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| Financial Law Update | Back to article summary. |
| MiFID & fund administrators, will it or won't it apply to them? | ||
| Joe Beashel |
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| Joe Beashel highlights the need for clarity by the Financial Regulator with regards to MiFID and how it applys to fund administrators. Clarity is needed for firms to plan for implementation but also to consider whether, if affected, MiFID affords any opportunities, such as the ability to reduce costs and outsource some of their activities to lower cost locations. | ||
| The Markets in the Financial Instruments Directive 2004/39/EC (MiFID) will be in force one year from now on 1 November 2007. It will replace the Investment Services Directive 92/33/EEC (ISD) and for many affected it will introduce far reaching changes. Although two implementing measures have been enacted (a further directive and a regulation) many aspects of implementation remain unclear, one of which is the extent to which MiFID will apply to fund administration companies. Helpfully, MiFID specifically provides in Recital 15 and Article 2 (1)(h) that it shall not apply to '...collective investment undertakings...whether coordinated at Community level or not and the depositories and managers of such undertakings.' Unhelpfully, the Directive (and the implementing measures) are silent as to companies which provide administration services to such schemes. What happens now? To ascertain whether MiFID will apply to any entity one has to consider whether a 'MiFID' investment service and activity is provided in respect of financial instruments on a professional basis. In this context, the most relevant investment services are 'the reception and transmission of orders in relation to one or more financial instruments' and 'the execution of orders on behalf of clients'. Do fund administrators provide these MiFID services?
Because these services are basically the same as under ISD an historical analysis should be helpful. The Financial Regulator has, to some extent, considered this issue in the past in its Guidance Note 1/99 which deals with Administration Companies and the Investor Compensation Act, 1998. It provides that normally subscription applications for, or requests to purchase, shares and redemption applications or requests to sell shares together with requests to switch or transfer ownership of shares in funds are regarded as constituting orders in shares in collective investment schemes. As such, an investment company which receives an order from an investor or intermediary is either engaged in 'receiving and or transmitting on behalf of investors' or 'execution of such orders other than for their own account' both of which are ISD (now MiFD) services. In that document the Financial Regulator goes on to acknowledge that the processing of orders may be structured in such a way as to ensure that an administrator acts on behalf of a manager fund and as such would not need ISD authorisation. It sets out the following conditions which would need to be satisfied in order to ensure that ISD (now MiFID) authorisation is not necessary: All shareholder orders must be clearly addressed to the manager/fund Payments in respect of a subscription of shares must be payable to the manager/fund or trustee At no point must the administration company hold shareholders' funds or securities Application forms, contract notes etc must make it clear that the contract for purchase/redemption is between the manager/fund and the shareholder The manager/fund must set down clear parameters governing the role of the administration company in relation to acceptance and refusal of orders One would expect that as a consequence of the above analysis, fund administration companies would have been authorised under the relevant Irish implementation of the ISD unless they avail of the exemption given above. In fact, the regulatory status of fund administration companies is not so straightforward; where authorisation under the Investment Intermediaries Act 1995 ('IIA') was necessary, many are authorised to provide the service of '..the administration of collective investment schemes, including the performance of valuation services or fund accounting services or acting as transfer agents or registration agents of such funds' (see paragraph (g) of the definition of investment business firm section 2(1) of the IIA) but others are authorised to provide the services of 'receipt and transmission of orders' and 'execution of orders' (see paragraphs (a) and (b) section 2(1) of the IIA). Clarity needed? It is not clear why there would be a difference. There is no doubt that it was intended that fund administration authorised under 'paragraph (g)' could 'receive and transmit orders' and/or 'execute orders' as part of acting as transfer agents but because the specific ISD services of 'receiving and transmitting' and 'executing orders' (i.e. paragraphs (a) and (b) respectively) were not specifically mentioned they could not passport such services. The regulatory requirements are currently the same no matter which particular paragraph(s) a fund administrator is authorised under. Whatever the reason, there was no necessity in the past to separate out ISD from non-ISD services and a totally local solution in the IIA was adequate. We suggest that with MiFID implementation imminent, such a position is no longer sustainable and some closer analysis will be needed. We do not believe that firms authorised under 'paragraph (g)' of the IIA can assume that MiFID will not apply to them. As set out above, if a firm offers MiFID services, such as the 'receipt and transmission or orders' or the 'execution of orders' the Financial Regulator will have to regulate that service under MiFID and the whole MiFID regime will have to apply to those services. It would be helpful if the Financial Regulator could consider how it intends to deal with this issue and whether it will be in a position to provide the clarity that is sought by industry. MiFID opportunities? Such clarity would assist affected firms plan for MiFID implementation but will also allow them to consider whether MiFID offers any opportunities. In this regard, it is worth noting that MiFID sets out a detailed set of requirements around the outsourcing of MiFID activities. For the first time there will be a clear set of statutory criteria around which outsourcing can be judged. Article 13 generally provides that important operational functions when outsourced, must not be undertaken '…in such a way as to impair materially the quality of its internal control and the ability of the supervisor to monitor the firm's compliance with its obligations'. Section 2 of the implementing Directive 2006/73/EC sets out in considerable detail, the controls and requirements that must be in place to permit outsourcing of 'important operational functions' but the fact is that such important functions can be outsourced and can be outsourced to non-EU countries. Many administration companies are part of an overall administration infrastructure which might have larger administration centres in the United Kingdom, Luxembourg, the Channel Islands, the United States or elsewhere. In many cases it would make financial sense to seek to leverage from such larger group operations located in another country in order to realise the benefits of economies of scale and thereby reduce costs. To date, the most significant impediment to any such outsourcing has been the Financial Regulator's minimum activity rules which are set out in its notices (both UCITS and non-UCITS). In essence, these provide that certain features which the Financial Regulator regards as important for its prudential supervision of the funds authorised by it must be carried out in the State. Post MiFID, where there is a clash between MiFID and the minimum activity requirements, MiFID must take precedence, therefore there is scope to explore how these new provisions interact with the minimum activities rules. We would also ask the fundamental question as to why such strict minimum activities rules are in place when MiFID offers the framework to permit and supervise outsourcing of a large range of 'important operational functions'. Does it make sense to permit outsourcing in some cases but not in others where both are important functions to the relevant entity? Summary To date it has not been necessary for fund administrators to consider whether they offer ISD or non-ISD services as the regulatory treatment in both instances was the same. Post-MiFID implementation, a new regime will apply to MiFID services only. It would be helpful if the Financial Regulator could clarify its intended approach in this regard to allow affected firms to plan for implementation but also to consider whether, if affected, MiFID affords any opportunities, such as the ability to reduce costs and outsource some of their activities to lower cost locations. |
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Joe Beashel is a partner in the Banking and Financial Services Department and is Head of the Regulatory Risk Management and Compliance Group at Matheson Ormsby Prentice. He can be contacted by phone: +353 1 619 9000 or by email: joe.beashel@mop.ie |
