1 Scope of Financial Instruments under MiFID Treatment of Transferable securities, Money market instruments, Derivatives, Forex transactions, Financial contracts for differences
2 Agenda I. Financial instruments under MiFID II. Treatment of financial instruments: complex and non complex III. Consequences of treatment as complex financial instruments on different aspects of investment services
3 Financial instruments under MiFID no general definition of a financial instrument in MiFID scope of financial instruments is defined by enumeration list of FI is provided in Section C of Annex I of MiFID
4 I. Scope of FI under MiFID Transferable securities (negotiable) Annex I section C(1) shares in companies, securities equivalent to shares, depositary receipts for shares bonds, other forms of securitised debt, depositary receipts for such securities any other securities, giving right to acquire or sell any such tranferable securities oor giving rise to a cash settlement, determined by reference to transferable securities, currences, interest rates or yields, commodities or other indices or measures Shares in collective investment undertakings Annex I section C(2) Money market instruments Annex I section C(3) All units or shares in collective investment undertakings transferable debt instrument, traded on money market: certificates of deposit, commercial paper, banker s acceptances, treasury and local authority bills
5 Scope of FI under MiFID Derivatives Annex I section C(4) C(7) options, futures, swaps, forward rate contracts and any other derivatives related to securities, currencies, interest rates/yields, other derivatives, financial indices or financial measures which may be settled physically or in cash Annex I Section C(4) commodities that must be settled in cash or may be settled in cash at the option of one of the parties Annex I Section C(5) commodities that can be physically settled provided that they are traded on a regulated market and/or an MTF Annex I Section C(6) commodities that can be physically settled, not mentioned in C(6 ), not being for commercial purposes, which have characteristics of other derivatives Annex I Section C(7)
6 Scope of FI under MiFID Derivatives Annex I section C(8) C(10) instruments for the transfer of credit risk Annex I Section C(8) financial contracts for differences related to MiFID instruments, currencies, interest rates or other financial indices Annex I Section C(9) options, futures, swaps, forward rate contracts and any other derivatives related to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics (cash settlement option) and assets, rights, obligations, indices and measures not otherwise mentioned Annex I Section C(10)
7 Scope of FI under MiFID Transactions/contracts, which form in point of fact financial instrument listed in Section C of Annex I of MiFID, should be treated as financial instruments under MiFID (i.e. so called marginal FOREX trading / rolling FX spot contracts take form of CFD)
8 Latvian experience (scope) From the point of view when having definition of financial instrument in national law: practical difficulties when applying certain restrictions provided in other laws (i.e. defined limits for collective investment undertakings); risk to spread MiFID provisions to non MiFID products.
9 II. Treatment of financial instruments Suitability requirements for investment advice and discretional portfolio management (Art. 19(4) MiFID L1D, Art.35&37 L2D) Appropriateness requirements for other investment services (Art. 19(5) MiFID L1D, Art.36&37 L2D) Providing of reception transmission and execution of orders without appropriateness test = execution only (Art. 19(6) MiFID L1D, Art.38 L2D) Ref: CESR published (2009) CP and policy statement on complex and non complex FI
10 Complex and non complex FI Which instruments are complex and non complex? Under MiFID, the following types of MiFID financial instruments are automatically non complex: shares admitted to trading on a regulated market or in an equivalent third country market; money market instruments, bonds or other forms of securitised debt (excluding those bonds or securitised debt that embed a derivative); UCITS; and other non complex financial instruments.
11 Shares MiFID does not define term shares. Definition of transferable securities in MiFID Art. 4(1)(18)(a) states: shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares Automatically noncomplex: shares in companies included preference shares that do not embed a derivative To be assessed against criteria, provided in MiFID Implementing Directive Art. 38: depositary receipts for shares; Shares not admitted to trading on a regulated market; Shares admitted to trading on a third country market; stapled securities ; Shares in non UCITS funds.
12 Money market instruments MMI that do not embed derivative, are noncomplex
13 Bonds Bonds that do not embed derivative, are noncomplex Depositary receipts in respect of bonds treated the same way as for shares to be assessed against criteria under Art. 38 MiFID Level 2
14 Bonds Bonds that embed derivative, are complex. No definition of bonds that embed a derivative in MiFID. IAS 39, 10 defines an embedded derivative as a component of a hybrid (combined) instrument that also includes a non derivative host contract with the effect that some of the cash flows of the combined instrument vary in a way similar to a standalone derivative.
15 Bonds Examples of bonds, MMI and other forms of securitised debt embedding a derivative
16 UCITS No special meaning of the term UCITS in MiFID. The reference captures investments in a collective investment undertaking which is constituted according to the UCITS Directive (Directive 85/611/EC). UCITS are non complex by definition regardless of the underlying instruments. Non UCITS has to be assessed agains criteria of Art. 38 of MiFID L2D none are automatically complex.
17 UCITS What can make non UCITS complex? not authorised or regulated in accordance with UCITS Directive. non UCITS can be more flexible than UCITS with regards to the assets they can hold and way they spread risk and use leverage. Investing in derivatives does not automatically make non UCITS complex.
18 Other non complex financial instruments are those that meet all the following four conditions: (i) not a derivative or any other security giving the right to acquire or sell transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures (Art. 4(1)(18)(c), points (4) to (10) of Section C of Annex I to MiFID); (ii) frequent opportunities to dispose of, redeem, or otherwise realise that instrument at prices that are publicly available to market participants and that are either market prices or prices made available, or validated, by valuation systems independent of the issuer;
19 Other non complex financial instruments (iii) it does not involve any actual or potential liability for the client that exceeds the cost of acquiring the instrument; (iv) adequately comprehensive information on its characteristics is publicly available and is likely to be readily understood so as to enable the average retail client to make an informed judgment as to whether to enter into a transaction in that instrument.
20 Other products Deposit with an embedded derivative that has the potential of reducing the initial capital invested as a financial instrument under MiFID; Other securities giving the right to acquire or sell a transferrable security or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measure, i.e. Warrants Covered warrants Financial contracts for differences, incl. Exchange traded commodities (that are contracts for difference and financial spread bets )
21 Consequences of treatment as complex financial instruments, some practical issues Practical issue: client s information Query: can firm simply rely on client s provided data on his/her knowledge and experience? The position of FCMC: when evaluating client s ability to understand the nature and risks related to investment (reading of client s data), differentiated approach is justified: the FI is non complex no additional information may be needed the FI is complex it s likely that more additional information may be requested
22 Practical issue: correlation of knowledge and experience Case: some firms assume that a single trade by client is enough to conclude that client has sufficient knowledge. The position of FCMC: when evaluating client s ability to understand the nature and risks related to investment (reading of client s data), differentiated approach can be justified: is the FI so simple and straight forward (noncomplex) such assumption may be justified is the FI complex it is ambiguous to conclude that client has sufficient knowledge
23 Practical issue: client s best interests Case: client has not provided information on his/her knowledge and experience or information provided leads to conclusion, that deal won t be appropriate for the client. According to appropriateness requirements the firm cannot proceed with the deal without warning. But different approach could be justified: i.e. in case of risky complex products such as oil futures it might be that provision to act in the best interests of client requires from the firm not to proceed with the deal even if client requests it.
24 Practical issue: best execution Complex FI: structured products, CFDs, spread bets These products are usually principal trades so best execution may not arise However, if best execution does arise, then there are usually proxies or reference prices for the components of the product after all, this is the firm s approach to pricing in case of CFDs, for retail customers, it is likely that they rely on the firm and so best execution will apply and the firm s price will usually be linked to the underlying market price
25 Thank you! Vadims Kolomijecs (Vadim Kolomiets) Financial and Capital Market Commission
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