MiFID3 View - February 2022

Welcome to our first 2022 edition of MiFID3 View. In case you have missed our earlier MiFID3 View publications you can find them here.

As expected, legislative developments slowed over the holiday period but things are certainly ramping up and we anticipate some big movements in 2022 in relation to MiFID reforms both in the EU and UK. To capture all the recent developments we have a bumper edition of MiFID3 View this month, focussing on the EU's Quick Fix, sustainability top-up changes to MiFID2 and other MiFID2/MiFIR market reforms currently underway.

EU 'Quick Fix' to apply 28 February 2022 - are you ready?

This month, a key deadline is the EU's 'Quick Fix' which is due to apply 28 February 2022.As you are no doubt aware, the 'Quick Fix' was adopted early last year with the aim to support recovery from the economic shock caused by the COVID-19 pandemic. For a refresh, below is a summary of some of the key changes that will apply later this month with highlights of areas of divergence to look out for. As with all EU directives, implementation by individual Member States should be considered to determine any gold plating or local variations. Our implementation table gives you an idea of the current status in Italy, France, the Netherlands, Germany, Spain and Ireland.

So what changes are we to expect?

Paper-based Communications The default method for EU firms to communicate with their clients will be switched from paper-based to electronic format communication, although retail clients can elect to continue receiving paper communications. Under the UK's Quick Fix, the UK maintains requirements for retail clients to receive paper communications as the base position. However, HM Treasury's Wholesale Markets Review is consulting on potentially extending electronic format requirements to retail clients which would bring it in line with the EU changes. For a quick recap on the HM Treasury's paper see our MiFID3 July update.

Costs and Charges Disclosures Professional clients and eligible counterparties are exempted from the costs and charges disclosure requirements, except when providing investment advice or portfolio management services. Although, the drafting of the EU 'Quick Fix' is slightly ambiguous and potentially leaves room for varied interpretation, we understand the intention is that this exemption applies to both ex ante and ex post costs. We understand this is the position that has been implemented in a number of EU member states including France and Ireland. These changes align with the changes under the UK's Quick Fix, which we covered in our MiFID3 View July update.

In a recent development, and an attempt to encourage EU convergence of the costs and charges requirements under MiFID2, ESMA announced last week that it has launched a Common Supervisory Action on the application of the regime for 2022. The focus will be on the retail sphere and ESMA hopes the initiative and the sharing of practices will help to clarify provisions and ensure consistent application of the regime across Member States - an area which has always been a bit murky and suffered from conflicting interpretations.

Suspension of Best Execution Reports The obligation for firms to submit quarterly best-execution reports under RTS 27 is temporarily suspended. The suspension will apply until 27 February 2023. However, in the recently published Capital Markets Union the European Commission is proposing to permanently remove RTS 27 obligations altogether. What remains unclear is the EU’s position on RTS 28 reporting. Both the EU's Quick Fix and the Capital Markets Union package of reforms make no changes to the RTS 28 reporting requirements. In addition, whilst ESMA has proposed changes to RTS 28 reporting requirements in its recent consultation paper it made no indication that it would suggest removing them altogether. So it looks like RTS 28 reporting in the EU is here to stay- for now....

As you know in the UK from 1 December 2021, firms have no-longer been required to prepare RTS 27 and RTS 28 reports.

Research Unbundling The research unbundling rules are amended to allow EU firms to bundle costs for research and execution with respect to small and mid-cap issuers, whose market capitalisation does not exceed EUR 1 billion. To use the exemption (i) the research recipient and the research provider must enter into an agreement which identifies which part of the bundled payment is attributable to research, and (ii) the research recipient must inform its client about the joint payment.

This differs from the UK's position set out in the FCA’s final policy statement, which introduces an exemption for research on listed or unlisted SMEs with a market capitalisation below £200m provided the research is offered on a rebundled basis or for free, in addition to additional exemptions for non-macro FICC research or research provided by independent service providers who don’t offer execution from their group, which will apply 1 March 2022.

Ancillary exemption The “ancillary activity” dealing on own account licensing exemption for commodity/emission allowances traders is amended with respect to how the quantitative thresholds as to whether activities are considered “ancillary to the main business” at group level are assessed. In order to implement the changes, the Commission Delegated Regulation (2021/1833) published in October last year repeals Commission Delegated Regulation (EU 2017/592),and sets out the following changes:

• Deletion of Market Size Test under Article 2 of the RTS 20.
• The introduction of a new De-minimis Threshold Test which offers a simplified test to non-financial firms.
• Level of thresholds: The amended test does not change the current methodology of the Trading Test and Capital Employed Test of Article 3 of the RTS 20. These two current tests are only changed with regard to the level of the corresponding test thresholds.
• The elimination of the requirement for non-financial firms to annually notify their relevant national competent authority that they make use of that exemption and to provide the necessary elements to satisfy the exemption prerequisites. Instead, non-financial firms should report only upon a request from the NCAs upon which basis they have assessed their activity to be ancillary to their main business.

With regards to notification requirements, in advance of 28 February 2022, BaFIN in Germany and the AMF in France have already announced that those that want to rely on the exemption do not need to make such a notification. Our understanding is that regulators in Ireland, Italy and Spain have not yet followed with any similar pre-emptive changes.

Position limits regime

The scope of the commodity derivatives position limits regime is being reduced, such that it will only apply to critical or significant commodity derivatives that are traded on trading venues, and to their economically equivalent OTC contracts. Critical or significant derivatives are commodity derivatives with an open interest of at least 300,000 lots on average over a one-year period, as well as agricultural commodity derivatives. To effect this new framework, towards the end of last year, ESMA published a final report setting out:

• Draft RTS 21a laying down rules for the calculation of the net position held by a person in a commodity derivative, the methodology for calculating the position limits on the size of that position and the procedures for applying for exemptions to position limits.
• Draft RTS on the content of position management controls by trading venues position management, designed to provide additional tools for market monitoring by trading venues.
• Draft ITS setting out the format of position reports.

The draft RTS' are awaiting endorsement by the Commissionand are expected to apply in time for 28 February 2022 - so watch this space.

What should EU firms be doing? Firms impacted by these requirements should already be in the process of making changes to their internal and external systems, processes and documentation including any repapering of client arrangements, terms of business and policies in time for this month’s deadline. If firms operate across the EU and UK, they will need to manage different implementation timetables and obligations and so care must be taken as to areas of divergence.

If you need assistance with any compliance, then please reach out to our MiFID3 Team and we would be happy to help.

Suitability Assessments and Sustainability

Another big ticket item, was ESMA’s consultation paper published on 27 January 2022 with proposals to update its November 2018 Guidelines on certain aspects of the MiFID2 suitability requirements. ESMA's review of the Guidelines takes into account the amendments made in August 2021 to the MiFID2 Delegated Regulation to integrate sustainability factors, risks and preferences into firms' organisational requirements and operating conditions - these changes come into effect on 2 August 2022.

The Guidelines are particularly relevant to EU firms who provide investment advice or portfolio management who will need to review and amend their suitability assessment procedures and policies in good time prior to 2 August to take account of the requirement to consider their clients' sustainability preferences. In addition, product providers (who may not be directly subject to the MiFID rules) will also be keen to identify how their products may be sold and what they will need to do in order to ensure their products are best positioned to take advantage of the changes to suitability assessments.

The consultation paper makes a number of proposals to amend the Guidelines and we have produced a useful Insights article should you wish to know more.

The consultation closes on 27 April 2022. ESMA expects to then publish a final report followed by the final guidelines in Q3 2022. ESMA has also just announced it is holding an open hearing on 18 March, to discuss the guidelines the outcome of which will feed into the final publication. Details of the event and where to sign up are here. In addition, ESMA also intends to consult separately on the product governance changes to MiFID2 made under the EU's ESG framework in August 2022. For a recap on those changes,we have a useful summary here.

We have actively been advising a number of clients on compliance around these changes so please reach out to our MiFID3 team if you have any questions.

MiFIR Call for Evidence – DLT and MiFIR pre- and post-trade transparency

On 4 January ESMA published a call for evidence on distributed ledger technology (DLT) on the need to amend the RTS on MiFID pre- and post-trade transparency requirements. The DLT Pilot requires ESMA to assess whether the RTS developed under MiFIR relative to certain pre- and post-trade transparency and data reporting requirements need to be amended to being effectively applied also to securities issued, traded and recorded on DLT. The call for evidence seeks input from stakeholders on the use of DLT for trading and settlement and on the need for amending RTS. See our January 2022-Markets View for further details on this development. In an update last week, the European Parliament intends to consider a proposed regulation on this regime at its 23-24 plenary session. For those keenly observing these proposals, we will provide a further update in next month’s MiFID3 View.

Timing of changes to clearing obligation and derivatives trading obligation

Towards the end of last year, ESMA issued a public statement on the implementation of the changes to the clearing obligation (CO) and derivative trading obligation (DTO) in light of the benchmark transition. The statement clarified the situation in which ESMA’s proposed draft RTS on the CO and DTO (submitted to the European Commission on 18 November 2021) would not enter into force in time for the transition to alternative benchmarks of EONIA or LIBOR- based OTC derivative contracts by the end of 2021. The European Commission last week adopted the RTS which are now with the Council and European Parliament for scrutiny, so we still await final publication. ESMA's public statement, has confirmed that during this interim period and until the RTS are adopted, ESMA expects Member States not to prioritise their supervisory actions in relation to the CO for IRD classes referencing EONIA, GBP LIBOR, JPY LIBOR or USD LIBOR and in relation to the DTO for IRD classes referencing GBP LIBOR or USD LIBOR and to generally apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in this area. As to the classes being introduced to the scope of the CO, ESMA recommends voluntary clearing of those ahead of the CO start date.

ESMA Guidelines on Appropriateness and Execution-Only Requirements

At the beginning of the year, ESMA published its final report on its Guidelines on certain aspects of the MiFID2 appropriateness and execution-only requirements. The Guidelines address several key aspects of the appropriateness process, including the information to be provided to clients regarding the objective of the appropriateness assessment, the arrangements required to comprehend clients and products, the matching of clients with appropriate products and the effectiveness of warnings. Additionally, other related requirements are clarified, such as the execution-only exemption and record-keeping and controls. The Guidelines will be translated into the official languages of the EU and will be published on ESMA’s website and will apply six months after the date of the publication on ESMA’s website. Firms impacted by these changes, should already be looking at their client communications and due diligence arrangements to ensure they are prepared for implementation.

Some clarification of trading perimeter for multilateral system

For years, concerns have been raised in the market on the perimeters around the definitions of trading venues with the various interpretations making it at times tricky to determine whether authorisation is required. This was highlighted in ESMA’s final report back in April last year on the back of which ESMA promised to follow up with some firm guidance. In what will be a welcomed development, ESMA has finally launched its consultation paper on what constitutes a multilateral system which includes guidance on concrete examples, where the trading venue perimeter is not easily identified and might be subject to different interpretations. This development is part of the EU's wider market reforms to level the playing field for EU firms and encourage market stability. Comments are invited until 29 April 2022 and ESMA aims to publish a final report in Q3 2022.

Update to transparency Q&A’s

Just one to flag for your attention, on 28 January 2022, ESMA published an updated version of its Q&As on MiFID2/MiFIR transparency topics confirming that before a trading venue starts operating or an instrument is admitted to trading or traded for the first time, that trading venue has the responsibility to verify whether the respective instrument is traded on other trading venues and is subject to an EU level suspension under the Double Volume Cap mechanism under Article 5 of MiFIR.

Now, let’s turn to the UK,

FCA extends relief on the supervision of commodity limits regime and 10% depreciation notifications

In some good news, the FCA in a statement has confirmed its approach to supervising commodity derivatives position limits. The statement follows the FCA's Supervisory Statement after the end of the EU withdrawal period in which it stated that until 1 January 2022, it would not take any supervisory action for positions that exceed limits where the position is held by a liquidity provider to fulfil its obligations on a trading venue. In its latest statement, the FCA confirms that it will extend this relaxation pending the outcome of HM Treasury's Wholesale Market Review and subject to any indications of market abuse arising. The FCA states that firms should make their own assessment of whether the positions they take are positions resulting from their actions as a liquidity provider. Firms do not need to report their assessments to the FCA. However, a firm may need to explain an assessment to the FCA on request.

In a similar vein, the FCA has also announced that it will extend its temporary measures on the requirement for firms to issue 10% depreciation notifications to investors (COBS 16A.4.3 UK) for a further 12 months until 31 December 2022. During this period, the FCA won’t take action for breach of COBS 16A.4.3 UK for services offered to retail investors provided that the firm has: (a) issued at least one notification in the current reporting period, indicating to retail clients that their portfolio or position has decreased in value by at least 10%; (ii) informed these clients that they may not receive similar notifications should their portfolio or position values further decrease by 10% in the current reporting period ; (iii) referred these clients to non-personalised communications, perhaps made available on public channels, that outline general updates on market conditions (these could contextualise potential drops in portfolio or position value to help consumers meet their objectives, rather than making impulse decisions about their investments); and (iv) reminded clients how to check their portfolio value, and how to get in touch with the firm.

FCA flexibility on the short sale indicator

You may recall in ESMA's Final Report on the review of transaction and reference data reporting obligations, it has proposed to remove the short sale indicator (Field 62 in the MiFIR Transaction Report) required under RTS 22 as part of its proposed reforms to the transaction reporting regime.

Like the EU, the FCA is similarly considering policy options for the UK transaction reporting regime, including the future of the short sale indicator. To address industry concerns, the FCA has published a notice putting in place temporary measures for the reporting of the short sale indicator in transaction reports whilst it considers reforms to the UK regime. The FCA notes 'we have received questions from firms regarding the requirement in Article 26(7) of UK MiFIR to correct errors and omissions in the short selling indicator field and resubmit affected transaction reports. Until the future of the short selling indicator field (for the purposes of the UK MiFIR transaction reporting regime) has been determined, we will not take action against firms who do not meet these requirements. We do not expect firms to notify us about issues affecting the short selling indicator field through an errors and omissions notification form. We will keep this position under review.'

As always if you have any questions on the above developments then please do not hesitate to reach out to our dedicated MiFID3 Team.