Countdown to compliance
11 July 2017
The FCA has revealed the UK market鈥檚 final rulebook for MiFID II and now participants must mobilise quickly to achieve compliance. Drew Nicol reports
Image: Shutterstock
The UK鈥檚 Financial Conduct Authority (FCA) pulled back the curtain on its collateral and reporting requirements for the second Markets in Financial Instruments Directive (MiFID II), and now the race is on to hit the 3 January 2018 deadline.
For securities lending activities, MiFID II places responsibility on the lender for ensuring that a borrower of safe custody assets provides appropriate collateral and accounts for value variables during the borrow period.
The FCA confirmed that this requirement applies in trilateral agreements if the lender is still arranging for the transaction to take place. However, although lenders must take responsibility for collateral, they are not required to hold the collateral directly, thereby allowing for central clearing to operate in the market.
In its final policy statement, the FCA said: 鈥淭hese rules apply to securities lending in respect of safe custody assets.鈥�
鈥淩esponses to our pre-consultation costs survey and the European Securities and Markets Authority (ESMA) MiFID II consultation indicated that the clear majority of firms already take collateral in these circumstances. We therefore do not believe these changes have a large impact.鈥�
There鈥檚 a hole in the bucket, dear borrower
Concerns about strains on liquidity have plagued MiFID II and similar initiatives that bring fresh collateral demands since their inception.
Speaking at The Network Forum in Warsaw, Anna Biala, a partner at Clifford Chance, highlighted some of the challenges of MiFID II that could affect custodians, including pointing out that the directive prohibits title transfer collateral arrangements with retail clients.
She said it is currently unclear as to whether this includes securities lending and repo transactions, adding: 鈥淚t seems that that was not the intention of the legislators.鈥�
Biala warned: 鈥渢he new rules might have an impact on securities lending and repo transactions鈥�, and a wider effect on the market.
鈥淸MiFID II] might impact market liquidity,鈥� she warned.
Segregation rules under the directive are quite restrictive, and 鈥渢he risk is that this will disrupt the flow of collateral in the financial systems, which is quite problematic, bearing in mind that various regulations now require additional collateral鈥�, she concluded.
Above and beyond
The FCA鈥檚 policy statement sets out the ways in which the UK鈥檚 policy will go beyond the requirements of EU legislation, but noted that the authority has an obligation to consider the government鈥檚 economic policies when implementing it.
鈥淲e have considered the benefits to consumers and to the integrity of the UK market of our proposals, set against the costs for firms and therefore overall the extent to which the UK remains attractive as a location for internationally active financial institutions.鈥�
Particularly, the statement responded to consultation paper CP16/29, released in September 2016, which received 211 responses and caused the FCA to revise some of its proposals.
Inducement rules in relation to research will still be applied to collective portfolio managers, not only to investment firms that are subject to MiFID II.
However, the FCA amended its original proposal around how quickly charge deductions should be passed into an research payment account (RPA), and clarified that it does not intend to require investment managers to have a single RPA per research budget.
The real winners of the final version of the FCA鈥檚 MiFID II rulebook were the local Government pension schemes (LGPS), which at the previous reading were at risk of being hit hard by the requirements.
The FCA appears to have acknowledged industry concerns and has lowered the threshold for the size of portfolio that a local authority must have in order to 鈥渙pt up鈥� to professional client status.
In essence, this makes it easier for local authorities investing on behalf of a LGPS pension fund to upgrade to professional client status if they wish to and benefit from the provisions that brings.
Speaking on the amendment, Joe Dabrowski, head of governance and investment at the Pensions and Lifetime Savings Association, said: 鈥淲e welcome the publication of the final MiFID II rules and guidance from the FCA as it shows that they have listened to the industry鈥檚 concerns.鈥�
鈥淭he LGPS has over 拢217 billion invested and one of our key concerns about the original consultation was that the decision to classify local authority pension funds as retail investors would have put real constraints on how they delivered value to their 5.3 million members and how they might continue to invest in infrastructure projects.鈥�
鈥淗owever, the FCA has listened to the industry鈥檚 concerns and taken steps to allow them to 鈥榦pt up鈥� more easily. In particular, the revised approach recognises the difference between authorities and pension funds and the skills, experience, and level of regulation that guides the LGPS. Following this announcement, it is now time to concentrate on making MiFID II work in practice to ensure that LGPS schemes are in a position to meet the January 2018 deadline.鈥�
Alas poor UCITS
For alternative investment fund managers, best-execution rules under MiFID II will not be extended to them, as was originally proposed. However, the FCA maintained that collective investment undertakings that are not UCITS will not be automatically considered either complex or non-complex. This includes non-UCITS retail schemes and investment trusts.
The FCA clarified that 鈥渕ost of what is in the MiFID II conduct provisions is familiar in the context of the existing UK regulatory framework.
But, as well as the specific adjustments firms will need to make, their implementation presents an opportunity for firms to consider their existing approach to compliance and their efforts to put the interests of clients at the heart of what they do.鈥�
鈥淚n this regard, having an effective governance structure and the right culture are crucial to implementing MiFID II successfully.鈥�
The FCA acknowledged that implementation of the directive before the 3 January 2018 deadline represents a challenge for firms, 鈥減articularly given that important issues concerning the interpretation of the legislation are still being resolved鈥�.
But it added: 鈥淲e expect firms to take reasonable steps to meet this deadline. Firms who still need to apply for authorisation or variation of permission should prioritise as a matter of urgency their submission of complete applications.鈥�
鈥淪uch firms must have contingency plans in the event that by 3 January 2018 they do not have the required permissions.鈥�
For securities lending activities, MiFID II places responsibility on the lender for ensuring that a borrower of safe custody assets provides appropriate collateral and accounts for value variables during the borrow period.
The FCA confirmed that this requirement applies in trilateral agreements if the lender is still arranging for the transaction to take place. However, although lenders must take responsibility for collateral, they are not required to hold the collateral directly, thereby allowing for central clearing to operate in the market.
In its final policy statement, the FCA said: 鈥淭hese rules apply to securities lending in respect of safe custody assets.鈥�
鈥淩esponses to our pre-consultation costs survey and the European Securities and Markets Authority (ESMA) MiFID II consultation indicated that the clear majority of firms already take collateral in these circumstances. We therefore do not believe these changes have a large impact.鈥�
There鈥檚 a hole in the bucket, dear borrower
Concerns about strains on liquidity have plagued MiFID II and similar initiatives that bring fresh collateral demands since their inception.
Speaking at The Network Forum in Warsaw, Anna Biala, a partner at Clifford Chance, highlighted some of the challenges of MiFID II that could affect custodians, including pointing out that the directive prohibits title transfer collateral arrangements with retail clients.
She said it is currently unclear as to whether this includes securities lending and repo transactions, adding: 鈥淚t seems that that was not the intention of the legislators.鈥�
Biala warned: 鈥渢he new rules might have an impact on securities lending and repo transactions鈥�, and a wider effect on the market.
鈥淸MiFID II] might impact market liquidity,鈥� she warned.
Segregation rules under the directive are quite restrictive, and 鈥渢he risk is that this will disrupt the flow of collateral in the financial systems, which is quite problematic, bearing in mind that various regulations now require additional collateral鈥�, she concluded.
Above and beyond
The FCA鈥檚 policy statement sets out the ways in which the UK鈥檚 policy will go beyond the requirements of EU legislation, but noted that the authority has an obligation to consider the government鈥檚 economic policies when implementing it.
鈥淲e have considered the benefits to consumers and to the integrity of the UK market of our proposals, set against the costs for firms and therefore overall the extent to which the UK remains attractive as a location for internationally active financial institutions.鈥�
Particularly, the statement responded to consultation paper CP16/29, released in September 2016, which received 211 responses and caused the FCA to revise some of its proposals.
Inducement rules in relation to research will still be applied to collective portfolio managers, not only to investment firms that are subject to MiFID II.
However, the FCA amended its original proposal around how quickly charge deductions should be passed into an research payment account (RPA), and clarified that it does not intend to require investment managers to have a single RPA per research budget.
The real winners of the final version of the FCA鈥檚 MiFID II rulebook were the local Government pension schemes (LGPS), which at the previous reading were at risk of being hit hard by the requirements.
The FCA appears to have acknowledged industry concerns and has lowered the threshold for the size of portfolio that a local authority must have in order to 鈥渙pt up鈥� to professional client status.
In essence, this makes it easier for local authorities investing on behalf of a LGPS pension fund to upgrade to professional client status if they wish to and benefit from the provisions that brings.
Speaking on the amendment, Joe Dabrowski, head of governance and investment at the Pensions and Lifetime Savings Association, said: 鈥淲e welcome the publication of the final MiFID II rules and guidance from the FCA as it shows that they have listened to the industry鈥檚 concerns.鈥�
鈥淭he LGPS has over 拢217 billion invested and one of our key concerns about the original consultation was that the decision to classify local authority pension funds as retail investors would have put real constraints on how they delivered value to their 5.3 million members and how they might continue to invest in infrastructure projects.鈥�
鈥淗owever, the FCA has listened to the industry鈥檚 concerns and taken steps to allow them to 鈥榦pt up鈥� more easily. In particular, the revised approach recognises the difference between authorities and pension funds and the skills, experience, and level of regulation that guides the LGPS. Following this announcement, it is now time to concentrate on making MiFID II work in practice to ensure that LGPS schemes are in a position to meet the January 2018 deadline.鈥�
Alas poor UCITS
For alternative investment fund managers, best-execution rules under MiFID II will not be extended to them, as was originally proposed. However, the FCA maintained that collective investment undertakings that are not UCITS will not be automatically considered either complex or non-complex. This includes non-UCITS retail schemes and investment trusts.
The FCA clarified that 鈥渕ost of what is in the MiFID II conduct provisions is familiar in the context of the existing UK regulatory framework.
But, as well as the specific adjustments firms will need to make, their implementation presents an opportunity for firms to consider their existing approach to compliance and their efforts to put the interests of clients at the heart of what they do.鈥�
鈥淚n this regard, having an effective governance structure and the right culture are crucial to implementing MiFID II successfully.鈥�
The FCA acknowledged that implementation of the directive before the 3 January 2018 deadline represents a challenge for firms, 鈥減articularly given that important issues concerning the interpretation of the legislation are still being resolved鈥�.
But it added: 鈥淲e expect firms to take reasonable steps to meet this deadline. Firms who still need to apply for authorisation or variation of permission should prioritise as a matter of urgency their submission of complete applications.鈥�
鈥淪uch firms must have contingency plans in the event that by 3 January 2018 they do not have the required permissions.鈥�
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