MiFID II and MiFIR - Financial services: Regulation tomorrow

Buy-side seminar 2014:
What to watch in the UK and EU
Hannah Meakin and Imogen Garner - Partners
Norton Rose Fulbright LLP
24 June 2014
• The domestic picture:
– focus on thematic issues
• The European dimension:
• Client assets
The domestic picture
Focus on thematic issues
The wider context: the FCA one year on…
• One year on from legal cutover, is the FCA really “a very different
animal” to its predecessor?
– Martin Wheatley, ABI Biennial Conference, 9 July 2013
• Recent FCA speeches have highlighted a “sea change” in the
attention being paid by firms to the conduct agenda
– Clive Adamson, Building Societies Association, 12 May 2014
• A strong and demonstrable conduct focus, including at executive
management and board level, will therefore be essential
• Outcomes-focussed regulation: How are businesses actually run,
and what is the impact of their activities on consumers and
markets? Second-line controls are not enough…
• Pre-emptive and judgement-based regulation – firms should mirror
this approach
• The FCA will want to demonstrate what it has achieved since its
creation, and firms should expect a tough stance if they fall short
Thematic issues: what have we seen so far?
• Much of the FCA’s recent thematic work has relevance for the
October 2013 – TR 13/9 on ABC/AML controls in asset management and platform firms
November 2013 – TR 13/10 on outsourcing in the asset management industry
March 2014 – TR 14/1 on risks to customers from financial incentives
March/April 2014 – TR1 14/5 and 14/6 on firms’ implementation of RDR
February 2014 – TR 14/1 on transition management
April 2014 – FCA TR 14/7 on clarity of fund charges
• FCA expectations and key themes:
– Firms are expected to be aware of and consider the FCA’s findings
– Senior management should satisfy itself that firms’ practices are appropriate, and should ensure
proper oversight and control
– Firms should consider published examples of good and poor practice, and benchmark themselves
against expected standards: what do you have that demonstrates you have done this?
– Role of industry guidance (e.g. the OWG’s Guiding Principles and Considerations)
− Follow-up work through routine supervision, but further policy action is possible where insufficient
progress made
− Note that the FCA is not afraid to devote resource to looking at smaller market sectors, which may
have been under the radar to date
− Common themes include conflicts of interest, transparency and communication with clients/client
understanding, asset managers’ agency responsibilities, and close scrutiny of firms’ arrangements and
Thematic issues: what is on the agenda?
• Asset managers’ role as trusted agents:
– are asset managers acting as good agents and taking proper account of
investor interests?
• Fairness and transparency as a key theme:
– conflicts of interest remain a significant area of focus, and are at the heart of a
number of themes in conduct regulation
– spotlight on use of dealing commission: “asset managers [should] spend their
clients’ money as though it was their own and manage costs with as much
tenacity as they produce returns” (Clive Adamson, October 2013)
– consistency of investment decisions with investors’ stated objectives, clarity of
information on risks and costs
• Market abuse controls – FCA is already looking at market conduct
controls within asset managers
• Conduct risk continues to be at the fore:
– FCA is actively engaging with firms on this
– How can your firms demonstrate their understanding of what conduct risk
means in the context of their business?
– How are you identifying, assessing, managing and monitoring conduct risk?
The European dimension
AIFMD: are we there yet?
• AIFMD has been transposed in most Member States, and cooperation agreements are in place between the competent
authorities of most EU Member States and key third countries
• UK AIFMs seeking authorisation by 22 July 2014 should have
submitted a complete application by 20 June 2014
• Transitional AIFMs submitting a complete application by 22 July
2014 can continue managing their AIFs:
– but, until authorisation is received, note potential for business disruption as
passports are not available – in any case, uncertainty around the passport
for MiFID add-ons has led some firms to restructure
• Firms have focused their efforts on areas that are time critical:
– for non-EU firms, this means many are still getting to grips with regulatory
reporting and annual report requirements
– some firms that did not use the transitional period are now reporting: what
are the lessons?
– the reverse solicitation “exemption”: a misnomer but we are seeing renewed
– service provider contracts: impact of the impending deadline on negotiations
UCITS V: state of play
Committee on Economic
published draft report on
Commission’s legislative
3 July 2012 –
published its
proposal for
11 January 2013
amendments to
European Parliament
the results of a plenary
vote on UCITS V, along
adopted amendments
2 December 2013
– Council of EU
Q2 2014 Publication
in Official
Journal of
the EU
European Parliament
approved UCITS V.
Adoption of UCITS V
Council of the EU
End 2015 – likely date from
which UCITS V will apply,
based on current status of
negotiations (MS will have 18
months to transpose UCITS V
into national law from date of
publication in Official Journal
of the EU)
During 2014 – ESMA to
develop UCITS V technical
standards and guidelines
UCITS V: what’s new?
• UCITS depositary function:
depositary duties
eligibility criteria
liability regime
The Madoff fraud has revealed
that the requirements of the
UCITS Directive have been
transposed in very diverging ways
creating an unlevel playing field in
the protection of retail consumers.
Charlie McCreevy, Commissioner
for Internal Market and Services,
• Remuneration:
– policies consistent with sound management of UCITS scheme and comply
with minimum remuneration principles
– remuneration disclosures in UCITS scheme’s prospectus, annual report and
• Sanctions:
– minimum administrative sanctions and measures
– minimum list of sanctioning criteria
– competent authorities and UCITS managers to establish whistle-blowing
– access to telephone and data records
UCITS V: what’s next?
• Depositaries:
– Commission invited to analyse in which situations the failure of a UCITS
depositary or a sub-custodian could lead to losses to UCITS unit holders
which are non-recoverable to ensure high level investor protection and
submit findings to EP and Council
• Remuneration:
– ESMA to issue remuneration guidelines concerning the size of the
management company and the UCITS schemes managed, their internal
organisation and nature, the scope and the complexity of their activities and
guidance on how remuneration principles are to be applied where
employees or other categories of personnel perform services subject to
different sectoral remuneration principles
• Sanctions:
– All publicly disclosed sanctions will be reported to ESMA, which will publish
an annual report on all sanctions imposed
• UK implementation:
– FCA Business Plan 2014/2015 indicates that UCITS V transposition will take
place during 2015
UCITS V: comparison with AIFMD
• Depositaries:
– Eligibility – UCITS depositaries restricted to EU authorised credit institutions
and MiFID investment firms that provide safe keeping and administration of
financial instruments
– Liability – UCITS depositaries may be strictly liable for loss of financial
instruments, even when custody has been properly delegated to a third
party – no option to transfer liability to sub-custodians
– Effect on industry – increased costs borne by UCITS and their investors.
May force smaller depositaries out of the market, resulting in market
domination by a few global depositaries
• Remuneration:
– ESMA guidelines to align UCITS V remuneration regime with AIFMD to
furthest extent possible
• Sanctions:
– UCITS V and AIFMD sanctions powers are similar in purpose
• 26 July 2012 – Commission published a consultation paper
seeking views on the UCITS regime, including on:
eligible assets and use of derivatives
efficient portfolio management
OTC derivatives
extraordinary liquidity management rules
depositary passport
money-market funds
long-term investments
improvements to UCITS IV
• September 2013 – Commission’s communication on shadow
banking referenced UCITS VI and proposed a global assessment
of the framework in which certain funds can operate
• Unclear when UCITS VI legislative proposal will be published
(references removed from Commission’s 2013 legislative
programme in November 2013)
MiFID II and MiFIR: timing
13 December
2012: Council
progress report on
18 June 2013:
12 November
2012: Note on
progress of
published by
the Council
30 month time frame
14 January:
Parliament and
Council reach
agreement on
7-8 July: ESMA open
hearing in Paris; 1
August is the deadline
Consultation Paper
13 May:
adopted by
the Council
20 June 2012:
First Council
16 March 2012:
Draft report from
Committee on
Economic and
Monetary Affairs
22 May: ESMA
publishes Level 2
Discussion Paper &
Consultation Paper
25-26 October 2012:
Parliament votes on
amendments to draft
legislation but then
refers matter back
to ECON for further
27 September and 5
October 2012:
ECON unanimously
adopts reports on
15 April: MiFID
adopted by the
12 June: MiFID
published; enter
into force after
20 days (2 July)
Q1: ESMA Consultation
Paper on draft Regulatory
Technical Standards (follow up
to May Discussion Paper)
2 July: 24 months
after entry into force:
date of transposition
and publication by
Member States of
legislation to
implement MiFID II
and Level 2 measures
By 2 July: 12
months after entry
into force –
adoption of
delegated acts &
objection period for
Parliament &
By 2 December:
Council begins
objection period for
Parliament & Council on
delegated acts ends
By 2 January: 6 months
after MiFID II and MiFIR
enter into force, ESMA
provides technical advice
to the Commission on
Level 2 measures
2 January: 30
months after entry
into force: date of
application of
and Level 2
A recap of the key sources
• MiFID II (Directive 2014/65/EU) and MiFIR (Regulation no.
600/2014) were published in the Official Journal on 12 June 2014
• The European Parliament and Council have delegated to the
Commission the power to adopt delegated acts which supplement
the high-level requirements of MiFID II/MiFIR
• ESMA also has a significant role in the Level 2 process by virtue
– its mandates, in MiFID II/MiFIR, to prepare Regulatory Technical Standards
(RTS) and Implementing Technical Standards (ITS) in a number of areas, and
– its mandate from the Commission to provide technical advice to assist the
Commission in its drafting of delegated acts
• Timeframes for ESMA deliverables:
– ESMA must provide technical advice on Level 2 within 6 months of MiFID
II/MiFIR entering into force: ESMA CP published on 22 May 2014
– RTS and ITS are due within 12 and 18 months of MiFID II/MiFIR entering into
force, respectively: ESMA DP published on 22 May 2014, and seeks
stakeholders’ views to inform a further CP which will include draft technical
– Responses to both papers are due by 1 August 2014
– Open hearings in Paris on 7 and 8 July
MiFID II and MiFIR: initiating MiFID projects
Macro theme 1: Strategic
implications – group
reorganisation necessary
due to changes in
exemptions and third
country requirements?
Macro theme 3: Dealing
effectively with the new
markets requirements –
OTFs, algorithmic trading,
position limits, increased
transparency etc
Macro theme 2: Conduct of
business – many small
amendments which add up
to significant changes
including amendments to
terms of business
Macro theme 4: Creating
a project team – we are
now moving onto detailed
Level 2 measures shortly
and the key question is
how you keep track of the
mass of paper
Key themes: conduct of business and
investor protection
Key themes: fees, commissions and non-monetary
benefits (1)
• Services covered:
– Investment advice on an independent basis
– Portfolio management
• Starting point – Article 24 and Recital 52:
– Firms ‘shall not accept and retain’ commissions or monetary or non-monetary benefits
paid or provided by any third party of any person acting on behalf of a third party
– All fees, commissions and any monetary benefits paid or provided by a third party must
be returned in full to the client
– Firm cannot offset any third-party payments from the fees due by the client
– Client should be accurately and, where relevant, periodically, informed about all fees,
commissions and benefits the firm has received in connection with the investment
service provided
– Firms providing independent advice or portfolio management should set up a policy to
ensure that third party payments received are allocated and transferred to clients
• But:
– Minor non-monetary benefits are allowed subject to certain conditions including that
they do not, or are not likely to, impair the firm to act in the client’s best interests
Key themes: fees, commissions and non-monetary
benefits (2)
• The requirement:
– When providing investment advice on an independent basis and portfolio
management, fees, commissions or non-monetary benefits paid or provided by
a person on behalf of the client are allowed BUT only as far as the person is
aware that such payments have been made on his behalf and that the amount
and frequency of any payment is agreed between the client and the investment
firm and not determined by a third party
• Cases which would satisfy the caveat:
– Where a client pays a firm’s invoice directly or it is paid by an independent third
party who has no connection with the investment firm regarding the investment
service provided to the client and is acting only on the instructions of the client
– Where the client negotiates a fee for a service provided by an investment firm
and pays that fee
• To further protect consumers:
– Investment firm that provides investment services to clients shall ensure that it
does not remunerate or assess the performance of its staff in a way that
conflicts with its duty to act in the best interests of its clients (Article 24 (6A))
Fees, commissions and non-monetary benefits: key
points from ESMA
Accept and not retain third party payments:
• Obligation to return to clients monetary third party
payments received asap by transferral to client
money account
• Obligation comprises all sums received in relation
to independent advice and portfolio management
• No specific timeframe mandated, but firms need to
establish policies
• Clients to be informed as part of regular periodic
• Ban on non-monetary benefits that are not “minor”
Minor non-monetary benefits:
• ESMA recommends an exhaustive list of minor
non-monetary benefits: even these only permitted if
reasonable, proportionate and unlikely to influence
behaviour in ways detrimental to the client
• List to include: (a) information/documentation
relating to FIs and investment services –
general/personalised to reflect individual
circumstances; (b) participation in conferences etc.
on specific FIs/investment services; (c) de minimis
hospitality – food/drink during meetings, seminars
Other investment services - disclosure
• Information on existence, nature and amount of
payments to be disclosed upfront – method of
calculation permitted where amounts cannot be
• But, exact amounts must be provided on an expost basis
• Annual disclosure of actual amount of
payments/non-monetary benefits received
• Each investment firm in distribution chain to comply
with obligations vis-à-vis its clients
Other investment services - quality enhancement:
• ESMA recommends a non-exhaustive list of
circumstances when quality enhancement test is
not met
• Potential for further ESMA Guidelines and
Recommendations in future
• Firms to be required to keep internal lists of
commissions, fees and non-monetary benefits
accepted, and to record how they use/intend to use
commissions and fees in order to enhance the
quality of their services
Key theme: best execution
– In complying with its existing obligation to monitor the effectiveness of its order execution
arrangements and to, where appropriate, correct any deficiencies, a firm will also be required to
take into account the information published by trading venues, systematic internalisers and
execution venues, under Article 27(2), on the execution quality of transactions and the
summary of its top five execution venues for each class of financial instruments under Article
27(4a) (Article 27(5))
• New obligations of best execution (Article 27):
– Information on a firm’s order execution policy must now explain clearly, in sufficient detail and in
a way that can be easily understood by clients, how orders will be executed by the firm for the
client (Article 27(4) sub para 2)
– A firm must now inform clients where there is a possibility that their order will be executed
outside a trading venue and it must obtain prior consent from its client before doing so (Article
27(4) sub para 3). Under MiFID I, firms only have the obligation to do this where there is a
possibility that their clients’ orders will be executed outside a regulated market or a multilateral
trading facility (MTF)
– A firm’s obligation to inform clients of material changes to its order execution arrangements has
been limited to an obligation to inform clients with whom the firm has an ‘on-going relationship’
(Article 27(5))
– ESMA regulatory technical standards:
– To determine the content and format of this information
– Upon request, firms will not only be required to demonstrate to the regulator that they have
executed their orders in accordance with their execution policy but also their general
compliance with the best execution obligation in Article 27 (Article 27(6))
Best execution: key points from ESMA (1)
Detail of execution/RTO/placing policies:
• Customisation, to reflect classes of instrument and
type of services
• Policies to include list of factors used for selection,
and their relative importance, and list of
entities/venues used
• Information on execution factors/venues to be
consistent with firm’s controls around
demonstrating best execution
• Firms should be able to check the fairness of
bespoke OTC product prices
Disclosure and consent:
• Firms to answer reasonable and proportionate
information requests from clients clearly and within
a reasonable time
• RTOs/portfolio managers to provide appropriate
information on their policies
• Prior express consent for transmitting/placing
orders that may be executed outside an RM, MTF
or OTF – but appropriate information must be given
(including information on the execution policies of
the entities selected to execute)
Content of disclosure:
• Firms executing/transmitting/placing orders for
execution outside an RM/MTF/OTF must clearly
indicate this in their policies – as well as indicating
the resulting counterparty risk consequences
• Retail clients must be given a summary of the
policy, focussed on costs (including venue fees,
clearing and settlement fees etc.) and including a
link to each venue’s most recently published
execution quality data
Third party payments:
• Execution/RTO/placing policies to include clear
information about payments received from venues,
market makers and entities to which orders are
• Where more than one participant in a transaction
can be charged, both parties should be aware of
the fees paid to the firm (particularly if the fees are
• In addition, the execution policy must indicate this
possibility, and specify fees charged for each leg of
the transaction – and give a range/maximum where
fees differ between clients
Best execution: key points from ESMA (2)
Transparency of venue selection:
• Where fees applied differ between execution
venues/entities, policies should provide sufficient
information to allow clients to understand the
relative advantages and disadvantages of different
• Information to be clear, fair and not misleading and
sufficient to prevent clients choosing solely on the
basis of the firm’s price policy
“Material changes”:
• Firms need to review their policies annually and
whenever there is a material change affecting its
ability to obtain best execution
• “Material change” defined as a significant event or
internal/external change that could impact
parameters of best execution – firms to consider
the materiality of changes to the relative
importance of execution factors or to
venues/entities on which it places significant
reliance in meeting the overarching requirement
Use of a single venue or entity:
• Firms can include a single venue or entity if they
can show that this still allows them to satisfy the
overarching best execution requirement
• Firms should reasonably expect that the
venue/entity will enable it to obtain results that are
at least as good as those it could reasonably
expect from alternatives – the expectation needs to
be supported by data or information published
under Article 27, or by other internal analysis
Publication of data by firms and trading venues:
• ESMA to develop RTS on the content, format and
periodicity of execution data to be published by
trading venues
• ESMA to develop RTS on the content and format of
data to be published by firms
Key themes: suitability
MiFID I on suitability (MiFID Article 19(4))
When making a personal recommendation or providing
portfolio management services to a client or potential client, a
firm must obtain the necessary information regarding the
client’s knowledge and experience, his financial situation and
his investment objectives so as to enable the firm to
recommend to the client or potential client the investment
services and financial instruments that are suitable for him
MiFID II on suitability (Article 25(1)
and (5))
A firm must also obtain information
about the client’s ability to bear
losses and risk tolerance in order to
ensure that investment services and
financial instruments are
recommended accordingly
ESMA guidelines:To be developed
specifying the criteria for assessing
the knowledge and competence of
the client
Key themes: appropriateness
• MiFID I on appropriateness (Article
– When providing services (other than investment
advice or portfolio management), a firm must
ask their existing or potential clients to provide
information regarding their knowledge and
experience relevant to the specific type of
service or product provided, to enable it to
assess whether it is appropriate for the client
• MiFID I on execution only services
(Article 19(6)):
– Firms are not required to ask their clients to
provide information or assess appropriateness if
the service is ‘execution only’, namely, the
service consists of execution and/or the
reception and transmission of client orders with
or without ancillary services, and provided that
certain other conditions are satisfied such as the
service relates to particular non-complex
financial instruments
• MiFID II on appropriateness (MiFID II
Article 25(3)):
– The list of financial instruments that fall within
the exempted ‘execution only’ regime, and in
assessment is not required, now covers:
– Shares admitted to trading on a regulated market,
an equivalent third country market or a MTF,
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 MTF (except
those that embed a derivative or incorporate a
structure which makes it difficult for the client to
understand the risk involved) *
– 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
– 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 its term)*
– Other non-complex financial instruments*
* Subject to ESMA guidelines.
Suitability and appropriateness: key points from
Suitability assessments:
• ESMA recommendations are presented as
• Explicit requirements in MiFID II for investment
firms to assess both a client’s ability to bear losses
and a client’s risk tolerance
• Technical advice would supplement current
requirements in a number of ways, including:
• more specific requirements around the reliability
of client information obtained (in relation to the
ways in which customer information is obtained
and subsequently assessed and used by firms)
• requirements for firms to look through small
entities/natural persons representing other
natural persons in relation to financial situation
and investment objectives (but not knowledge
and experience)
Suitability reports:
• MiFID II introduces a specific requirement to supply
a written suitability report to retail clients where
investment advice is given
• ESMA recommendations specific required content,
which goes further than current UK requirements
set out in COBS 9
• Further narrowing of the scope of execution-only
• Instruments not specifically identified as being noncomplex would need to meet two new criteria (in
addition to those currently specified in the MiFID
Implementing Directive) to be considered noncomplex:
• they do not incorporate a clause, condition or
trigger that could fundamentally alter the nature
or risk of the investment or pay-out profile (e.g.
conversion rights)
• they do not include any explicit or implicit exit
charges that make the investment illiquid despite
technically frequent opportunities to
• Explicit clarification that the features listed in Article
38 of the MiFID Implementing Directive (i.e.
frequent opportunities to redeem/dispose,
availability of information) cannot be used as a
means to pull instruments into the non-complex
Key themes: conflicts of interest
MiFID II will strengthen current
rules by adding a new
requirement to “prevent”
In this, as in other areas, MiFID
II addresses perceived failures
in the implementation of MiFID I
periodic reviews of their operations
to identify new conflicts that need to
be managed or disclosed
gifts and entertainments policies
remuneration structures
information and physical barriers, as
well as electronic separation
Firms should consider:
their record keeping practices and
audit trail
conflicts policies: how
comprehensive are they, and what
level of detail will be expected in the
new environment?
staff training
restrictions on staff outside interests
independent management structures
and reporting lines
personal account dealing policies
conflicts management committees
Conflicts: key points from ESMA
• ESMA is proposing amendments to Article 22 of the
MiFID Implementing Directive – intended to
clarify/supplement, rather than replace, existing
provisions – ESMA sees itself as addressing
• Reiteration that disclosure to clients should be a
measure of last resort – firm’s should not over-rely
or use disclosure as a self-standing measure
• The first step for firms should be to consider what
additional reasonable measures and arrangements
can be put in place – NCAs requesting evidence
from firms
• Disclosure should be used only where the firm’s
arrangements are not sufficient to ensure, with
reasonable certainty, that damage to client interests
is prevented
• Where disclosure is required, disclosures must
clearly state that the firm’s arrangements are not
• Disclosure must be made in a durable medium, and
include a specific description of the conflict – taking
account of the nature of the client
• NCAs have found disclosures to be too generic and
unclear: not just an issue for the retail sphere
• Disclosures must explain the nature and/or sources
of the conflict, the risks to the client and the steps
taken to mitigate them – sufficient detail is needed to
enable client to make informed investment decisions
• Proposal to formalise a requirement for periodic
(and at least annual) review of conflicts policies
• ESMA sees this as a concretisation of existing
business practice
• Feedback invited from stakeholders in relation to the
continued appropriateness of existing requirements
• specify the situations firms must take into account
when identifying conflicts (Article 21 MiFID
Implementing Directive)
• specifically impose requirements relating to the
provision of investment research, including
additional organisational requirements (Articles 24
and 25 MiFID Implementing Directive)
Key impacts: markets issues affecting the
Key theme: algorithmic trading and direct electronic
Algorithmic trading
Direct electronic access
• Where a computer automatically
determines individual parameters of
orders with limited human intervention
• Where member of trading venue
permits a person to use its trading
code to electronically transmit orders
directly to trading venue
• Must notify relevant competent
authorities – they may require
• Must have systems and risk controls:
– resilience, capacity, limits, continuity
– do not contribute to disorderly
– cannot be used contrary to market
– testing and monitoring of systems
• Extra requirements where using high
frequency techniques
• Requirements on firms providing DEA
will mean that firms using DEA will be:
– assessed for suitability upfront and
– subject to trading and credit
– monitored and subject to risk
controls to ensure compliance with
MiFID II, market abuse and market
– required to enter into a written
agreement with DEA provider
Key theme: post-trade transparency
Shares and equity-like instruments
Other instruments
• Extended to equity-like
instruments such as depositary
receipts, exchange traded funds
and certificates
– Investment firms must make
public trades through an
Approved Publication
– Applies in respect of
instruments traded on a trading
venue but if venue can defer,
this should also apply to OTC
– Make public volume, price and
time of transaction
• New regime extended to bonds,
structured finance products,
emissions allowances and
• Investment firms must make
public transactions traded on a
trading venue through an
Approved Publication
• Competent authority can permit
deferral, or restricted or
aggregated disclosure, and can
suspend and this also applies to
OTC trades
• Further detail to be set out in RTS
Key theme: transaction reporting
Transaction reporting
Financial instruments which are:
– admitted to trading or traded on a trading venue
– where underlying is a financial instrument traded on a trading venue
– where underlying is an index or basket of financial instruments traded on a trading
• even if transaction is not carried out on a trading venue
No later than close of following working day
Firms that execute: any action that results in a transaction
– ESMA proposes broad concept of execution for these purposes
Firms that transmit orders must either transmit specified details or report them
– ESMA suggests an agreement between transmitter and receiver is needed
New fields will include:
– Client ID
– Trader ID
– Algorithm ID
Reports can be made by firm or through an ARM or trading venue
Transaction reports to a trade repository under EMIR will count provided (i) the trade
repository is also an ARM and (ii) the reports contain all information required by MiFIR
Key theme: mandatory on-platform trading
Mandatory on-platform trading for derivatives under MiFIR
Derivatives that are subject to clearing obligation in EMIR which:
– are traded on at least one RM, MTF, OTF or third country trading venue; and
– are considered sufficiently liquid to only trade on these venues
The Commission and ESMA will define eligible derivatives through technical standards
ESMA also has an own initiative power to identify derivatives that are not CCP cleared
or traded on a trading venue for this purpose
If within scope then must be traded on an RM, MTF, or equivalent third country venue
Same scope as EMIR in relation to counterparties:
trades between financial counterparties and in-scope non-financial counterparties;
trades between an EU captured entity and third country entities that would be
subject to EMIR;
trades between third country entities that would be subject to EMIR if they were
established in the EU where their transactions could have a direct, substantial and
foreseeable effect within EU or where necessary to avoid evasion; and
excludes certain intra-group transactions
EMIR Q1: what is the difference between accounts?
Omnibus segregation
Individual segregation
In CCP’s books and
CM’s positions and assets are distinct from
client’s positions and assets
Positions and assets of each client are distinct
from one another as well as from CM’s positions
and assets
Assets in one account
cannot be used to
cover losses in another
Any client within account could be taking risk
on other clients in same account
No fellow client risk
Excess margin
CM can hold excess margin itself
CM must post any margin in excess of CCP’s
requirement to CCP
Likelihood of porting
Likely to be more difficult
Should be more achievable but still many
Other risks
Neither of these accounts (in their plain form) mitigate other risks such as:
• transit risk: exposure to CM before it transfers margin to CCP
• CCP risk: exposure to failure of CCP
NB: Each account offered by a CCP is different and exact risk depends on how that CCP operates – need to check CCP
disclosure documents and rules – some accounts may involve extra documentation
Omnibus segregation
Clearing Member
(books + records)
Client 1
Client 1
Client 2
Client 2
Client 3
Client 3
CCP (books +
Clients 1, 2 + 3
Individual segregation
Clearing Member
(books + records)
CCP (books +
Client 1
Client 1
Client 1
Client 2
Client 2
Client 2
Client 3
Client 3
Client 3
Additional information to be armed with
Costs and credit
Jurisdictional scope
• CCPs and CMs must disclose levels of
protection and costs - must be on
reasonable commercial terms
• Applies to all CMs of EU CCPs
• Any collateral on a client account can be
ported so CMs may be less ready to prefund or provide credit
• Consider your client’s obligations – where
do they need to clear?
• CMs of non-EU CCPs need not comply
• It is possible your client may need an LSOC
account instead
Title transfer v security interest
• CM and CCP can decide basis on which
they want to take collateral – it need not be
the same
• Title transfer (credit risk)
– outright transfer of legal and beneficial
– obligation to return equivalent assets
• Security interest (no credit risk)
– provider retains beneficial ownership
– taker can enforce if provider defaults
– if provider exercises right of use assets
become taker’s assets
Client money v non-Client money (cash only)
• CM must provide client money unless there
is a carve out:
– banks
– title transfer (TTCA)
• Cash is not held as client money by CCP
but client money and TTCA must be kept
separate at CM and CCP levels
• Can have any combination of:
– Client money v TTCA
EMIR Q2: how does porting work?
• Part VII Companies Act
1989 should prevent
challenge to actions
taken by CCPs, pursuant
to their default rules:
– to settle contracts or
transfer them to a Back-up
– to transfer Client
Transactions to that Backup CM
Security Interest (may
be tri-party and may
include a security
Back-up CM
– for English CCPs and
English CMs, can be
achieved under default
– sometimes supported by
security interest
Cleared Contracts
• Principal to principal
Client Transactions
• If CM becomes insolvent
and client so requests,
transfer client positions
and assets to another
CM, which has agreed to
step in
• CCPs must commit to
trigger procedure for
• CCPs can actively manage
their risks by liquidating
positions and assets if this
cannot be done within a
pre-defined timeframe
Consequences of Clearing Member default
Port positions
and margin
Return balance
to Client
Individual Client
Not Client
Return balance to
Clearing Member
Omnibus Client Omnibus Client
account (gross) account (net)
Not part of
notional pool
Notional Client money
All accounts
‘For account of
Full sum minus
In accordance with CCP or CM
information minus costs
Sum rateable to Client
money entitlement
A typical client clearing structure and documentation map
Also: CCP and CM
Disclosure Documents
on protections and
pricing for different
CCP Membership
Agreement and Rules
Back-up CM
Client Clearing
Clearing Master
CCP’s Client Clearing Documentation
Security Trustee
Execution Standard Terms
Non-clearing master agreement
and collateral document
OTC derivative
EMIR Q3: what are the new client clearing
• ISDA Addendum/ FOA Module - designed as amendment to ISDA Master
Agreement/ FOA Terms of Business
• Document relationship between CM and Client for clearing derivatives on
principal to principal CCPs
• Designed as templates – CMs may adapt
• Can be used for:
– different CCPs and services provided by them
– both individual and omnibus Client accounts
• Client Transaction arises between CM and Client which is identical to transaction
between CM and CCP save that:
– subject to terms of agreement as supplemented
– if CM was buyer in CM/CCP transaction, it is seller in Client Transaction (and vice versa)
• Client agrees:
– CCP’s Mandatory Provisions will prevail if there is any conflict
– in Addendum, to be bound by CCP’s Core Provisions (and facilitate CM’s compliance)
What do the client clearing agreements do?
• Sit alongside and amend existing client documentation in respect
of cleared transactions only
• Client cannot default CM (any rights are disapplied)
• Alternatively, under Addendum, client can ask CM to:
– transfer Client Transactions and CM/CCP transactions and related collateral to
a new CM:
– CM is obliged provided no CCP or CM default and any Transfer Conditions
are satisfied
– in accordance with CCP’s rules
• Clear an Offsetting Transaction
– CM is obliged subject to any Offsetting Conditions
– CM must then compress CM/CCP transactions
• However, if CCP defaults CM, or CCP itself defaults:
– Client Transactions are automatically terminated at same time and given same
value as CCP determines for CM/CCP transactions
– Cleared Set Termination Amount is calculated for each Cleared Transaction Set
(defined by reference to Agreed CCP Service)
– CM may set off against any amounts owed to client
EMIR Q4: what will bilateral collateralisation require?
Scope of Principal
FCs and NFCs+
Variation margin
All counterparties must exchange full amount daily
Effective on 1 December 2015 – only applies to new contracts entered into after that date
All counterparties must exchange
EUR 50m threshold applies to consolidated group
Calculated by reference to a model or standardised schedule – models can consider risk
within netting sets and asset but must be notified to relevant supervisor
Must exchange gross initial margin
All margin transfers subject to de minimis margin transfer amount not exceeding EUR
To be phased in between 1 December 2015 and 1 December 2019 depending on aggregate
notional amount of group’s non-centrally cleared derivatives entered into with counterparties
At end of phase in, firms will only be subject to requirements if they exceed minimum level of
non-cleared derivatives – EUR 8 bn gross notional outstanding
Should be highly liquid and, after haircutting, be capable of holding value in financial stress
and not be exposed to excessive credit, market or FX risk unless an appropriate haircut
Examples include cash, high quality government securities, high quality corporate and
covered bonds, equities in major indices and gold
Should not correlate with creditworthiness of counterparty or value of portfolio
Initial margin
Margin requirements may not apply to physically settled FX forwards and physically settled
FX swaps
Intra-group transactions
Timing for initial margin
Eligible collateral
ESAs principles for margin requirements
• Requirements for holding collateral:
– margin must be immediately available on posting counterparty’s default
– margin arrangements must protect posting entity’s bankruptcy
– protection will need to be supported by legal opinions
– Variation Margin can be re-hypothecated
• IM cannot be re-hypothecated, re-pledged nor otherwise re-used
– This is a deviation from the BCBS- IOSCO principles that allows rehypothecation if certain conditions are met. According to ESAs these
restrictions appear to be limited of use within EU market, and ruling out this
possibility will simplify the overall framework
Client assets
Changes to client assets regime
From 1 July 2014
From 1 December 2014
• Clarifying the application provisions
• With transitional until 1 June 2015 for
arrangements in place as at 30 November
• Removing auditor’s confirmation for alternative
• Changes to right to use arrangements
• Changes to money ceasing to be client money
• Amending rules applying to trustee firms
• Prohibiting placement of client money in 30+
day unbreakable term deposits
• Clarifications on payment of interest
• Changes to client money held by third parties
• A revised definition of the ‘standard method of
internal client money reconciliation’
• Clarification of CFTC Part 30 Exemption Order
• Clarifications to client money distribution rules
written custody agreements
acknowledgement letters
banking exemption
TTCA – written agreements
DvP commercial settlement systems
information to be provided to clients before
the provision of investment service
• With no transitional provisions:
– unclaimed custody assets
– unclaimed client money
– transfer of client business – handling client
• Introducing multiple client money pools
• Alternative approach/non-standard
reconciliation method
– but firms using these as of 30 November
2014 can continue until 1 June 2015
From 1 June 2015 - All firms to comply with all requirements
but firms can comply with any requirements ahead of time
Clearing member client money sub-pools 1
• CMs may offer sub-pools in relation to net omnibus accounts at
CCPs authorised or recognised under EMIR
• Assumes some client money is held at CM level:
– if CM defaults, IP would be able to make it available to back-up CM
– if not ported, CM must keep separate from main client money pool and return to
clients within sub-pool rateably
• CM must segregate client money, do separate reconciliations and
keep separate records
• Disclosure document to be given to client reminding client that it
will have no claim on any other client money pool:
– firms may use template provided
– client must return signed copy
– at least 2 months’ notice of material amendments
• FCA requires at least 2 months’ notice of any new sub-pool
Clearing member client money sub-pools 2
Information for clients
• Provide COBs 6.1.7 information to all client money and custody
clients before providing services
• Reminder of obligation to send a statement at least annually:
– but firm must provide statement or copy of information when requested
– copy must be provided within 5 business days
– any charge must be agreed and correspond to costs
– must be clear which assets are protected under CASS
• Firms holding cash as banker must set out in terms of business
any circumstances in which cash will become client money
• Title transfer arrangements must be in written agreement and set
out terms on which ownership returns to client
• Need client’s written agreement to use of DvP exemption
• Firms must have written custody agreements, even where only
arranging custody
• Client Assets Disclosure Document is on hold but will be kept
under review
Client money acknowledgement letters
New template letters must be countersigned and returned before
client money can be held:
– save that firms just need to send them to authorised CCPs
– no grace period, regardless of where accounts are held
• Guidance on use:
– only variable text can be amended but not in a way that would change meaning
of letter
– can choose non-UK governing law and jurisdiction provided letter remains
– must use reasonable endeavours to ensure signatory is authorised to bind
counterparty and need evidence
– accounts must be clearly identified in body of letter, including any abbreviations
– electronic signatures can be used provided admissible in evidence
• Review at least annually and replace whenever details change or
an error or mis-spelling is discovered
• All Client accounts to be re-papered
Pegasus: Our guide to MiFID II
AIFMD expert: Our guide to the AIFMD
Key contacts in London
Hannah Meakin
Imogen Garner
Partner, Norton Rose Fulbright LLP
Partner, Norton Rose Fulbright LLP
Hannah Meakin is a partner in the financial
services team in London. She advises
clients, mostly on the wholesale side of
the industry, on a wide range of regulatory
matters. Hannah has particular expertise
in investment management, custody,
brokerage, clearing and outsourcing
related issues.
Imogen Garner is a partner in the financial
services group, where she advises a
broad range of clients on the UK and EU
financial services regimes.
Hannah also has experience of advising
clients on perimeter issues, compliance
with FCA Rules and implementation of
European legislation (the Markets in
Financial Instruments Directive and the
Capital Requirements Directive). She also
advises on regulatory structuring issues
involving fund set ups and transfers of
She has also provided clients with training
on various regulatory topics and provided
regulatory audits for FCA authorised
Imogen’s areas of practice include
advising on perimeter issues, the
regulatory aspects of acquisitions and
disposals and clients’ on-going compliance
with anti-money laundering and other
financial services law and regulation.
She also frequently drafts and negotiates
investment management and other client
agreements. Imogen has particular
experience advising asset managers, and
has also worked with a number of asset
management industry trade bodies. She
spent nine months on secondment to the
FSA’s (as it then was) General Counsel’s
Division, where she advised the FSA’s CIS
Policy Team and HM Treasury on the
Global coverage
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activities of the Norton Rose Fulbright members but does not itself provide legal services to clients.
References to ‘Norton Rose Fulbright’, ‘the law firm’, and ‘legal practice’ are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together ‘Norton Rose
Fulbright entity/entities’). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is
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The purpose of this communication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose
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