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.
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.