2. 2 Extraterritorial Reach of the MiFID Review Snapshot
Disclaimer
We try to ensure that the information in this document is correct at the time of going to press, but we do not give any express or implied warranty as to its accuracy. We do not
accept any liability for error or omission.
We are not liable for any damages (including, without limitation, damages for loss of business or loss of profits) arising in contract, tort or otherwise from the use of this document,
or from any action or decision taken as a result of using this document. Any opinions or suggestions contained in this document are for discussion purposes only and do not
constitute financial, legal or other professional advice. You should consult your professional adviser if you require financial or legal advice.
The content of this briefing paper represents the opinion of the author and does not necessarily represent the Hatstand corporate view. We encourage our readers to seek legal
advice before taking any action based on the contents of this document.
Contents
1 Introduction....................................................................................................................................................3
2 Data............................................................................................................................................................................4
3 Relationship between Entities..............................................................................................5
4 Product Governance and Unbundling.......................................................................7
5 How Hatstand can help..................................................................................................................8
3. Extraterritorial Reach of the MiFID Review Snapshot 3
1 Introduction
Disclaimer: At the time of writing this paper (early February 2016) MiFID II/MiFIR is still not
cast in stone. The start date has not been confirmed. This paper is based on the most recent
documentation published by ESMA and the European Commission, not the latest rumour. Things
may change and once they do, this paper will be updated.
Investment banking is a global business. Most regulators however, have a tendency to look at
things in isolation. It is as if the borders of a jurisdiction are brick walls that rival the Great Wall of
China for thickness rather than electronic firewalls or less.
As a consequence, legal entities based outside the MiFID jurisdiction will be affected by some
regulatory aspects if they have a business relationship with a legal entity based inside this
jurisdiction. Moreover, although some regulations may not be mandatory, it may be advisable
for a ‘foreign’ legal entity to comply with them for the sake of the business relationship with a
stakeholder based within the jurisdiction and to protect itself.
This snapshot gives an overview of the impact of MiFID II/MiFIR on clients and legal entities based
outside the Single Market for Financial Services (EU plus Norway, Iceland, Liechtenstein and
Andorra). It is divided into three areas: data, relationships between entities (an investment firm as
defined by MiFID
1
, a trading venue and a client) as described in Figure 1 below when one or more
of those entities are based outside the MiFID Area and issues around inducements, unbundling
and product governance.
Figure 1 describes the information flows if all the participants are in the same jurisdiction. This
paper aims to provide an overview of what happens when they are not.
Figure 1 - Reporting and Information Flows
4. 4 Extraterritorial Reach of the MiFID Review Snapshot
2 Data
One of the greatest challenges posed by MiFID II/MiFIR is having the right data in the right place at
the right time. There are instances where the ‘right data’ may come from a source outside of the
MiFID Area, a ‘source’ that may have no direct relationship with the entity based in the MiFID Area.
For instance:
ƒƒ Transaction reporting requires the person/entity responsible for the investment decision to be
identified.
ƒƒ The investment decision may have been taken outside the jurisdiction (e.g. a US company
instructing a broker-dealer who then passes the order on to their European office).
In this case, the identification of the entity responsible for the investment decision must be
communicated to the European broker even though the business relationship is with the US
head office and not with the European subsidiary. Following this example, the US Company that
instructs a broker/dealer in the US may have to identify the person responsible for the investment
decision in accordance with the Regulatory Technical Standard 22 of MiFID II/MiFIR. This applies
even if the American client has nothing to do with the investment firm based in the MiFID area.
5. Extraterritorial Reach of the MiFID Review Snapshot 5
3 Relationship Between Entities
Figure 1 demonstrates the reporting and information flows irrespective of jurisdiction as
described in MiFID II/MiFIR. This section looks at what happens when there are jurisdiction
boundaries between entities. The issues described include both “exported compliance”, when a
‘foreign’ legal entity is subject to a MIFID II/MiFIR rule, and “courtesy compliance” when, in theory,
they do not have to do it but it either helps a client to meet their regulatory obligation or may
possibly protect them from future problems e.g. fines or lawsuits.
3.1 Investment Firm outside the MiFID Area trading on an Execution
Venue inside the MiFID Area
The execution venue will have to keep a record of the order and so will require the investment
firm to provide the correct data-set for that order regardless.
ƒƒ The execution venue must report the transaction, providing the correct data-set to its
authority when nobody else does. This may require an extended set of data-items to be sent
to the execution venue when the order is being transmitted.
ƒƒ The non-MiFID investment firm will have to provide more data to the execution venue to
enable it to meet their its obligations.
ƒƒ The investment firm will receive the Venue Execution Quality report quarterly as part of the
venue’s obligations.
6. 6 Extraterritorial Reach of the MiFID Review Snapshot
3.2 Investment Firm outside the MiFID Area with Clients resident
inside the MiFID Area
It is our understanding that if a client based in the MiFID Area has signed a discretionary mandate
in the jurisdiction2
of the investment firm then there is no obligation to provide Best Execution
according to MiFID II/MiFIR rules.
ƒƒ If the client is based in a jurisdiction where the investment firm has a cross-border licence, the
client is entitled to Best Execution. In practice this means that:
• the investment firm will have to keep records of the transactions executed on behalf of the
client and their environment;
• the investment firm will have to show evidence that they consider more than one trading
venue to execute the orders received by clients;
• the client is owed an Execution Quality Report annually. This report requires information
from the execution venue. If the execution venue is based inside the MiFID Area, the
investment firm will receive them quarterly. If not, an arrangement needs to be put in place
to ensure that the information required to compile their annual Execution Quality Report is
provided.
ƒƒ If the client is based in a jurisdiction where the investment firm has no cross-border licence,
the client is still entitled to Best Execution and therefore the issues raised above still apply
but the investment firm will have to limit its business relationship with the client to the
services that the client has proactively sought. Anything else must be provided by a branch or
subsidiary based in the Area.
3.3 Execution Venue outside the MiFID Area executing orders
forwarded by an Investment Firm inside the MiFID Area
An investment firm in the MiFID Area needs the information received in the quarterly Execution
Quality Report from an execution venue to show their client that their decision to use a specific
trading venue provided the best possible environment for executing that specific client order. The
Best Execution policy of an investment firm will be communicated to its clients on onboarding
and verified by an annual report also called an Execution Quality Report. A firm’s report can only
be compiled if an execution venue provides the relevant information required in their quarterly
report to the investment firm.
This is a case of ‘courtesy compliance’. There is no obligation for an execution venue to prepare an
Execution Quality Report. Without one, those of its members who are based in the MiFID Area will
not be able to fulfil their obligations.
7. Extraterritorial Reach of the MiFID Review Snapshot 7
4 Product Governance and Unbundling
4.1 Product Governance
An investment firm that creates an investment product will have an obligation to assess all
the risks associated with that product, define a profile of investors for whom the product
will be suitable, define the relevant guidelines for selling it, produce documentation for the
potential investor to clarify all the risks, and train its own advisors and distribution network in
all aspects. Investment firms also have to have monitoring processes in place to ensure that the
guidelines are met and that the documentation is distributed appropriately. Failing to meet these
requirements make firms liable for fines associated with product mis-selling.
If the product is originated by a firm outside the MiFID Area and it is pro-actively sold in the MiFID
Area, the originating firm will need either a branch/subsidiary or a lead distributor in the Area who
will take responsibility for meeting the product governance guidelines.
4.2 Research Unbundling and Inducements
The MiFID II/MiFIR rules concerning the provision of research will be detailed in the Delegated
Acts expected at the end of February 2016. The basic principle is that the cost of research has to
be specifically paid for and not ‘bundled’ with commissions, transaction fees or other service fees.
A client can decline to pay for research and therefore not receive it.
MiFID II/MiFIR Level 1 contemplate two possible arrangements:
1. Commission Sharing Agreement – Where research is a percentage of the Commission Fee,
a budget for research has to be agreed annually and the total cost of research capped. If
research is 25% of commission fees and there is an annual budget of 5,000, once commissions
have reached a total value of 20,000 it will not be possible to charge the 25% for any more
research that year.
2. Research Supply Arrangement – Where research is the subject of a separate contractual
relationship, it should be charged for accordingly.
Irrespective of the arrangements that will be included in the Delegated Acts, this will have global
consequences. Will providers of research have different rules for the EU/EEA? How will that
impact local rules (e.g. the US )? Unfortunately, it will be impossible to answer these questions
until there is a stable version of the Delegated Acts. Future updates of this paper will provide the
details as they become available.
8. 8 Extraterritorial Reach of the MiFID Review Snapshot
5 How Hatstand can help
Hatstand’s approach to Regulatory Change Management consists of three stages:
The Regulatory Management Office (RMO) provides a comprehensive review of all the new
regulations affecting our clients. We take a step back and look at all your regulation related
obligations and their relevant timelines. We then consider your current business and its
strategy for the future. We may suggest changes to that strategy depending on any new factors
introduced by the regulation(s) considered.
Once we have completed the analysis we define the change and implementation strategy
following the steps broadly described above.
We implement the strategy or support you in its implementation in any way you require. We can
cover the whole programme, support your existing team in specific areas or just run the Project
Management Office on your behalf.
9. Extraterritorial Reach of the MiFID Review Snapshot 9
Endnotes
1 This definition includes an investment bank, an asset management and fund management
company, a private bank and a retail bank.
2 The reader may want to seek legal advice before acting on this statement.
