various examples of how it considers disclosures might be made in the final advice.

Information in client agreements

ESMA’s advice significantly expands the scope of the current requirements as follows the:

  • requirement for a written client agreement, in a durable medium, is extended from retail clients to also include ‘new’ professional clients (i.e. relationships with professional clients entered into after MiFID II comes into force);
  • current exclusion from needing to provide a client agreement for advisory services is removed. However, the exclusion will still apply when ‘one-off’ advice is provided;
  • requirement to provide a client agreement will extend to where custody is provided; and
  • scope of the client agreement is proposed to be expanded beyond merely recording the ‘essential rights and obligations’ of the parties, to: (i) the ‘nature and extent of any investment advice services’ to be provided; (ii) the types of financial instruments which may be bought or sold, and transactions undertaken on behalf of the client, as well as any which are prohibited (in the context of portfolio management); and (iii) an explanation of the key features of any custody services to be provided by the firm, including setting out the firm’s role in relation to corporate actions and the terms on which securities financing transactions will generate a return for the client.

Information on client assets

See ‘Safeguarding of client assets’ in this note.

Record keeping

What are the current requirements?

Firms (where applicable) are currently required to keep records in a significant number of areas, including in relation to:

  • client orders;
  • decisions to deal;
  • transactions (both where executed by a firm or passed to another to execute); and
  • client files (including client agreements, information to assess suitability).

The records are required to be kept for a period of 5 years or for the duration of the client relationship (if longer). MiFID requires Member State national regulators to draw up a list of minimum records that should be retained, and ESMA’s predecessor, CESR, provided recommendations in 2007 about what those minimum records should be.

What is new in MiFID II Level 1?

MiFID II does not make any substantive changes to the existing requirements. It does emphasise that Member State regulators must be able to use records to fulfill their supervisory tasks and perform enforcement actions under MiFID / MiFIR and market abuse legislation - and there is an express reference to records being used to demonstrate that firms have complied with their obligations around market integrity.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation did not propose to alter the existing requirements but sought to codify its previous Level 3 recommendations published by CESR in 2007. These proposals would have seen a non-exhaustive list of minimum records prescribed that firms would need to keep and what they should cover, to harmonise practices across the EU. In addition, ESMA proposed that all policies that firms were required to maintain under MiFID II and the EU market abuse regime need to be kept in writing.

ESMA’s technical advice introduces some additional requirements to what was proposed last summer as follows:

  • despite push-back from the market, ESMA has decided to keep the list of records non-exhaustive. It has, however, noted that it may develop additional guidelines in future. ESMA has tweaked its original proposals as follows;
    • ESMA is letting the Commission decide whether to include policies and procedures that are already mandatorily required to be implemented under MiFID II (e.g. order execution and conflicts policies) – they are currently excluded by ESMA from its list;
    • ESMA has confirmed that the requirement to keep these records will technically only apply from 3 January 2017, noting however that the advice represents to a large extent a codification of CESR’s pre-existing Level 3 Recommendations (so, much of it should not be new);
    • ESMA has acknowledged that although records are required to be kept under MiFIR and the EU market abuse regimes, its list does not cover those records; and
    • ESMA is also developing regulatory technical standards which will include some record-keeping requirements – these are not currently included in the table, but ESMA acknowledges that the Commission may wish to update the table to include them in due course.
  • despite originally proposing to retain Articles 7 and 8 of the MiFID Implementing Directive, ESMA’s advice is to amend them to extend and enhance the record keeping requirements for firms in relation to client orders, decisions to deal, transactions and order processing;
  • the record keeping requirements in relation to client orders and decisions to deal are now extended also to decisions to deal originating from the activity of dealing on own account (and not just portfolio management, as currently). Those relating to transactions and order processing will apply even where no transaction results from an order or decision to deal; and
  • ESMA has clarified that record-keeping requirements should be complied with regardless of the technology used to keep the record.

Recording of telephone conversations and electronic communications

What are the current requirements?

There are currently no mandatory requirements under MiFID to record telephone conversations or electronic communications, although Member States have the discretion to require it.

What is new in MiFID II Level 1?

To increase certainty, investor protection and deterrence of market abuse, MiFID II has introduced organisational requirements which require firms to record telephone conversations or electronic communications when they:

  • receive and transmit orders;
  • execute orders on behalf of clients; and
  • deal on own account.

The requirements cover all telephone conversations and electronic communications that relate to activities that are intended to result in the conclusion of a transaction or the provision of client order services, even if they in fact do not. The Level 1 text also requires records to be kept for five years, and potentially a further two years where the MiFID II Member State national competent authority requests.

What is ESMA’s advice for Level 2?

ESMA’s advice and commentary include the following:

  • firms should have effective organisational arrangements to ensure compliance with the rules on recording telephone conversations and electronic communications, and should have an effective and appropriate written policy in this area;
  • firms’ management body should have effective oversight and control over the policies and procedures in this area;
  • all conversations and electronic communications that result or may result in a transaction are to be recorded, including conversations / communications within firms and where such communications are made in the course of providing investment advice. Despite push-back from the market that this is too onerous, and that only conversations relating to the “concrete” order should be captured, ESMA does not consider it to be so;
  • all firms in a transaction chain must record all relevant calls, and not just the receiving firm;
  • the content of face-to-face conversations with clients should be documented (by a file note), with the minimum content of the file note prescribed. Although ESMA has noted that this record need not be kept in a minuted form, specifically, but should be kept in a durable medium;
  • records must be stored in a durable medium;
  • firms must notify customers in advance: (i) that communications are being recorded; and (ii) that a copy of the record will be kept which will be available on request for a period of at least five years; and
  • firms can adopt a proportionate, risk-based approach to monitoring phone records of transactions.

Complaints handling

What are the current requirements?

MiFID introduced high level requirements in relation to the organisation of firms and the handling of complaints raised by retail clients, their record-keeping and resolution.

What is new in MiFID II Level 1?

MiFID II continues the current regime.

What is ESMA’s advice for Level 2?

ESMA’s summer 2014 consultation proposed to significantly extend the requirements in relation to complaints handling and its technical advice confirms this.

The measures contain strict (albeit still high-level) requirements (similar to the complaints handling guidelines developed by ESMA / EBA for the banking industry) with the aim that this will implement harmonised complaints-handling across the EU and apply to both retail and professional clients.

The additional requirements include:

  • a written complaints procedure for handling complaints;
  • the ability for clients to be able to make a complaint without charge;
  • communication requirements with client (i.e. in plain language);
  • responding without unnecessary delay;
  • providing the firm’s response to a complaint, and requiring firms to explain the client’s options and (where relevant) that they may be able to refer the complaint to an Alternative Dispute Resolution entity or take civil action;
  • complaint data reporting requirements to a firm’s regulator; and
  • meaningful analysis of complaints data by compliance to identify issues.

Despite market push-back, ESMA has retained its requirement that complaints handling guidelines apply to both retail and professional clients (both per se and elective professional clients).  On request, ESMA has tried to clarify (albeit not as part of its advice) what amounts to a ‘complaint’ (“a statement of dissatisfaction addressed to a firm by a client or potential client relating to the provision of investment services”) which is particularly relevant in the context of complaints by professional clients.  But the explanation is of a high level nature and so is unlikely to be of much material assistance.

Despite market push-back, ESMA has confirmed that complaints handling applies to potential clients as well as clients.

ESMA has also elaborated further on the level of detail that needs to be provided to complainants about firms’ complaints handling processes.

There are also new requirements in relation to the governance of complaints. ESMA has retained its proposal for firms to have a person responsible for oversight over the complaints function (which can be performed by compliance) (see our separate note on Corporate Governance).

ESMA has stated that it may set out more specific guidelines in the future.

Safeguarding of client assets

What are the current requirements?

In relation to client assets, MiFID put in place the following requirements:

  • organisational arrangements – including requirements to make arrangements to safeguard the client’s ownership rights, and to minimise the risk of loss or diminution of client assets;
  • requirements relating to the registration of title to custody assets;
  • requirements to keep accurate records and perform reconciliations;
  • requirements for firms to perform due diligence on third parties with whom custody assets are deposited;
  • restrictions on the use of client assets; and
  • requirements for auditor confirmation that firm’s arrangements for compliance with the custody rules are adequate.

What is new in MiFID II Level 1?

MiFID II continues the current regime.

What is ESMA’s advice for Level 2?

ESMA’s proposals in its summer 2014 consultation have been confirmed in the technical advice with some tweaks as summarised below.

Governance arrangements in firms concerning custody

  • There is a new requirement for a dedicated officer (who may, where appropriate, be the compliance officer) to take overall responsibility for client assets and funds and (as consulted upon) this does not need to be the sole role held by this officer. ESMA has clarified within its advice, however, that the individual needs to have sufficient skill and authority.

Title transfer collateral arrangements (TTCA)

  • While TTCAs are not permitted to be used with retail clients, ESMA advises that there be restrictions in relation to the use of TTCAs with non-retail clients – specifically, TTCAs should not be used where: (i) there is a weak argument for doing so (so no real connection between the TTCA and the client’s obligation to the firm); (ii) the amount of client funds or assets subject to the TTCA far exceeds the client’s obligation; and (iii) firms insist all clients’ assets are subject to TTCAs without considering what obligations each client has to the firm.
  • ESMA requires firms to be able to demonstrate the appropriateness of any TTCAs used. Due to responses on the meaning of ‘appropriateness’ in this context, ESMA has clarified that it means having a robust link between the need to use the TTCA and the client’s liability and is a distinct concept from the ‘appropriateness’ assessment required to be carried out in relation to certain execution-only business.
  • Requiring disclosure to clients of the risks of TTCAs.

Securities financing transactions and collateralisation

  • Requiring that firms monitor stock lending activities to ensure borrowers provide the appropriate collateral and the necessary steps are taken to maintain the balance with the value of client assets.
  • This applies not only to retail clients but also to non-retail clients.
  • The express, prior written consent of all clients is required for firms to enter into arrangements for securities financing transactions and should be clear, recorded in writing and affirmatively executed by the client. The client’s prior consent is also to be required for the use of client assets by any person.

Considering diversification of firms’ holding of client funds

  • A requirement on firms depositing client funds with third parties to consider diversification as part of their due diligence in the appointment of those third parties. ESMA has clarified that no specific percentage of diversification will be set and that diversification is still required when the funds are held with a group entity (subject to the requirement below).

Intra-group deposits of client funds

  • Imposition of a 20% limit on intra-group deposits, unless the firm can demonstrate that this is disproportionate.

Custody liens

  • A ban on custody liens enabling third parties to recover debts unrelated to the client or the provision of services to the client, except where this is required by law in a third country jurisdiction.
  • Disclosure requirements (i.e. warnings) where firms are obliged to enter into these types of liens. Although not contained expressly in the technical advice, ESMA has further clarified that the warnings are to be tailored not generic.
  • Record-keeping requirements, to make clear the ownership status of client assets, in respect of liens, security interests or other encumbrances granted by firms.
  • ESMA has clarified that the restrictions apply to security interests and rights of set-off, as well as liens.

Segregation of client assets in third countries

  • Limitations on the ability of investment firms to rely on “other equivalent measures” when they are unable to comply with segregation requirements in third countries as a result of applicable law. Originally, ESMA had proposed that ‘market practice’ in a particular jurisdiction should also allow firms to disapply segregation requirements but in its final advice removed this.

Preventing unauthorized use of client financial instruments

  • Investment firms must take ‘appropriate measures’ to prevent unauthorized use of client assets, including agreeing with clients the measures the firm will take in the event of a shortfall in the client’s account, monitoring by investment firms of their ability to settle transactions and monitoring (and promptly requesting) undelivered securities that are outstanding on the settlement date.

Availability of information to insolvency practitioners and others

  • Requirements on investment firms to make information easily available to Member State national regulators, insolvency practitioners and those responsible for the resolution of failed institutions.



Directive on Markets in Financial Instruments repealing Directive 2004/39/EC and amending Directive 2011/61/EU and Directive 2002/92/EC.


Regulation on Markets in Financial Instruments and amending Regulation 648/2012.


Directive 2013/36/EU on access to the activity of credit institutions and investment firms, amending Directive 2002/87 and repealing Directives 2006/48 and 2006/49.

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