Norton Rose Fulbright: EU Sets New Financial Laws for Non-EU Entities

Introduction

The Markets in Financial Instruments Directive (MiFID) is one of the cornerstones of EU financial services law setting out which investment services and activities should be licensed across the EU and the organisational and conduct standards that those providing such services should comply with.

Following technical advice received from the European Securities and Markets Authority (ESMA) and a public consultation, in 2011 the European Commission published legislative proposals to amend MiFID by recasting it as a new Directive (MiFID II) and a new Regulation (MiFIR). The legislative proposals were the subject of intense political debate between the European Parliament, the Council of the EU (the Council), and the Commission. However, informal agreement between the EU institutions was finally reached in February 2014. This led to MiFID II and MiFIR being approved by the European Parliament on 15 April 2014 and by the Council on 13 May 2014.

On 12 June 2014, MiFID II and MiFIR were published in the Official Journal of the EU with entry into force being on the twentieth day after publication. MiFID II and MiFIR enter into application 30 months after coming into force (beginning of 2017). In relation to implementing measures for both MiFID II and MiFIR, ESMA has now published its discussion paper on future technical standards and a consultation paper on draft technical advice on the possible content of delegated acts to be produced by the Commission. The deadline for comments on both papers is 1 August 2014.

Third Country Provisions: Changes under MiFID II

Of all the provisions of the MiFID II and MiFIR texts, the third country provisions were the subject of some of the most heated – and high profile – debate and lobbying. Articles have dropped in and out of different drafts produced by the Council and the European Parliament at a confusing rate, and it has been difficult to keep track of the latest developments.

The term “third country” refers to jurisdictions outside the EU and “third country firms” refers to entities incorporated outside the EU, whether they do, or seek to do, business by way of a branch established in the EU, or on a cross-border basis – i.e. providing services to persons in one jurisdiction from a place of business in another jurisdiction, without any establishment in the client’s jurisdiction.

“With the review of MiFID, the Commission has attempted to create a harmonised regime for granting access to EU markets for firms in third countries.”

With the review of MiFID, the Commission has attempted to create a harmonised regime for granting access to EU markets for firms in third countries. However, the regime is limited in scope to the cross-border provision of investment services and activities provided to per se professional clients and eligible counterparties.

As regards the third country regime for retail clients and opted-up professional clients, full EU harmonisation could not be achieved, as member states are free to continue to apply national rules. However, where member states chose not to maintain their respective national regime, MiFID II provides for a detailed set of rules that are designed to harmonise the requirements with which the branch of the third country firm will have to comply in order to be authorised by the national competent authority of the member state.

To put it in the Commission’s words “third country firms should see this as a positive step forward as it reduces divergences across member states and therefore the legal and regulatory costs for third country operators.” Where a member state makes use of this option, third country firms may not provide services to these clients other than through a branch authorised pursuant to the harmonised procedure set out in MiFID II by the respective member state.

Third country firms dealing with professional clients or eligible counterparties will, on the other hand, be permitted to operate on a cross border basis either from outside the EU or (if provided for in the respective member state and then subject to further conditions) from a branch in a member state.

In each case, there will be a greater, formalised focus on agreements between the EU and third country regulators and the assessment of third country regimes. There is also an exclusion in the form of exclusive initiative.

Through an Authorised Branch

A member state may allow third country firms to provide investment services or perform investment activities to clients in its territory through a branch authorised in that member state.

However, such branch authorisation may only be given by the member state’s national competent authority:

• Where the firm is authorised and supervised in respect of the provision of the relevant services in its home third country jurisdiction;
• Having regard to the Financial Action Task Force (FATF) recommendations relating to anti-money laundering and counter terrorist financing;
• Where co-operation arrangements exist between the relevant member state and third country regulators, relating to the exchange of information for the purposes of preserving the integrity of the market and protecting investors;
• Where the branch has sufficient initial capital at its free disposal;
• Where branch management consisting of one or more persons is appointed in accordance with, and complies with, the governance requirements of MiFID II and the CRD IV;
• Where a tax information sharing agreement (complying with the standards in Article 26 of the OECD Model Tax Convention) has been entered into between the relevant member state and the home third country jurisdiction ensuring an effective exchange of information in tax matters; and
• Where the firm belongs to an EU investor compensation scheme.

Such branches must comply with various organisational, conduct of business, trading and other MiFID II requirements and will be subject to the supervision of the national competent authority in the respective member state where the authorisation was granted. It is interesting to note that member states will not be permitted, save in limited circumstances, to impose any additional requirements on the organisation and operation of the branch in respect of matters covered by MiFID II and that such branches may not be treated more favourably than EU investment services firms. Insofar, MiFID II amounts to maximum harmonisation.

An important point to note is that the relevant member state national competent authority may only authorise a branch where the applicant is authorised and supervised in its third country home to provide all of the services for which it is requesting branch authorisation. This not only would exclude branches of unregulated firms, but would also restrict the scope of activities that a regulated third country firm can perform through a branch, to the extent that any such services are not regulated in the home third country. This may cause problems given the complexity of the definitional scope of different services and activities in and outside the EU.

Different Types of Client

On the face of it, this provision in MiFID II applies to firms providing services specifically to retail clients and opted up professional clients. However, MiFIR provides that branches authorised pursuant to MiFID II may provide investment services to eligible counterparties and per se professional clients across the EU, provided their third country legal and supervisory framework has been recognised by the Commission as equivalent (see below).

Author: Simon Lovegrove is a lawyer in the financial services group at Norton Rose Fulbright LLP.

From this, it can be concluded that such branches can provide their services to per se professional clients and eligible counterparties throughout the EU on a cross border basis (with appropriate equivalence decisions). However, where such a third country firm wishes to provide services to retail clients and opted-up professional clients in other member states, it would either need to:
Apply for a separate authorisation in each member state in which it wishes to provide services and establish a branch in each one (where the member state’s regime provides for this possibility); or
Comply with the local regime governing market access in case of retail or opted-up professional clients.

Where a member state has implemented the MiFID II provisions on the establishment of third country branches, a third country firm that has not established a branch in that member state will not be able to provide investment services with or without any ancillary services to retail clients or opted-up professional clients (except on such client’s exclusive initiative, see below).

Where a member state’s regime does not require the establishment of a branch, the provision of services to retail clients and opted-up professional clients will be subject to the respective national requirements.

Cross-Border

However, a third country firm may provide investment services to eligible counterparties and per se professional clients on a cross border basis where such firm is registered with ESMA.
ESMA will only register such third country firms where:

• The Commission has adopted a decision that the prudential and business conduct requirements in the firm’s home third country have equivalent effect to MiFID II and CRD IV;
• The Commission’s decision also concludes that such third country also has an effective and equivalent system for the recognition of investment firms authorised under the respective third country regime;
• The firm is authorised and supervised in its home third country in respect of the provision of the relevant services (as with the requirements for branch authorisation, this would restrict the scope of cross border services that a regulated third country firm can perform to the extent that any such services are not regulated in the home third country); and
• Co-operation arrangements exist between ESMA and the firm’s third country home regulator which, among other things, relate to the exchange of information and co-ordination of supervisory activities.
• An ESMA registered third country firm will have to inform prospective EU clients that it cannot provide services to EU clients other than per se professional clients and eligible counterparties and is not supervised in the EU. It must also offer to submit any disputes relating to its services or activities to a court or tribunal in the EU.

Transitional Provisions

Where there is no currently effective Commission equivalence decision in respect of any particular third country, member states may allow firms from such third country to continue to provide investment services to eligible counterparties and per se professional clients, if permitted by (and in accordance with) the relevant national regimes.

There is also a transitional provision in MiFIR under which firms will be able to continue to provide services and activities in accordance with national regimes until three years after the adoption of a Commission equivalence decision in respect of the relevant third country. It is not clear whether this transitional provision is intended to apply to services provided to all client types or whether it is limited to cross border business.

Exclusive Initiative of Client

A third country firm may, however, provide investment services and activities to clients on the exclusive initiative of such client, without requiring authorisation or registration in the EU.
Such “exclusive initiative” rules will likely be interpreted strictly and a number of points in particular must be considered:

• There is a clear indicator that a bullish approach to “reverse solicitation”, where firms raise their profile through various forms of marketing and seek to claim that any prospective clients that subsequently get in touch have not been solicited, should not be tolerated;
• Once a third country firm that is not authorised in a member state has established a relationship with a client (following the exclusive initiative of such client), it cannot subsequently provide such client with other services (unless such additional services have also expressly been sought at the exclusive initiative of the client). In other words, the “exclusive initiative” test applies on a service by service basis, not on a relationship basis; and
• That said, there is some ambiguity as to whether, having been approached by the client (on the client’s exclusive initiative) to provide a service, the third country firm may subsequently provide repeat instances of the same services/product type to the client. In theory this may be possible, but in practice it is likely to be a risky approach to take.