MiFID, COBS and Corporate Finance

Transcription

1 MiFID, COBS and Corporate Finance November 2007 Contents - Introduction - Principles-based regulation - MiFID scope and non-mifid scope business - Provisions common to MiFID-scope and non MiFID-scope business only - Provisions applying to MiFID-scope business only - Conclusion

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3 MiFID, COBS and Corporate Finance Introduction Under the FSA s old conduct of business rules, a specific regime existed for corporate finance business which was within the scope of regulation by limiting the extent to which the conduct of business rules applied to these activities. This limited application reflected the nature of the relevant business and the generally sophisticated nature of the customers in those markets. The Markets in Financial Instruments Directive (MiFID) - the replacement for the Investment Services Directive (ISD) - is a maximum harmonising directive and as such leaves little scope for discretion on the part of the UK authorities to formulate a concessionary regime. As a result, from 1 November 2007, when MiFID came into force, separate regimes were established for the activities of corporate finance firms depending on whether the business in question is within the scope of MiFID or not. There will be extremely limited concessions only in relation to those rules which are not required to implement MiFID. Where the business is within the scope of MiFID, all relevant rules implementing MiFID will apply. In relation to business outside the scope of MiFID, the FSA has much greater freedom to disapply the conduct of business rules as it considers appropriate. Therefore, the FSA has extended the more relaxed policy approach for non MiFID scope business reflected in the old FSA conduct of business rules. Principles-based regulation The revision of the FSA s conduct of business rules is not only driven by the introduction of MiFID. That is only one component in the FSA s broader strategy of moving to a more principles-based regulatory regime. The rules relating to conduct of business have been rewritten in the form of the FSA s new Conduct of Business Sourcebook (COBS) not only to implement MiFID but also with a greater focus on the principles for conduct of business and the intended outcomes and with fewer detailed and prescriptive rules. The task for regulated firms is to ensure that their systems and processes are designed to secure the purposes of the principles-based regulation. Devising the necessary systems and processes will be a task for each individual firm, but there will also be a need procedures which ensure that a firm can record and articulate how it intends to comply with the relevant rules and achieve the required outcome. In particular, the FSA expects senior managers to be able to explain to the FSA how adoption of the new rules will enhance the firm s ability to treat customers fairly. From the enforcement viewpoint, the FSA would be looking at whether a reasonable firm applying its mind to the issues and circumstances could reasonably have predicted at the outset that a breach of the rules/principles would result. Principles-based regulation obviously brings new risks. In addition to the need for better records of decision-making processes being required, uncertainty may be created. There is clearly scope for this as the FSA is more and more adopting various informal ways of expressing its views (such as speeches and published case studies) and industry guidance is to be used more often. Also retrospective enforcement is a real concern. In truth, though, none of this is a new concern because we already have Principles for Businesses, which are susceptible to similar criticism. Balancing the advantages of the FSA s new approach with its potential risks is not easy, but overall it would appear to us that the risks either exist anyway and/or are probably worth running in order to have the chance of achieving the potential advantages. It should also be preferable to advocate a UK regulatory regime which is flexible and facilitates innovation. We are already seeing, on the international front, that firms which are subject to various regulators approaches indicate that they quite like the FSA s new more principles based approach. 3

4 MiFID scope and non-mifid scope business Turning to the detail of the changes, as noted above, the regime which is to apply to a particular firm will depend on whether its business is within the scope of MiFID or not. It will be essential for a firm to identify whether it is within the scope of MiFID or not in order to be able to understand the obligations it is bound to observe. The investment services covered by MiFID are: reception and transmission of orders in relation to one or more financial instruments; execution of orders on behalf of clients; dealing on own account; portfolio management; investment advice; underwriting of financial investments and/or placing of financial instruments on a firm commitment basis; and operation of multilateral trading facilities together with certain ancillary activities in relation to MiFID financial instruments. Merely arranging transactions (without receiving and transmitting orders or dealing as agent) would, for example, fall outside the scope of MiFID. The financial instruments covered by MiFID are: transferable securities (e.g. shares, debt instruments); money market instruments; units in collective investment undertakings; and a range of derivatives (including commodity derivatives), such as futures, options and contracts for differences. A number of corporate finance firms currently fall within the scope of the ISD and, in future, these will fall within the scope of MiFID. However, from 1st November 2007, other corporate finance firms may also have been drawn within the scope of MiFID. In particular, the addition of investment advice as an investment service under MiFID, rather than an ancillary activity (as is the case under the ISD) may bring additional firms within the scope of MiFID. However, some firms may be able to take advantage of the exemptions in Articles 2 and 3 of MiFID: Article 2 includes a variety of exemptions for particular types of firm, but the exemption for persons providing investment advice in the course of providing another professional activity which is not MiFID scope business may be particularly relevant. Article 3 exempts intermediaries who do not hold client money or assets, only receive and transmit orders for transferable securities and units in collective investment undertakings instruments to a limited range of other forms firms, and only provide advice on those orders. The UK has implemented this as an optional exemption which firms may apply for if they choose. Provisions applying to MiFIDscope and non MiFID-scope business The provisions of COBS now applying to MiFID scope and non-mifid scope business are summarised in the Appendix to this briefing. Note should be taken of the following changes affecting firms and, in particular, that while these apply to both MiFID scope and non-mifid scope business, they may apply differently depending on the type of business in question. Client categorisation (COBS 3) We start with client categorisation, as this defines the scope of the regulatory obligations which a firm has to comply with in providing services to its clients and the other COBS rules flow from that categorisation. Who is a client? One incidental but significant point regards who is a client in the context of corporate finance business. The definition of client under the old COB rules excluded corporate finance contacts, i.e. those contacts with whom a firm may potentially conduct investment business as a result of carrying out corporate finance business, but who are not to be considered a client. There is no longer such a specific exclusion. However the FSA has expressed the view that, because of the new services-based definition of a client, firms will typically not be providing MiFID scope services to such contacts in corporate finance transactions, but will be providing the services to its real client for whom it is, for example, raising funds. Consequently the FSA believes there is no need to 4

5 reproduce this exclusion in the new rules, although guidance to this effect is included at COBS G. However firms should continue to include similar wording to that which has been used in the past in relation to corporate finance contacts to make it clear that the firm does not envisage such persons will be treated as clients or will receive the protections afforded to clients or advice from the firm. It should however be note that if the firm is making or approving a financial promotion it will be necessary to consider the categorisation of the person in question to determine the application of the financial promotion rules (see further below). The new categories The FSA has decided the new categorisation rules will generally apply to both MiFID and non-mifid business in order to maintain consistency between them. The three new categories are similar, but not identical, to the old COB client categories. Existing Category Private customer Intermediate customer Market counterparty If a firm undertakes "mixed business" for a client, i.e. both MiFID scope and non-mifid scope business, the categorisation must follow that required for MiFID scope business. ECPs New category Retail client Professional client Eligible counterparty (ECP) The category of eligible counterparties automatically includes entities such as investment firms, credit institutions, insurance companies, UCITS funds and their management companies, pension funds and their management companies, other authorised and regulated financial institutions in the EU, national governmental bodies, central banks and supranational institutions. In addition, certain professional clients may request treatment as ECPs provided that the client has given an express confirmation that it is willing to be treated as such. While the ECP category contains many clients which are currently market counterparties, a significant change is that the ECP category is available only for a limited range of investment business (principally dealing on own account, execution of orders on behalf of clients or the reception and transmission or orders and ancillary services). So, for example, investment advice falls outside the ECP regime, except if it is an ancillary service directly related to a transaction, which does fall within the ECP regime. Consequently, some clients who have previously been classified as market counterparties may now have to be classified as professional clients for certain types of business. This may be particularly significant for corporate finance firms, because of the importance of investment advice to their activities. While they may have been drawn within the scope of MiFID by the addition of investment advice as an investment service, they are not be able to get the benefit of the light touch regime applied to ECP business. Professional clients The professional clients category will, broadly, cover: entities required to be authorised or regulated to operate in the financial markets; large undertakings (where they cannot be classified as ECPs); national, regional, international and supranational institutions and central banks; and other institutional investors whose main activity is to invest in financial instruments, including entities dedicated to the securitisation of assets or other financing transactions. Note in particular the following significant changes from the previous intermediate customer category: - For MiFID scope business there will be new quantitative thresholds for large undertakings. They must meet any two of the following criteria: a balance sheet of 20 million, a net turnover of 40 million; and/or own funds of 2 million. Also, these apply on an entity-by-entity basis, not on a group basis, as is currently the case. For non-mifid scope business the thresholds remain as they currently are, and may continue to be applied on a group basis. - Most professional clients may agree to be treated as an ECP, but the firm must obtain express confirmation from the client (either generally or for an individual transaction). Retail clients Any client who is not an ECP or a professional client is a retail client. However, some retail clients may request to be treated as professional clients. This option is broadly similar to the existing expert private customer provisions but the details of qualifying 5

6 criteria will change. MiFID introduces a new quantitative test for retail clients requesting professional client status (which will only apply to MiFID scope business). At least two of the following quantitative criteria must be met: the client has carried on transactions in significant size on the relevant market at an average frequency of 10 per quarter over the previous four quarters; the size of the client's financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds 500,000; and/or the client works or has worked in the financial sector for at least one year in a professional position which requires knowledge of the transactions or services envisaged. There must be appropriate written internal policies and procedures to categorise clients and to notify these clients of categorisation under the rules. In order to be able to operate appropriate policies and procedures, it will inevitably be necessary for firms to collect data on clients which may be relevant to the new client categories. The client s best interests rule (COBS 2.1) Turning to the substantive obligations on conduct of business, COBS contains a new high-level statement of the overall obligation of a firm to act honestly, fairly and professionally in accordance with the best interests of its client (known as the client s best interests rule ). This rule applies in relation to designated investment business carried on for a retail client and, where it is MiFID scope business, for any other client. While this is similar to the FSA s existing Principle for Businesses 6, the obligation has been reproduced here as that Principle does not precisely reflect the provisions of MiFID. Inducements (COBS 2.3) One particular area where there has been significant change is the rule on inducements. The new COBS rules generally apply to both MiFID and non-mifid business, although with slight but significant differences. They also only apply to business with retail clients and professional clients. Broadly inducements are only permitted where they are one of three types: a fee, commission or non-monetary benefit paid or provided to or by the client or on behalf of the client; a fee, commission or non-monetary benefit paid or provided to or by a third party or a person acting on behalf of a third party, if: - the payment of the fee or commission or the provision of the non-monetary benefit does not impair compliance with the client s best interests rule; - in relation to MiFID-scope business only (or other business involving a personal recommendation of a packaged product), the existence, nature and amount of the fee, commission or benefit or, where the amount cannot be ascertained, the method of calculating that amount, is clearly disclosed to the client in a manner that is comprehensive, accurate and understandable prior to the provision of the service; and - in relation to MiFID-scope business only, the payment of the fee or commission, or the provision of the non-monetary benefit is designed to enhance the quality of the service to the client; or proper fees which enable or are necessary for the provision of designated investment business or ancillary services (such as custody costs, settlement and exchange fees, regulatory levies or legal fees) and which by their nature cannot give rise to conflicts with the firm s duties to act honestly, fairly and professionally in accordance with the best interests of its clients. Factors to be taken into account The published Recommendations of the Committee of European Securities Regulators (CESR) on inducements include factors to be taken into account in assessing compliance with the above requirement, which are: the type of the investment or ancillary service provided by the investment firm to the client, and any specific duties it owes to the client, including those under a client agreement, if any; the expected benefit to the client(s) including the nature and extent of that benefit, and any expected benefit to the investment firm (it being possible to perform the analysis about the expected benefit at the level of the service to the relevant client group); whether there will be an incentive for the investment firm to act other than in the best interests of the client and whether the incentive is likely to change the investment firm s behaviour; 6

7 the relationship between the investment firm and the entity which is receiving or providing the benefit (although the mere fact that a group relationship exists is not by itself a relevant consideration); and the nature of the item, the circumstances in which it is paid or provided and whether any conditions attach to it. The enhancement of service requirement A number of concerns have been raised by the new rules. There is, for example, concern that the requirement that a payment be designed in particular to enhance the quality of the service to the client may be difficult to justify. However, the FSA, following the CESR Recommendations, thinks this expression makes it clearer that a judgement about a fee or payment or arrangements for fees or payments can be made at the time the arrangement is proposed, rather than only after the payment has been made. It also considers that such payments may also benefit other clients or groups of clients apart from the particular client that is receiving the investment service. So the requirement to enhance the quality of the relevant service to the client is met at the level of the service, provided that the other clients or groups of clients are receiving such a service. The assessment could therefore be performed at the level of a service provided under a particular business line. (It should not however be performed across different business lines. If this were to be the case it would, in the FSA s view, convert the test into a meaningless exercise.) One can see this new requirement being problematic, at least in the first instance when firms are trying to implement new procedures for conducting this assessment. The receipt of commission has been seen as particularly problematic. Accordingly, and in the context of recital 39 of the MiFID Implementing Directive, CESR considers that commission on advised sales is permissible (provided the advice has not been biased as a result). Commission on unadvised sales is not necessarily excluded as the conditions may still be met if, for example, the recipient is providing distribution of the product in question, even if investment advice is not given. The disclosure requirement Concerns have also been raised regarding the means and extent of disclosure of inducements required. The key point is that the client must have sufficient information to make an informed decision about the matters disclosed. A generic disclosure regarding the fact that payments of such a type may be made is not acceptable. For clarification, CESR s Recommendations confirm that the matters to be disclosed are all those inducements which can influence or induce the intermediary who has the direct relationship with the client. Conflicts of interest Consideration of inducements should of course be viewed in the wider context of managing conflicts of interest generally, and this in turn should link with the client s best interests rule. (Note that in relation to managing conflicts of interest generally, SYSC 10 will apply to a firm which is a common platform firm, which will include firms subject to MiFID.) Communications and financial promotions (COBS 4) The general approach to financial promotions and other communications is to reduce substantially the number of detailed rules and focus much more on principles and high level standards. The new rules generally apply to all MiFID-scope business but they will also be applied on a rule-by-rule basis to business outside the scope of MiFID. These new rules may be seen as a reversionary step. The principal rule to observe is now embodied in a clear statement that a firm must ensure that all information addressed by it to a client in relation to a relevant business is fair, clear and not misleading the so-called fair, clear and not misleading rule. This looks very similar to the wording in the old COB rules. There is however one concern: the removal of the reasonable steps wording in relation to the obligation for a firm to ensure that communications are fair, clear and not misleading. The reasonable steps wording appears in the current similar provision in COB 2.1, but MiFID makes the obligation an absolute requirement (hence the use of the word must in COBS). The FSA, probably rightly, indicates that the change in wording will make little difference to firms in practice because the FSA should take a risk based and proportionate approach and use discretion in dealing with firms, and any Financial Ombudsman Service determination must be on the basis of what is fair and reasonable. Furthermore there will be no right under section 150 of the Financial Services and Markets Act 2000 or a client to make a claim directly against the firm for breach of this particular requirement. Of possible interest to corporate finance firms is that the fair, clear and not misleading rule does not apply to: third party prospectuses; 7

8 financial promotions (but not other communications) to non-retail clients; and other communications which are excluded communications, e.g. those which would otherwise benefit from an exemption under the Financial Promotion Order. One further point for firms to be aware of is that financial promotions addressed to clients are to be clearly identifiable as such. This does not mean it must say, This is a financial promotion, but such a statement may be needed where there might otherwise be confusion as to the status of the communication and accordingly clients may be mislead as to the nature of the information contained in it. However this does not apply in relation to third party prospectuses and also, where non-mifid scope business is concerned, communications subject to the prospectus advertisement rules as well as excluded communications. In relation to financial promotions to corporate finance contacts, the extent of the exemption from the financial promotion rules in COBS 4 will need to be determined on a case by case basis depending on whether or not the business in question is MiFID scope business - the fact that it might be exempt under the Financial Promotion Order does not mean it is automatically exempt from these rules. In practice however that may be the case: merely arranging transactions, without receiving and transmitting orders or dealing as agent, is in many cases likely to be the business undertaken in dealing with corporate finance contacts and will normally be non-mifid scope business. For such business the exemptions available are wider, usually including an exemption for excluded communications (which include those which benefit from an exemption under the Financial Promotion Order). It is to be hoped that the new flexibility will result in less reliance on complying with the detailed specifics of the financial promotion rules in COBS - the tick box approach. This could provide the opportunity for a positive improvement. Hopefully more original thought will be given to particular issues. Personal account dealing (COBS 11.6) The old COB rules required a firm to take reasonable steps to ensure that personal transactions undertaken by employees of firms do not conflict with duties owed to customers. While MiFID contains similar provisions, not all the current requirements are reflected and where they are not reflected in MiFID they are being removed. Accordingly, the new rule is as follows: a firm that conducts designated investment business must establish, implement and maintain adequate arrangements aimed at preventing any relevant person engaging in certain activities, where that person is involved in activities that may give rise to a conflict of interest or has access to inside information or other confidential information relating to clients or transactions with or for clients. A relevant person is broadly a director, partner, manager, appointed representative of the firm or such an appointed representative and any other employee or other person whose services are placed at the disposal and under the control of the firm or an appointed representative of the firm. The activities are as follows: entering into a personal transaction which is either prohibited under the Market Abuse Directive, involves the misuse or improper disclosure of that confidential information, or conflicts, or is likely to conflict with, an obligation of the firm to a customer under the regulatory system; advising or procuring, other than in the proper course of his employment or contract for services, any other person to enter into a transaction in designated investments which, if a personal transaction of the relevant person, would be covered by the preceding requirement; or disclosing, other than in the normal course of his employment or contract for services, any information or opinion to any other person if the relevant person knows, or reasonably ought to know, that as a result of that disclosure that other person will or would be likely to enter into a transaction which would be a prohibited personal transaction or to advise or procure another person to enter into such a transaction. It will therefore be seen that the circumstances potentially covered are wider than under the old COB rules. Note for example that the individuals whose dealings are covered could potentially include those associated with any person providing outsourced services to the firm, rather than just the firm s own personnel. The arrangements required to be put in place by a firm under this rule must (as with current rules) be designed to ensure that: each person is aware of the restrictions on personal transactions and of the relevant 8

9 measures established by the firm in this connection; the firm is informed or made aware in some way of any personal transaction entered into; and a record is kept of the personal transaction and any authorisation given or prohibition imposed on it. Investment research (COBS 12) The rules on investment research are in many respects unchanged. However, the key change is that MiFID distinguishes between investment research (which must be, or must be held out as being, independent) and non-independent research. This is a distinction the current rules do not make. Under the revised rules, there are only limited changes to the regime for investment research. The main elements of it (the bar on dealing ahead of publication, the requirement for a conflicts policy to manage the conflicts of interest and the disclosure requirements) all continue in place without material change. For non-independent research the rules are that it must be clearly identified as a marketing communication (and as such will be subject to the COBS rules on financial promotions, in particular that it must be fair, clear and misleading ) and it must also contain a clear and prominent statement that it has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Provisions applying to MiFIDscope business only The rules relating to MiFID scope business are much more extensive, although in a number of cases the FSA considers them unlikely to be applicable as a matter of fact. Nevertheless the FSA is obliged to impose them by the terms of MiFID. So the following will apply but only to MiFID scope business: Information about the firm (COBS 2.2 and 6.1) MiFID requires a certain minimum level of disclosure about a firm when providing services, and the FSA has adopted this as a universal standard. So a firm must provide appropriate information in a comprehensible form to a professional client or retail client about: the firm and its services; the designated investments and proposed investment strategies (including appropriate guidance on and warnings of the risks associated with investments in the designated investment investments in question or in respect of the particular investment strategies in question); the execution venues to be used; and any costs and associated charges in connection with the firm and its services. The purpose is that the client should be reasonably able to understand the nature and risks of the service being provided, the specific type of designated investment that is being offered and, consequently, to take investment decisions on an informed basis. This information may be provided in a standardised format. This is going to be of some relevance to corporate finance firms, even if not relevant in every respect. There are also additional rules set out in COBS 6.1 to provide any retail client with certain more specific information, although for many corporate finance business this may not be relevant. In relation to a firm carrying on MiFID-scope business, information must also be made available to a client who has used or intends to use those services to allow the client to identify the Financial Services Compensation Scheme, including the amount and scope of the cover offered. Client agreements (COBS 8) On client agreements, there was previously no requirement in the FSA s rules in relation to client agreements for corporate finance business. COB 4.2 did not apply, on the basis that clients of firms would be sufficiently sophisticated to be able to protect themselves. Under the new rules, the position has changed. The rules in relation client agreements apply, but a principles-based approach should mean that the impact on firms is limited. Indeed, where the client is a professional client which will often be the case for corporate finance firms the requirement is simply to provide terms and conditions in advance. For eligible counterparties there is no obligation at all. However this is not likely to result in an absence of agreements or unsigned, short-form ones. General legal principles make retention of client agreements desirable, while many firms will consider them the 9

10 most appropriate medium for satisfying the information disclosure requirements. In reality contracts will probably remain very much on the same terms as they do currently in many cases, and signatures will often still be required in order to evidence contracts. Our Briefing Paper NEWCOB and Financial Promotion (July 2007) discussed the changes for client agreements in more detail. Suitability of investment advice (COBS 9) The FSA already regulates the provision of investment advice and corporate finance firms were subject to those rules when undertaking regulated activities. Corporate finance firms which provide investment advice will already have been familiar with the UK s existing requirements to know your customer. However, investment advice is now within the scope of MiFID. While the FSA has understandably decided to retain much of the established arrangements, some adjustments have been made to fit in with MiFID. On advised business, the old COB rules already required a firm to take reasonable steps to ensure it had sufficient personal and financial information about a customer before it gave a personal recommendation to a private customer or acted as investment manager for a private customer. Any advice or discretionary transaction must then be suitable in the light of this information. There were however no specific rules requiring a firm to assess the suitability of investment advice or portfolio management provided to intermediate customers or market counterparties, although these factors are to some extent covered by the FSA s Principles for Businesses 6 (customers interests) and 9 (customers: relationship of trust). The new MiFID standard will form the nucleus of the rules for suitability when providing advice and discretionary portfolio management. In reality there are only few practical differences between the previous and new regimes. However, note the following key changes: The new rules will be more specific as regards the relevant information to be obtained. The new requirement is that a firm must obtain the necessary information regarding the client s knowledge and experience in the investment field relevant to the specific type of designated investment or service, financial situation and investment objectives so as ensure that the advice given: - meets the client s investment objectives; - is such that the client is able financially to bear any related investment risks consistent with his investment objectives; and - is such that he has the necessary experience and knowledge in order to understand the risk involved in the transaction or in the management of his portfolio. Under the new rules, the requirement to assess suitability extends to both retail clients and professional clients, meaning corporate finance firms may need to assess suitability on a wider range of occasions. Although the rules have been extended to cover professional clients, there are certain relieving provisions which cut the obligation in relation to professional clients back and reduce the burden of these requirements. So a firm is entitled to assume, or will already have assessed in classifying them as a professional client, that a professional client has the necessary level of experience and knowledge for the purposes of the requirement to obtain information about the client s experience and knowledge. Furthermore a firm may, when giving investment advice to a per se professional client (that is, a professional client who is automatically classified as such, rather than being opted up ), assume that the client is able financially to bear any related investment risks consistent with its investment objectives. Appropriateness (COBS 10) Where a firm does not provide investment advice (or portfolio management services) there is a new requirement that, where carrying on MiFID scope business, the firm must assess the appropriateness of a particular investment or transaction for a client, that is whether the client s knowledge and experience is such that the client understands the risks involved. Where investment advice is the main service offered by a corporate finance firm, this may only be relevant on rare occasions when an alternative service is being offered. While this applies to retail and professional clients (but not eligible counterparties), it is possible to assume that professional clients properly classified as such have the relevant knowledge and experience, so in effect this requirement only applies to retail clients. For such clients the firm must request information from the client which enables the firm to make such assessment and if it does not receive it, or judges the 10

11 investment or transaction as not appropriate, it must warn the client and then decide whether or not it is in the best interests of the client to proceed or not. There is an exemption from this requirement which allows pure execution-only (i.e. without having to assess appropriateness) where: the transaction relates to non-complex products; the services are provided at the initiative of the client; the client has been warned that no assessment of suitability or appropriateness has been made; and the firm complies with its obligations regarding conflicts of interest. This may however be of limited benefit to corporate finance firms as, for example, unlisted shares do not amount to non-complex products for these purposes. Best execution (COBS 11.2) The dealing rules are now generally applied to corporate finance firms (apart from the rules on the use of dealing commission). In practice this may be rarely applicable for many firms as dealing is not normally core to corporate finance business. Nevertheless the FSA envisages that in some cases they may come into play, e.g. where a firm is instructed by its client to build a stake or dispose of a shareholding in a company. In those cases the firm will have to consider the dealing rules. The application of the rules on best execution is likely to be of particular interest. Firstly, it should be noted that the obligation applies for both retail and professional clients and it is not possible for professional clients to waive the requirement for best execution (as intermediate customers could do in the past). However, best execution will not have to be provided to ECPs (when ECP business is being undertaken). Best execution also need not be delivered where a firm accepts a specific instruction from a customer. In that case it must execute in accordance with that instruction and does not need to apply best execution in respect of those matters which the instruction specifies. However, best execution must still be applied in relation to those parts of an order which are not the subject of the specific instructions. The overarching standard is now that a firm, must take all reasonable steps to obtain, when executing orders, the best possible result for its clients, taking into account the execution factors. As the FSA points out, this does not require firms actually to achieve the best possible result only to take all reasonable steps to do so. This invites firms to make a judgement, balancing the resources which would be required to actually achieve best execution in every case against the interests of the client. It is an objective test as to what can be expected of the firm in question. The size and resources of the firm may affect this. The execution factors are: price; cost (both direct and indirect); speed; likelihood of execution and settlement; size; the nature of the transaction; and any other factor relevant to the execution of an order. The MiFID requirements thus remain reasonably high level ones, leaving the industry with the task of working out how to apply these high-level principles in practice. To support their obligations firms must establish and implement effective arrangements for complying with this standard. As noted above, it is the key to the MiFID approach that the correct systems and processes are in place with the aim of achieving the goal of best execution, which should then flow from having those systems and processes in place. Once formulated, a firm must disclose appropriate information to clients about its execution policy. The FSA has suggested that what is appropriate ought to be gauged against what information would be required to enable a client to make meaningful choices about the nature and quality of the execution arrangements. If the best execution policy provides for the possibility that orders may be executed outside a regulated market or multilateral trading facility, the firm must inform its clients about this possibility. Having prepared and implemented its execution policy and processes, a firm must then get the prior consent of its clients to that execution policy and, where executing outside a regulated market or a multilateral trading facility, that consent must be express (rather than implied), but may be obtained in the form of a general agreement or in respect of individual transactions. The operation of the execution policy is an ongoing process: a firm must monitor the effectiveness of their execution arrangements under the policy in order to be able to identify and correct any deficiency. In particular it must assess on a regular basis whether the execution venues included in the execution policy provide for the meeting of the best execution standard. If material changes are required, clients must be notified of those changes. This is without prejudice to a duty to review the execution policy at least annually, and also whenever a material change occurs that affects the firm s ability to continue to obtain the best possible result for the execution of its client orders. 11

12 Information on designated investments (COBS 14.3) Previous specific requirements existed relating to risk warnings for particular products, such as warrants and derivatives, retail securitised derivatives, non readily realisable investments, penny shares, securities that may be subject to stabilisation, stock lending activities, listed securities where gearing is involved and structured capital at risk products (SCARPs). These have now been removed. The MiFID based requirements now introduce a general rule in this area. Any firm doing MiFID-scope business will need to provide the client with a general description of the nature and risks of designated investments, taking into account the client s categorisation as a retail client or a professional client. That description must: explain the nature of the specific type of designated investment, as well as the risks particular to that specific type of designated investment, in sufficient detail to enable the client to take investment decisions on an informed basis; and where relevant, refer to the following: - the risks associated with that type of designated investment (including an explanation of leverage and its effects and the risk of losing the entire investment); - the volatility of the price of designated investments and any limitations on the available market for such investments; - the fact that an investor might assume as a result of transactions in such designated investments financial commitments and other additional obligations (including contingent liabilities) additional to the cost of acquiring the designated investments; and - any margin requirements or similar obligations, applicable to designated investments of that type. The firm must also provide a retail client with the information that a prospectus is available where the designated investment in question is the subject of a current offer to the public and a prospectus has been published in connection with the Prospectus Directive. That may be particularly relevant to corporate finance firms. It will be noted that this approach is a high level approach in line with principles-based regulation and removes the detailed product specific risk warnings which the industry has been accustomed to using to date. Note also that these rules apply in respect of both retail and professional clients, whereas the current approach only applies to private consumers. However this only relates to business within the scope of MiFID. For business outside the scope of MiFID these requirements will relate to retail clients only and then only in respect of certain types of activity, such as that involving derivatives. The clear implication of all this is that firms will have to assume a greater responsibility for identifying and explaining to clients the relevant risks in relation to products they offer. Reporting to clients (COBS 16) The old COB rules for corporate finance firms were limited to customer order and execution records. COBS, following MiFID, imposes higher-level requirements over and above transaction and periodic reporting requirements: a firm must ensure that, in relation to MiFID scope business, a client receives adequate reports on the services provided to it by the firm, including information on the costs associated with the transactions and services undertaken by the firm on behalf of the client. The detailed requirements for occasional and periodic reporting requirements are similar to current requirements. The detailed requirements as to the information to include in these reports are set out in the annex to the rules, although with some adjustments to the time limits for reporting when compared to current rules. Conclusion The effect of these proposals is essentially largely to remove the concessionary regime which previously existed for firms who undertake corporate finance business within the scope of MiFID - something which the FSA is obliged to do under MiFID. It perhaps does not generally agree with that approach as, where it has discretion, it has decided to continue with a concessionary regime similar the existing one for firms outside the scope of MiFID. Further information on all these areas can be found in our Guide to the New Conduct of Business Sourcebook and new Systems and Controls rules, available on our website at 12

13 Appendix Provisions applying to MiFID business and non-mifid business = Applicable [ ] = applicable in theory, but unlikely to be relvant in practice = Not applicable COBS Provision 1. (Application) MiFID Business Non- MiFID Business 2.1 (Duty to act in a client s best interests) 2.2 (Information disclosure before providing services) 2.3 (Inducements) 2.4 (Agent as client and reliance on others) 3 (Client categorisation) 4 (Communication to clients including financial promotions) subject to 4.5 (Communicating with retail clients) 4.6 (Past, simulated past and future performance) 4.7 (Direct offer financial promotions) 4.8 (Cold calls) 4.9 (Financial promotions with overseas elements) 4.10 (Systems and controls) 4.11 (Record keeping) 5.1 (Distance marketing), but only in relation to distance contracts concluded with consumers [ ] [ ] 5.2 (E-commerce) [ ] [ ] 6 Disclosure of information about the firm and compensation information) subject to (Information about breadth of advice) 6.3 (Information about fees packaged products) 6.4 (Information about fees generally) 7 (Insurance mediation) [ ] 8 (Client agreements) 13

14 COBS Provision MiFID Business Non- MiFID Business 9 (Suitability) subject to (Suitability report) 9.6 (Basic advice regime) 10 (Appropriateness) 11 (Dealing) subject to (Use of dealing commission) 11.7 (Personal account dealing) 12 (Investment research) 13 (Preparing product information) [ ] 14.2 (Providing product information) [ ] 14.3 (Information on designated investments) 15 (Cancellation), but only in relation to distance contracts concluded with Consumers [ ] [ ] 16 (Reporting information to clients) subject to (Contingent liability transaction reporting) 16.5 (Quotations for surrender values) 16.6 (Communications on life insurance contracts) 17 (Claims handling for long term care insurance) [ ] 18 (Specialist regimes) (excluding COBS 18.3) [ ] 19 (Pensions supplementary) [ ] 20 (With profits) [ ] 21 (Permitted links) [ ] 14

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16 Contacts Kirstene Baillie Partner e: Suzanne Adair Assistant e: Graham Busby Assistant e: Andrew Massey Assistant e: Field Fisher Waterhouse LLP 35 Vine Street London EC3N 2AA t. +44 (0) f. +44 (0) This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed. Copyright Field Fisher Waterhouse LLP All rights reserved. Field Fisher Waterhouse LLP is a limited liability partnership registered in England and Wales with registered number OC318472, which is regulated by the Solicitors Regulation Authority. A list of members and their professional qualifications is available for inspection at its registered office, 35 Vine Street London EC3N 2AA. We use the word partner to refer to a member of Field Fisher Waterhouse LLP, or an employee or consultant with equivalent standing and qualifications. 16