MiFID3 View - July 2021

Welcome to the first edition of our MiFID3 View which contains highlights of the latest developments in relation to the UK and EU's MiFID2 reforms that may be of interest to you or your clients. We aim to cover not only key legislative developments but also industry discussions and trends we are seeing in the market. We will also be covering the divergence/convergence between the UK and the EU. Over 120 of you subscribed for our MiFID2 Manager and our MiFID2 Toolkit for your implementation and we are looking at building these out over the coming weeks. Our MiFID3 View will be circulated as and when key developments happen, and we hope that you find it a useful tool to keep on top of current MiFID2 reforms.

So, what's been happening recently? Following the EU's 'Quick Fix' changes to the EU MiFID2 regime, that will generally apply from 28 February 2022, the UK has taken the initiative to push ahead with its own MiFID2 review. For the first round of reforms, the FCA published (CP21/9) setting out proposals to change the UK rules on inducements and best execution reporting, some of which diverge from the EU 'Quick Fix' proposals. Please see our client note on 'Top 10 things firms should know about the FCA CP21/9' which sets out a summary of the key changes. We worked closely with several industry bodies and clients to assist with responding to the consultation which closed on 23 June 2021.

In more recent developments, HM Treasury published its Wholesale Markets Review and the Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021 (otherwise known as the 'UK MiFID2 'Quick Fix'') has been laid before Parliament, both of which set out further UK MiFID2 reforms. Notably, these reforms contain significant areas of divergence from the EU, which suggests that the UK is continuing its own path of reform away from the EU where it sees necessary.

So, let's look at these developments in a bit more detail.

1. UK's MiFID2 "Quick Fix"

When? The Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021 was laid before Parliament on 30 June 2021, along with an explanatory memorandum and sets out the UK's own MiFID2 'Quick Fix' package of reforms. The proposals make several changes to the on-shored Delegated Regulation (Organisational Requirements) 2017/565 ('DR') and the FSMA (Recognised Requirements for Investment Exchanges, Clearing Houses and CSD) Regulation). Many of the changes apply from 26 July 2021, which is significantly sooner than the EU MiFID2 'Quick Fix' which generally applies from 28 February 2022. Accordingly, if you are caught by these reforms, you need to be acting now.

Who is impacted by these changes? These sweeping changes are far-reaching and directly impact both buy-side and sell-side, including credit institutions, brokers, asset managers, AIFM/UCITS managers with MiFID top up permissions and trading venues.

What should you be doing? The arrival of the UK MiFID2 'Quick Fix' may have come as a surprise for some as the measures did not follow the usual consultation process and timing for implementation is immediate. It presents significant changes to client communications and reporting requirements that need to be implemented. Many current requirements are entrenched in firm's internal systems and policies and contractual arrangements with clients and counterparties (i.e. terms of business, investment management agreements etc) which means implementation will be operationally complex and a challenge. So far, there has been no UK guidance on how firms should approach implementation with existing clients. However, we understand industry bodies are in discussions to consider remedial plans.

If you are impacted by these changes, you should have already commenced conducting a full gap-analysis to determine what changes are required to internal and external systems, processes and documentation including any repapering of client arrangements, terms of business and policies. If you need assistance with any implementation, then please reach out to our MiFID3 Team and we would be happy to help.

What are the key changes?

Durable Medium: All information that is to be provided in a 'durable medium' must now be provided to professional clients and eligible counterparties in electronic format. Retail clients can continue to receive information on paper which must be provided free of charge. However, HM Treasury's Wholesale Markets Review is consulting on potentially extending electronic format requirements to retail clients. More about that later.

Distance communications: Where an agreement to buy or sell financial instruments is concluded via distance communication and where the client consents, subject to certain conditions, firms can provide costs and charges information to clients after the transactions have been carried out.

Professional Client/ Eligible Counter Parties (ECP's) Exemption: The requirement for firms to provide detailed costs and charges disclosures to professional clients and ECPs is removed, unless providing portfolio management or investment advice.

Information to ECPS's: There is a further relaxation of information requirements in relation to ECPs. This relates to information about the firm and its services, risk warnings, information regarding client assets and costs and charges required under UCITS or PRIIPs.

Portfolio Management 10% loss reporting: The obligation to report to a client when the overall value of the portfolio depreciates by 10% and thereafter at multiples of 10% is removed for professional clients. Again, HM Treasury's Wholesale Markets Review is consulting on extending this exclusion to retail clients.

Portfolio Management Periodic Reporting: Whilst firms are still required to provide periodic reports to professional clients, the specific list of detail which is to be included only applies to retail clients.

Switching: Exemption for firms when providing portfolio management services to professional clients from the requirement to provide cost/benefit analysis to professional clients when they switch the instruments in which they invest.

Best Execution Reporting: Firms will no longer be required to produce RTS 28 reports in relation to the services of reception and transmission of orders or portfolio management. These changes come into effect on 1 December 2021. Trading venues will no longer be required to publish RTS 27 reports and firms providing services to retail clients will no longer be required to provide links to RTS 27 reports in their execution policy summary. These changes correspond with the proposals set out in FCA CP (21/9), essentially removing RTS 27 and RTS 28 reporting requirements altogether.

A link to a red line of the full changes can be found here.

How do these changes differ from EU MiFID2 'Quick Fix'? As you will have noticed some of these changes are in line with the EU MiFID2 'Quick Fix'. However, there are several differences most notably:

• Whilst the obligation for trading venues to produce RTS 27 reports under MiFID2 has been suspended (for 2 years) in the EU, the requirement for firms to produce RTS 28 reports remains in place.

• Pending the outcome of the Wholesale Markets Review, the UK maintains requirements for retail clients to receive paper communications, whereas the EU MiFID2 'Quick Fix' applies electronic communications to retail clients. Unlike the EU, the UK MiFID2 'Quick Fix' does not provide any direction of how to implement these changes with existing clients.

• The EU's MiFID2 'Quick Fix' permits professional clients to opt in to switching protections, whereas in the UK this requirement is removed altogether.

2. HM Treasury Wholesale Markets Review

When? On 1 July, the HMT published Wholesale Markets Review: Consultation which proposes further amendments (some of which are already mentioned above) to the UK's MiFID2 regime. The proposals cover trading obligations, transparency, market data, market structure and the commodities regime and shows a clear focus to simplify the regime, provide flexibility and remove regulations that are costly and provide little benefit or protection.

What is being consulted on? The detailed proposals are relevant across industry to both buy-side and sell-side firms. Some key takeaways from the paper are:

• Proposals to align the derivatives trading obligation and the EMIR clearing obligation (bringing it into line with the EU) and to permanently remove the double volume cap and share trading obligation.

• Review of systematic internaliser ('SI') regime including proposals to move from a quantitative to qualitative definition of SI's and determination to be made at entity level.

• Review of changes to trading venues to clarify perimeter for venues, as well as a simplification of the operating conditions for MTFs and OTF's.

• Recalibration of the transparency regime for fixed income and derivatives markets to ensure they are proportionate to the features of those markets.

• Proposals to reform the commodities regime to ensure that market activity is not needlessly restricted.

What's next? The Consultation closes on 24 September 2021. The Government intends to bring forward primary or secondary legislation as soon as parliamentary time allows. The FCA has also indicated it will take forward any further consultations about parts of the regime that fall within its remit from the second half of 2021.

Some more developments in the UK

3. Modification of the list of derivatives subject to the DTO In another development, the FCA has published CP 21/22 where it is reviewing the list of derivatives subject to the derivatives trading obligation ('DTO') under MiFIR. This follows the recent benchmark reform and Bank of England's proposed changes to the derivatives clearing obligation under EMIR. The FCA intends to remove derivatives referencing GBP LIBOR from the current DTO and replace them with overnight indexed swaps (OIS) referencing SONIA. The FCA's liquidity analysis indicates that SONIA OIS as a class of OTC derivatives is sufficiently liquid to impose a DTO. The deadline for responses is 25 August 2021, following which the FCA intends to publish a policy statement in late Q3 or early Q4 2021.

4. Non-discriminatory Access to Exchange Traded Derivatives (ETDs) Whilst not a major change, but worth flagging, on the 20 July 2021, HM Treasury published the draft version of the Markets in Financial Instruments, Benchmarks and Financial Promotions (Amendment) (EU Exit) Regulations 2021, together with an explanatory memorandum. The regulations remove the non-discriminatory access provisions in MiFIR for ETDs, as since the UK has left the EU the provision would only operate domestically and therefore would essentially be redundant to its purpose. The draft regulations are yet to be laid before parliament but are stated as coming into force on 13 October 2021.

What's been happening in the EU

Finally, a quick glance at some developments in the EU this month.

5. Remuneration Guidelines ESMA is consulting on the MiFID2 remuneration guidelines, to update the 2013 guidelines. ESMA's proposals do not substantially change the current guidelines but rather reinforce and clarify existing provisions whilst proposing some additional guidance in relation to design, governance, and risks controls. The consultation closes 19 October and ESMA is expected to publish a final report, and final guidelines, by end of Q1 2022.

6. Suitability under review ESMA has published its results of the 2020 Common Supervisory Action (CSA) on MiFID2 suitability requirements. ESMA will use the results to update its guidelines to clarify areas where they have seen divergence on application and to align them to the guidelines on appropriateness and execution-only and to the revised delegated regulation on the topic of sustainable finance.

7. Ancillary Exemption The European Commission adopted a Delegated Regulation on 14 July 2021 amending the criteria for ancillary activity test for the commodities regime. You may recall that the EU's 'Quick Fix' package revisited the ancillary activity exemption with the aim of removing unnecessary red tape that restricts access. Key changes are the removal of the overall market size test and the introduction of the new de-minimis threshold test. There is no substantial change to the established calculation methodology of the trading test and capital employed test. It's useful to note that HM Treasury's Wholesale Market Review is also consulting on amending the ancillary activity test in the UK and proposes to move back to a more qualitative/principals-based test that applied pre-MiFID2.

8. Transparency Regime In advance of the European Commission's full MiFID2/MiFIR review report and legislative reforms scheduled for Q3/Q4 2021, on 9 July ESMA published a Consultation on the review of Equity/Non-Equity Transparency Regime. The review focusses on a recalibration of the commodity derivatives regime to provide better tailored transparency requirements, further clarity on the reporting fields for post-trade transparency and reporting of reference data and on the pre-trade transparency requirements for new types of trading systems.

If you would like to know more about any of the topics covered in this update then please get in touch with our dedicated MiFID3 Team. We are closely following developments in this area and would be happy to discuss how we can help and the work we are doing in this sphere. We also welcome any feedback you may have.