MiFID analysis: Industry predicts the nature of first FSA visits

MiFID analysis: Industry predicts the nature of first FSA visits

Jan 16 2008 Joy Archer

The Financial Services Authority recently suggested that although firms would be given time to bed in their Markets in Financial Instruments Directive requirements, it was likely that firms would be visited in the first quarter of 2008. In the light of this Complinet spoke to a number of leading industry figures to gauge what firms should look out for. We asked the following question:

What are the biggest issues that firms are still getting to grips with, in view of the Q1 MiFID visits that the Financial Services Authority will be making, and what should firms prioritise?

Angela Knight
Chief executive of the British Bankers' Association

It has now been three months since the MiFID implementation date of November 1. The Financial Services Authority will now be making concerted progress in visiting firms to review their implementation of the new handbook rules. Priority areas will be firms' approaches to best execution. A firm will be expected to have made a considered and detailed review of the new best execution requirements. Client classification and the processes surrounding it are an important starting point when implementing the new rules. The FSA grandfathering provisions were certainly helpful, however, in the event of any disagreement between a firm and its client, the appropriate classification is vital. Finally, cross-border firms should pay keen attention to the bilateral home/host negotiations that are going on between the FSA and other member states' regulators. These negotiations will determine which responsibilities are carried out by which regulator, the extent of dual supervision and the set of applicable rules for cross-border clients and business. There is still a lot of work for firms to do in bedding down the new rules — MiFID is gone but not forgotten.

John Ahern
Partner, DLA Piper

In November 2005, the FSA published its "Planning for MiFID" paper. In the paper, the FSA highlighted the main regulatory changes that MiFID would bring about and suggested to firms what areas they should consider as they prepared for implementation. Some of the requirements, such as the new client categorisation regime, are comparatively easier to implement because they are not as dependent on technological systems enhancements as others. In the trading sphere, some firms are still getting to grips with best execution and with the pre-trade reporting requirements. The FSA's paper suggested that firms would need to consider how they will monitor execution performance by the venues included in their policy, and their processes for determining which execution venues to use.

Regarding pre-trade and post-trade transparency, the paper pointed out that firms would have to consider their internal controls for applying the new block trading provisions. Investment firms that trade outside a regulated market or MTF should have addressed issues such as how they would publish details of their trades and the steps they would take to ensure the accuracy and timeliness of publication. Larger firms with considerable internal resources have coped better with meeting the implementation challenges in these areas.

For smaller firms, however, there is still considerable uncertainty about execution and reporting in a number of areas, not least the treatment of limit orders and publication. It is to be hoped that some degree of latitude would be forthcoming with regard to firms who are still bedding down their processes as long as they are in a position to comply. Firms should, however, give top priority to their risk management processes and ensure that they are paying particular attention to their customer obligations — in particular, there ought to be a very high standard of compliance with the rules relating to client categorisation, customer documentation, disclosure, marketing and information gathering.

Charlotte Hill
Partner, Stephenson Harwood

The dust is still settling on the issue of transaction reporting for many firms, and there is more to come. The FSA expects to consult the industry shortly on a number of outstanding issues in relation to transaction reporting, such as the introduction of the new alternative instrument identifier and also, the extension of the rules to ensure the continued reporting of certain transactions in instruments admitted to trading on exchanges outside the European Economic Area.

A small piece in the FSA's statement of supervisory priorities, dated September 19, 2007, is of particular concern for firms in the wake of the introduction of the new transaction reporting requirements. The FSA has said that it will be looking in some depth at how firms are meeting their transaction reporting obligations. It referred particularly to those passported EEA branches which will come within the scope of the FSA regime for the first time. Firms would do well to take this warning to heart — in particular, those firms that are coming within the transaction reporting regime for the first time and those which are passported EEA branches.

Rob Moulton
Partner, Nabarro

A main issue that firms are still getting to grips with is financial promotion. There has been quite a lot of confusion, in particular in the corporate finance market, about the way that MiFID impacts upon the financial promotion order. The issue is complex, but there is increasing clarity about the outcome. Documents that are sent to corporate finance contacts do not count as promotions made to MiFID clients, therefore, the financial promotion order exemptions are still applicable. Lots of participants are still trying to get their heads around this.

One issue looming in 2008 is best execution reviews. Best execution received a lot of attention in 2007, but in practice most firms documented their existing practices in their order execution policy. There will be more fall out when firms carry out their first annual review of that execution policy to demonstrate performance. The suspicion is that clients will be flooded with data from different exchanges and service providers trying to show that execution on their platform produces the best results.

Tim Dolan
Partner, Pinsent Masons

Matters which can lead to direct client detriment should be prioritised. Most firms have worked through the client categorisation exercise and have provided their clients with, where required, notifications about how they are being treated in the light of MiFID and, if necessary, with amended terms of business. Firms have also identified some, but not always all, of the points that they need to seek prior written consent from their clients about. All MiFID firms must prioritise these matters and the application of the FSA's new Conduct of Business 4: Communicating with Clients rules, because they are matters which can lead to direct client detriment. Given the extensive changes to the Handbook regarding systems and controls, however, and the requirement for many new policies and procedures, the FSA will also look at matters which, if left untouched, can indirectly lead to client detriment. For example, the FSA will look to ensure that policies such as conflicts policies and, where required, order execution policies have been created and that senior management are actually engaged to ensure that the firm is operating in a compliant manner.

Nick Gibson
Head of compliance solutions, Chase Cooper Limited

The answer varies according to the size and nature of the firm and the resource they have devoted to the programme. Most firms have best execution and conflict management policies in place, and are trying to close off the merry-go-round of client and counterparty documentation. The clear issues that the industry is concerned about are recordkeeping and staff training. It is commendable to have coherent policy, but if the front end have not been comprehensively trained in their changed obligations then it is just a piece of dangerous — as in binding the firm but not properly observed — documentation. Another unregarded area is outsourcing, where the definition of what constitutes outsourcing is wide, and all relevant arrangements (including those pre-dating MiFID) have to be MiFID-compliant. This is a huge undertaking.

Mike Parker
Director of regulatory affairs, Deutsche Bank AG

From the viewpoint of a bank with a genuine pan-European franchise, the biggest challenge will be anticipating and reconciling MiFID's different regulatory expectations and interpretations. Copy-out is evident in many member states, however, the actual application of a requirement may vary between jurisdictions and, therefore, country-by-country analysis will still take up significant resource. For branches, the roll-out of the Committee of European Securities Regulators' protocol and its application by home and host regulators will also be of fundamental importance.

Specifically, as regulators such as the FSA begin their Q1 reviews, firms will have to examine their progress so far and prioritise what should have been achievable (e.g., a per cent target for obtaining client consents) over that which is not (e.g., complete roll-out of transaction reporting capability across the EEA). Several vital parts of MiFID require that something is put in place up front and then supplemented by specific procedure, such as conflicts policy supported by conflicts identification procedure, or best execution policy supported by internal monitoring of execution quality and venues. Firms should, therefore, have set out a plan to meet these requirements and be able to demonstrate how far along the road they are on implementation and what experiences they are having.

Clearly for those caught by SI and pre/post transparency and transaction reporting obligations the challenges are significant and go beyond the pure compliance aspects. Business will have taken ownership of these projects and it will be important to ensure that in taking them forward the varying requirements are identified and addressed — which will probably necessitate a clear understanding of who takes ownership of the new internal policies and procedures (compliance, legal, business management, ops, IT).

Some issues will continue to cause uncertainty for some while yet. In areas such as the level of disclosure of inducements, there will hopefully still be the opportunity to enter into a constructive dialogue with the regulator. In the UK, the move to principles-based regulation, along with "comply or explain", should result in a flexible attitude to implementing the enormity of MiFID. It would be disappointing if FSA-regulated firms are taken to task over some difficult detail while in other parts of the EEA the ink is still drying on the level one legislation.

The views and the opinions expressed in 'hot topics' are that of the individual authors and not necessarily those of the Securities & Investment Institute.