MiFID II: Early questions for foreign AIFMs
By Andrew Henderson, Partner, Eversheds LLP
Published: 30 June 2014
The European Commission, Parliament and Council have now reached agreement on the texts for the Recast Markets in Financial Instruments Directive (MiFID 2) and the Markets in Financial Instruments Regulation (MiFIR). MiFID 2 and MiFIR, which comprise the MiFID II pieces of primary legislation, are expected to come into force by the end of 2016.
MiFID II represents the response to the Commission’s review of the Markets in Financial Instruments Directive (MiFID). MiFID governs those firms that provide investment services and products in the EU. It also sets out the framework for regulating securities and investment markets and market infrastructure in the EU. MiFID II expands MiFID’s scope particularly with respect to commodity derivatives, adds further investor protections and increases the requirements related to the trading of financial instruments.
In addition to these revisions to MiFID, MiFID II has introduced a special regime for Non-EU investment firms, including non-EU asset managers (Foreign Managers), who wish to provide cross-border services to clients established in any EEA member state (Member State). The impact of the Third Country regime for Foreign Managers will not be immediate for not only is there some time to go before Member States are required to implement MiFID 2, the Third Country provisions in MiFIR are subject to transition period which means, in practice, that Foreign Managers will not be able to rely on them until at least 2019.
However, with questions being raised on the limitations on what Foreign Managers can do under the Alternative Investment Fund Managers Directive (AIFMD) and many Foreign Managers wanting to offer segregated mandates without also wanting to manage non-UCITS investment funds (AIFs), Foreign Managers may need to look at MiFID 2 in the medium term and MIFIR in the longer term. In the case of MiFID 2, of course, the extent and manner of Member State implementation will be important and, as was the case with the AIFMD, predictions as to what Foreign Managers can expect need to be undertaken with caution.
A new package of rights
MiFIR will permit Foreign Managers to provide investment services to Eligible Counterparties, as defined in MiFID, and the entities identified in Section I of Annex II to MiFID 2 (Per se Professional Clients) throughout the EU. A Foreign Manager will be able to do so without having to establish a branch in the EU but will have to become registered with the European Securities and Markets Authority (ESMA) and comply with MiFIR.
MiFID 2 will give Member States the power to allow a Foreign Manager to provide investment services to other types of professional clients identified in Section II of Annex II to MiFID 2 (Elective Professional Clients) and Retail Clients, i.e. those clients which are neither Eligible Counterparties nor Per se Professional Clients. The Foreign Manager will need to establish an authorised branch in the relevant Member State (Host State) and comply with the Host State rules which implement MiFID 2. Member States will also have the power to allow the Foreign Manager to provide investment services to Eligible Counterparties and Per se Professional Clients.
MiFID 2’s impact on the AIFMD: Benefits for Foreign Managers?
Where a Foreign Manager wishes to offer a segregated mandate which is not treated as managing an AIF, AIFMD would not apply: the offering/marketing of that service will be governed by the relevant Non-AIFMD related Member State rules. Moreover, where a Foreign Manager wishes to provide sub-management or sub-advisory services for an EU manager managing an EU UCITS fund or EU AIFs, under a UCITS Directive or AIFMD compliant delegation arrangement, these services should fall within the definition of a MiFID investment service. In this respect, the services and activities of “portfolio management” and “investment advice” are captured under the investment services in Annex I of MiFID and will also be captured under MiFID 2.
It is expected that in late 2015 or early 2016 Member States will be given the power to authorise Non-EU AIF managers (AIFMs) to manage EU AIFs and market EU and Non-EU AIFs in reliance on the “AIFMD passport”. This will include the power to authorise Non-EU AIFMs to provide MiFID investment services, which include portfolio management and investment advice (Non-Core AIFMD Services), in addition to the services set out in Annex I to AIFMD (Core AIFMD Services).
MiFID 2 has provided an important amendment to AIFMD. It is now clear that an EU AIFM authorised to manage an EU AIF in one Member State may provide Non-Core AIFMD Services together with Core AIFMD Services in another Member State. In this respect, MiFID 2 has addressed the conflicting approaches taken by the Commission, which took the view that the AIFMD passport could not be extended to Non-Core AIFMD Services, and the UK Financial Conduct Authority, which took the view that it could. However, the amendments to AIFMD made by MiFID 2 have not been extended to include Non-EU AIFMs. MiFID 2 rather than AIFMD will, therefore, be relevant where a Foreign Manager wishes to provide Non-Core AIFMD Services to clients in more than one Member State.
Exercising the right to provide cross-border services to Per se Professional Clients or Eligible Counterparties
Under MiFIR, a Foreign Manager will have to apply to ESMA to become registered in ESMA’s register of Foreign Managers (the ESMA Register). In order to register the Foreign Manager, ESMA will need to satisfy itself that: (a) the Commission has made an a decision by the Commission on whether the regulatory arrangements in the country where that Foreign Manager has its registered office (Home Country) satisfy certain requirements in MiFIR (Equivalence Decision) with respect to the Foreign Manager’s Home Country, (b) the Foreign Manager is authorised to provide the relevant investment services in its Home Country and subject to effective supervision and enforcement and (c) appropriate co-operation arrangements are in place between ESMA and that Home Country. The Foreign Manager will also have to make certain disclosures to those Per se Professional Clients or Eligible Counterparties to whom it markets its investment services and agree to submit to the jurisdiction of court or tribunal in a Member State.
Establishing a branch to provide services to Elective Professional Clients and Retail Clients
In order for a Host State competent authority to authorise a branch of a Foreign Manager, the authority would need to satisfy itself that: (a) the Foreign Manager is appropriately authorised in its Home Country; (b) there are appropriate co-operation arrangements between the Host State and the Foreign Manager’s Home Country, dealing with the exchange of information, including an effective exchange of information on tax matters; (c) the Foreign Manager has adequate regulatory capital; (d) the Foreign Manager’s senior management systems and controls are sufficient; and (e) the Foreign Manager belongs to an authorised or recognised investor compensation scheme. The Foreign Manager will have to comply with the Host State rules giving effect to many, but not all, of the provisions in MiFID 2 governing conduct of business.
MiFID 2 does not give the branch of a Foreign Manager authorised in a Host State the freedom to provide investment services to Elective Professional Clients and Retail Clients in other Member States. A branch of a Foreign Manager authorised in its Host State could not therefore provide investment services to Elective Professional Clients and Retail Clients in reliance on a MiFIR Foreign Manager Passport. MiFIR indicates that a Foreign Manager authorised as a branch in a Host State will have the freedom to provide investment services to Per se Professional Clients or Eligible Counterparties in other Member States in much the same way as if the Foreign Manager was registered on the ESMA Register. The Foreign Manager will also have to make certain disclosures to those Per se Professional Clients or Eligible Counterparties in other Member States and agree to submit to the jurisdiction of court or tribunal in a Member State.
What next?
As is the case with AIFMD, a large part of the Third Country provisions are delayed. Under MiFIR, Foreign Managers will be able to provide investment services to Eligible Counterparties and Per se Professional Clients under the individual Member State rules. A Foreign Manager will be able to do so for a period of three years after an Equivalence Decision. Although this is described as a “transitional period”, it is not a transitional period in the normal sense in that it is not determined by the date on which MiFIR comes into force but rather by a decision made under MiFIR, which may occur some time later. The MiFID 2 provisions on establishing a branch to serve Retail Clients will come into force as soon as MiFID 2 comes into force although the extent to which they are brought into law in a particular Member State will be a matter for the relevant Home Member State authorities. ESMA will also be responsible for drafting approximately 100 Level 2 Measures between now and the end of 2016, when the Member States are required to implement MiFID 2 and MiFIR comes into effect. There is still a lot of work to be done.