knowledge 15 March 2017 |

MiFID II - In or Out?

Definition of Investment Firm

MiFID II applies to investment firms, namely, “any legal person whose regular occupation or business is the provision of one of more investment services to third parties and/or the performance of one or more investment activities on a professional basis.” The relevant investment services and activities are those listed in Section A of Annex I when provided or performed in relation to any of the instruments listed in Section C of Annex I (“MiFID II Instruments”).

Investment services and activities

The most significant new regulated investment activity introduced by MiFID II is the operation of an Organised Trading Facility (“OTF”). An OTF is defined as a multilateral system which is not a regulated market or multilateral trading facility, which brings together multiple third-parties buying and selling interests in bonds, structured finance products, emission allowances or derivatives.

Accordingly, any firm that is operating an OTF in relation to any of the relevant MiFID II Instruments will fall within the scope of MiFID II. Significantly, there is a carve-out from the definition of MiFID II Instruments for wholesale energy products within the scope of REMIT (Regulation 1227/2011) that are traded on an OTF and that must be physically settled. On 25 April 2016 the Commission published a Delegated Regulation which, among other things, provides further detail on when a wholesale energy product can be considered to be “physically settled”.

MiFID II Instruments

MiFID II applies to a broader range of financial instruments than MiFID I Notably, MiFID II Instruments include:

• physically settled derivatives relating to emission allowances; and
• emission allowances, consisting of any units recognised for compliance with the requirements of the EU Emissions Trading Scheme Directive 2003/87.

Although structured deposits are not MiFID II Instruments, investment firms and credit institutions selling or advising clients in relation to structured deposits are subject to a number of MiFID II requirements (including organisational and conduct of business requirements and powers of competent authorities).

Exemptions

MiFID II amends certain exemptions available under MiFID, largely with the aim of restricting their application and increasing investor protection, and deletes other exemptions. It has a significant impact on the existing exemptions for proprietary trading and ancillary trading, whereas the MiFID exemption for investment services offered in a group context remains unchanged. While MiFID II adds two new exemptions, these are a consequence of the fact that MiFID II encompasses a wider range of financial instruments, the net effect being that an additional number of activities will be subject to MiFID II.

Proprietary trading

MiFID II removes the current exemption for firms whose main business consists of dealing on own account in commodities or commodity derivatives. Moreover, it significantly narrows the main dealing on own account exemption contained in MiFID.

Specifically, MiFID exempts from its scope persons that do not provide any investment services or activities other than dealing on own account unless they are:

• market makers; or
• deal on own account outside a regulated market or MTF on an organised, frequent and systematic basis by providing a system accessible to third parties.

MiFID II restricts the scope of this exemption so that it no longer applies to persons dealing on own account in commodity derivatives or emission allowances or derivatives thereof. In addition, the exemption is no longer available to persons dealing on own account who:

• are members of or participants in a regulated market or an MTF or have direct electronic access to a trading venue;
• apply a high-frequency algorithmic trading technique; and/or
• deal on own account when executing client orders.

Ancillary activity

In addition to the proprietary trading exemption discussed above, each of MiFID and MiFID II contains an exemption in respect of investment services provided on an ancillary basis.

Under MiFID the exemption applies to a person:

• dealing on own account in financial instruments; or
• providing investment services in commodity derivatives to the clients of its main business;

provided that the relevant activity is ancillary to the person’s main business, when considered on a group basis, and that main business is not the provision of investment or banking services.

MiFID II narrows the scope of this exemption in a number of ways. Specifically, it restricts the “dealing on own account” limb of this exemption to persons dealing on own account in commodity derivatives, emission allowances or derivatives thereof. It also:

• excludes from its scope persons applying a high frequency algorithmic trading technique; and
• introduces a new notification requirement pursuant to which any person relying on the exemption must notify its relevant competent authority of this fact annually and upon request report to that authority the basis on which it considers that its activity is ancillary to its main business.

Moreover, whereas under MiFD the question of whether the relevant activity was being conducted on an ancillary basis was largely made on a case by case basis, MiFID II empowers the European Commission to adopt regulatory technical standards (“RTS”) specifying the criteria for establishing when an activity is to be considered ancillary to the main business of a group. These RTS have been finalised and will be published in the OJ shortly.

Conclusion

Generally, MiFID II has a broader scope and more limited exemptions than MiFID. This means that certain firms that were either outside MiFID’s scope or benefitted from an exemption will be in scope for MiFID II. Firms providing investment services will need to assess their position in relation to the application of MiFID II and ensure that they put in place any necessary compliance arrangements.

In a speech delivered on 7 February 2017, Michael Hodson, Director of Asset Management Supervision at the Central Bank of Ireland, indicated that the Central Bank expects firms to be in the process of prioritising and actively developing the systems, policies and procedures that will enable them to comply with MiFID II on time. As 3 January 2018 approaches, MiFID II preparedness will become a standing item for every engagement between a firm and its supervisory team. Mr Hodson also indicated that one of the Central Bank’s Supervisory and Thematic Priorities for 2017 will be to review firms’ preparedness for MiFID II.