A European regime to harmonize practices & consumer protections
MiFID II regime first introduced into the UK back in January 2018 (applying Directive 2014/65/EU) brought about some key changes and obligations impacting CFD-related business and operations, from underlying client categorizations to transaction execution and trading venues, etc. This has equally extended to documentation and policy standards surrounding product/client disclosure and other conduct-of-business (COB) matters and now extends even to the formal recording of communications involving investment services such as the reception/transmission of orders and trade execution.
For UK-based Forex (FX) and Contracts for Difference (CFD) trading firms, the prospect and ability to acquire and/or service EU clients beyond the UK’s exit from membership of the European Union (Brexit), without the need for doing so through the legal and regulatory establishment of a local branch, is likely to be an important factor and consideration in any future business-modeling and strategic or financial target-setting.
But any options and approach may also depend on the future ability and commitment of the UK Government towards continued regulatory alignment with the EU concerning financial services in the face of any pressures or pursuit of actual potential divergence in the longer term.
An ongoing process of structural reform
MiFID II has affected both ‘retail’ and ‘wholesale’ investment markets, bringing about new obligations for a range of investment service firms, and directly impacting those business dealers and sectors engaged with and ancillary to commodity-based derivative trading and markets. Even now in late 2019, reviews and further reforms of MiFID II implementation issues continue to evolve and be updated with recent findings and future proposals concerning the unbundling of research costs and fees involving asset and investment management activity being published very recently in September 2019 (see UK FCA multi-firm review publication ‘ Implementing MiFID II’ dated 19/9/19).
The extent to which any provisions relating to ‘reverse solicitation’ being used to continue to drive future growth and profitability within the business modeling of UK-based CFD/FX firms, now becomes very pertinent in respect to the UK leaving the EU and potentially becoming a ‘third-country jurisdiction’ itself in regard to the underlying and overarching European MiFID regime.
Clients using their exclusive initiative
Article 42 of MiFID II concerns the provision of services at the exclusive initiative of the client. The European Securities and markets regulator (ESMA) has published its own ‘Q&A’ guidance material to assist firms in properly understanding and correctly interpreting and applying this provision. This suggests that where an EU-based ‘retail’ and/or ‘professional’ client initiates the provision of an investment service or activity ‘at its own exclusive initiative’ from a third-country firm, then the normal requirement for local authorization of that service/activity (or any relationship relating to it) shall not apply as otherwise required under Article 39.
However, any initiative made by any such client(s) does not mean that any such third-country firm is then able to simply market or elicit in the same way new investment products or services to those same clients. Indeed, without the criteria and conditions of the Article 42 provision being met, any third-country firm seeking or intending to provide or perform investment services or activity may well be required by any EU member state to first establish and then only do such business through a branch in its own territory and with its prior authorization by the relevant competent authority (regulator) of that member state (under Article 39).
A balance of costs & benefits
To confidently avail itself of the provisions of Article 42, any third-country firm will need to ensure that it can confidently demonstrate and evidence how any contact and communications in respect to at least initiating the provision of any investment services or activity comes exclusively from the client(s) without any undue influence, direction or collaboration of the firm. This is likely to involve some element of client-disclosed attestation or affirmation, but the actual firm will also need to ensure its related processes and controls provide ongoing assurance, and that it retains adequate records of fact and circumstance for audit reference and challenge purposes. But this could also extend to ensuring that any online presence does not unduly encourage, solicit or promote this type of access or approach to any potential client(s) which might otherwise nullify any objective assessment that the client(s) had acted on their absolutely own and exclusive initiative!
The requirement to establish and maintain any local branch entity and operations will inevitably impact any firm in respect to the level of engagement and cooperation between its respective regulatory agencies in terms of ongoing monitoring, scrutiny and exposures for the whole organization, as well as specific financial (capitalization) and resourcing elements and expectations concerning the branch itself.
Financial services alignment & BREXIT outcomes
Perhaps more importantly, the actual way in which BREXIT is ultimately effected and achieved, and if the UK can be treated with due equivalence as a third-country, or through its own voluntary non-divergence in its own future internal regulatory systems, will determine how UK-based financial services can continue to be successfully operated within and across the future European single-market. It cannot be overlooked that the BREXIT negotiations are yet to determine any guaranteed outcomes for future financial-services provision!
Any FX and CFD firm will need to look closely (and even take on appropriate legal/technical opinion and advice) at the extent to which its business activities and operating circumstances might enable it to utilize the existing provisions of Article 42 within MiFID II. If the answer is ‘yes’ then it could provide a basis to help confidently drive and/or sustain its business and growth objectives into the future and beyond BREXIT.
We invite you to CONTACT US to find out how we can help your organization on this important and topical subject.