Technical summary - MiFID II (Directive)

MiFID II introduces the concept of "independent advice". Any investment firm that declares itself to be an independent adviser must comply with two requirements:

• It must assess a sufficiently large and diverse range of financial instruments and not limits the assessment to instruments that it -or its related entities- issues.
• It must not accept or retain inducements from third parties.

ESMA clarifies the selection process that independent advisers have to set-up to assess and compare an 'adequately representative' range of sufficiently diverse financial instruments. The process must include elements such as a diversified selection of products by type, issuer, or product provider or criteria of comparison such as costs, complexity and the characteristics of the clients.

ESMA also specifies (1) the conditions under which a firm providing independent advice is allowed to focus on certain categories or a specified range of financial instruments and (2) those under which a firm can provide both independent and non-independent advice. In that case, the firm must not hold itself out as "independent" for its business as a whole and ensure a clear separation between both type of advice services and advisers (physical persons).

MiFID II strengthens the requirements regarding the "appropriate information" that an investment firm must provide in good time to the client.

Information on the service provided

• In case of investment advice, clear explanation of the nature of the advice services: obligation to inform the client as to whether the advice is provided on an independent basis or not and whether it is based on a broad or more restricted analysis of the financial instruments available on the market.

Information on the financial instruments

• Clear warnings and guidance of the risks associated the financial instruments and of whether the financial instrument is intended for retail or professional clients.

Information on costs and charges

• Additional disclosure requirements about a firm’s cost and charges:
  • Information to provide on both investment and ancillary services and including the cost of advice, the cost of the financial instrument and how the client may pay for it;
  • Information on the aggregated costs to allow the client to understand the overall costs and the cumulative effect on return of the investments;
  • An itemised breakdown of the costs if the client requests one.

ESMA advises the following:

• Extension of the disclosure requirements to professional clients and eligible counterparties (possibility for firms to agree on a limited application of such requirements for these clients, except when the financial instruments embed a derivative or when services of investment advice or portfolio management are provided to professional clients);
• Further specifications regarding the firms subject to the disclosure obligation and the costs and charges to aggregate and disclose;
• As regards UCITS, recommendation to the European Commission to consider UCITS KIID to be sufficient, with the possibility of requiring the disclosure of costs and charges that are not included in the UCITS KIID. Transaction costs should be calculated and disclosed by the firm if not provided by the UCITS management company.

MiFID II restricts the possibility to receive or retain inducements from third parties.

Minor non-monetary benefits

ESMA proposes to define minor benefits as benefits that are:

• Reasonable and proportionate and
• Unlikely to influence the recipient’s behaviour.

ESMA also advises to introduce an exhaustive list of minor non-monetary benefits.

Financial research

ESMA specifies the treatment of financial research. The provision of research is not to be considered as an inducement if it is received in return for direct payments by the firm out of its own resources or payments from a separate research payment account controlled by the firm under certain conditions.

Quality enhancement

ESMA advises to introduce a non-exhaustive list of situations where this quality enhancement test is not passed. The list that ESMA had initially drawn up had raised great concern, some viewing it as introducing a de facto ban of inducements.

ESMA has amended the list and has removed the situation where the inducement is "used to pay or provide goods or services that are essential for the recipient firm in its ordinary course of business".

An inducement is now considered as not enhancing the quality of the service if:

• It is not justified by the provision of an additional or higher level service to the client, proportional to the level of inducements received (e.g. the provision of non-independent advice combined with a periodic assessment of suitability of the products the client has invested in); or
• Directly benefits the recipient […] without tangible benefits to the client; or
• In relation to an on-going inducement, it is not justified by the provision of on-going benefit to the relevant client.

The final report gives examples of higher quality service situations that aim at encouraging the provision of high quality non-independent advice, the assessment of a wide range of financial instruments (in favour of open architecture) or the provision of post-sale services by firms to clients.

Suitability

• Explicit requirement to take into account the client's risk tolerance when assessing the investment objectives and the ability to bear losses when assessing the financial situation.
• Statement of suitability to provide to retail clients in case of investment advice before the transaction or immediately after the client is bound, specifying how the advice meets the preferences, objectives and other characteristics of the client.
• Periodic assessment of suitability (ESMA advises to impose to carry it out "at least annually"), mandatory in case of portfolio management and possible in case of investment advice if the firm informs the client at the outset.

Appropriateness

Extension of the scope for the appropriateness test i.e. expanded list of complex financial instruments. The list now also includes, amongst others, structured UCITS, shares in non-UCITS, shares that embed a derivative and structured deposits "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 term".

MiFID II introduces specific requirements when an investment firm offers a package of products or services:

• Information to clients on: whether it is possible to buy the components separately, evidence of the costs and charges for each component and explanation on how their interaction changes the risks; and
• Suitability/appropriateness test at the level of the package.

MiFID II imposes additional information requirements for both investment firms and trading venues regarding best execution.

Investment firms

• Obligation to publish annually, for each class of financial instruments, the top five execution venues in terms of client orders in the preceding year and information on the quality of execution.
• Prohibition to receive any remuneration, discount or non-monetary benefits from routing orders to particular venue.

Trading venues

• Obligation to make available to the public at least annually, and without any charges, data relating to the quality of execution of transaction on the venue.
• Obligation to inform the client where the order was executed and to make periodic reports including details about price, costs, speed and likelihood of execution for individual financial instrument.

MiFID II extends to the relationship with eligible counterparties the following requirements:

• Obligation to act honestly, fairly and professionally and communicate in a fair, clear and not misleading way.
• Obligation to provide appropriate information with regard to the investment firm and its service, the financial instruments, the execution venues and all costs and charges.
• Periodic reporting requirements.