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| Financial Law Update | Back to article summary. |
| MiFID a challenge of ongoing implementation |
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| As the MiFID implementation date draws ever closer, much of the focus in recent months has been on fulfilling the pressing, client facing requirements of client classification, amending terms of business and the like |
| As the MiFID implementation date draws ever closer, much of the focus in recent months has been on fulfilling the pressing, client facing requirements of client classification, amending terms of business and the like. Affected firms should however, not lose sight of the important internal organisational obligations imposed on investment firms, including the obligation to produce regular reports and at least an annual report for senior management on MiFID compliance. Following live date, firms will need to continue to focus, on an ongoing basis, on implementation to ensure their firms successfully adapt to the new MiFID regime. The Financial Regulator has indicated that it will review the effectiveness of MiFID implementation next year, initially on a ‘good faith’ basis but graduating to a ‘best practice’ basis from 2009 onwards. In order to be able to demonstrate effective implementation, senior management of firms will need to be able to clearly and consistently demonstrate their approach to implementation. The key difficulty in tackling implementation is that MiFID consists of a mixture of both fixed rules and more fluid principles, language such as ‘adequate’, ‘effective’, ‘sufficient’ and ‘appropriate’ give firms the flexibility to design solutions that best fit with their businesses but present challenges in demonstrating compliance. This will mean that some judgements that a particular solution is ‘adequate’, ‘effective’ etc will have to be made and the implementation project should record, and senior management should be careful to document, why particular judgements were made. Unless the rationale for determining that a particular approach is ‘effective’ or ‘adequate’ (as the case may be), it will be difficult to demonstrate effective implementation. In all circumstances it will be the board of the relevant investment firm that must satisfy themselves that the rules and principles have been interpreted correctly and that the obligations under SI No 60 of 2007 as amended, (the ‘Regulations’) have been implemented and where necessary, be in a position to demonstrate compliance. This may mean agreeing minimum standards and making explicit reference to how such judgements were made. On an ongoing basis, senior management should appraise themselves of the adequacy of the firm’s implementation of the rules and principles. This may take the form of financial reporting, key performance indicators, regular or periodic conference calls, additional management reporting and/or compliance reports. The board too must receive regular written reports as to MiFID compliance. General Obligations Regulations 33 and 34 set down some general obligations that take precedence over the more specific requirements detailed below and set the parameters in which those obligations must operate. These Regulations rely heavily on a principles-based approach and require investment firms to implement defined organisational and reporting structures, to employ competent personnel and to follow the procedures and processes required under the Regulations. This structure must be supported by capable IT systems and accountancy procedures and the entire set of obligations must be monitored on a regular basis. Regulation 37 emphasises that senior management are responsible for the firm’s obligations under the Regulations. Compliance The Regulations provide a statutory definition of the role of a compliance function for the first time, notwithstanding that it is an existing requirement to have a compliance officer in every regulated firm. Primary responsibility for ensuring compliance rests with senior management and Regulation 37 requires that ‘frequent reports’ (at least annually) must be provided to them in written format in respect of the compliance obligations under the Regulations. Risk Regulations 33 and 34 require all investment firms to have a business continuity plan in respect of their systems, resources and procedures. Regulation 36 requires all investment firms to have management procedures in place to identify risks and set tolerance levels; to adopt effective measures where such risks are identified and to monitor the effectiveness of the management function, the manner in which risks are addressed and the success of the monitoring process itself. As with the compliance function, frequent reports should be supplied to senior management. Internal Audit The Regulations require investment firms to have an internal audit function to examine and evaluate the adequacy of its systems and control mechanisms. The Regulations require that ‘frequent reports’ (at least annually) must be provided to the senior management of the investment firm in written format. In the case of smaller firms a case can be made to the Financial Regulator to justify not having separate Risk and Internal Audit functions though the obligations still need to be discharged. Complaints Regulation 38 requires investment firms to establish procedures for handling and recording retail client complaints. We are seeing firms that are also affected by the Consumer Protection Code (‘CPC’) apply this process for MiFID services. Although the CPC process is more prescriptive in this regard some firms prefer to have one process only for obvious reasons of efficiency and effectiveness. Outsourcing The Regulations set down a number of requirements for investment firms where any investment service or activity is outsourced or where a critical or important operational function is outsourced. For these purposes, advisory services and other services that do not form part of the investment business of the firm do not constitute important operational functions. Where these criteria are met, the Regulations (at Regulation 105) detail a number of obligations including specific requirements in respect of senior management’s retention of control and responsibility for the outsourced function. Regulation 105 requires all outsourcing arrangements to be captured in writing by means of a document that sets out the rights and obligations of the respective parties. Conflicts of Interest Regulation 33 requires investment firms to take reasonable steps to prevent conflicts of interest that are detrimental to the interests of its clients. Firms must identify, manage and if necessary, disclose conflicts of interest that may adversely affect the interests of clients and Regulation 75 requires investment firms to put a conflicts of interest policy in place. Recital 27 of the Level 2 Directive makes it clear that over-reliance on disclosure of conflicts of interest in the policy is not sufficient and the investment firm must endeavour to manage such conflicts or prevent them from occurring. Recital 26 of the Level 2 Directive identifies investment research and advice, portfolio management and corporate finance business, including underwriting as areas requiring special attention. Regulation 75 obliges investment firms to maintain a log of all types of conflicts of interest that have occurred or which may occur. Records Regulation 33 requires investment firms to maintain records of all services and transactions undertaken by it that are sufficient to evidence compliance with its obligations under the Regulations. Regulation 40 requires that all records required pursuant to the Regulations should be maintained for at least five years and that all client agreements should be kept for the duration of the relationship. Execution Policy The Regulations require that the execution policy of a firm be reviewed both annually and whenever a material change occurs that affects its ability to obtain the best possible result for clients. This would suggest that there should be a wholesale annual review with a more focused review, should a material change occur. Investment firms must regularly monitor the effectiveness of their order execution arrangements and execution policy and assess whether the execution venues included in the policy provide for the best possible result for their clients. Where an investment firm executes orders, they must also be in a position to demonstrate to clients, on their request, that the policy has been followed. Website Where investment firms provide information to clients by way of a website, Regulation 77 requires that the information must be up to date and must be accessible continuously by means of that website for a reasonable period of time. It will therefore be necessary to ensure that adequate procedures are in place in this regard. Transaction Reporting Regulation 112 requires that, unless exempted, where an investment firm executes any transaction in any financial instruments admitted to trading on a regulated market it shall report details of any such transaction to the Financial Regulator or its nominee no later than the close of the following working day. Similar requirements apply in respect of executing instruments that are admitted to trading on a MTF where that instrument derives its value from an instrument traded on a regulated market or MTF. Auditors Regulation 144 requires investment firms to ensure that their external auditors report at least annually to the Financial Regulator where that investment firm holds financial instruments or funds on behalf of clients. Ancillary Processes In addition to the prescribed amendments to an investment firm’s internal structure contained in the Regulations, there also exists a number of less clearly identifiable impacts to ancillary processes and procedures. For example, an investment firm may need to amend HR policies in respect of the conflicts of interest policy adopted by the firm to ensure that employees can operate at a level of independence indicated in the policy and avoid any inappropriate influence. The training department may need to update their procedures to capture the new requirements under the Regulations including capturing the requirements in respect of personal transactions. All new product development will now need to be assessed on the basis of the requirements under the Regulations. This may mean amending the execution policy in certain circumstances, updating client documentation and capturing the new risks presented by the product in reports to senior management. Summary On the eve of the MiFID implementation date, it is clear that MiFID is here to stay and that its requirements will be a significant influence on the way investment firms carry on their business over the coming years. Adapting to new regulatory requirements is never easy and MiFID implementation is particularly challenging given its broad scope and its overlap with other requirements, notably the CPC. While meeting the external client facing requirements for 1 November is a challenge, we feel that implementing the internal organisational and process requirements of MiFID will present an ongoing challenge for some time to come. _____________________________________________________________________________ Further information on the firm is available at www.mop.ie |
Joe Beashel is a partner in the Banking and Financial Services Department and Head of the Regulatory Risk Management and Compliance Group at Matheson Ormsby Prentice; email: joe.beashel@mop.ie or telephone +353 1 232 2000. |