EU regulators remind firms on conduct of business obligations under MiFID II during COVID-19

The COVID-19 outbreak has forced many countries to implement measures to prevent the spread of the pandemic and has caused a major shock to the worldwide economy and financial markets. The approach of competent authorities responsible for the oversight of the financial services industry has been no different: new times call for new measures, or at least a reminder of the measures firms should already be following to protect the investing public.

ESMA's announcement

In consequence, on May 6, 2020, the European Securities and Markets Authority (ESMA) issued a public statement for the benefit of authorised firms and their clients regarding the risks the pandemic poses to the functioning of markets. The regulator also reminded firms of their conduct of business obligations under the EU Markets in Financial Instruments Directive (MiFID II).

ESMA noted in its statement that, during the pandemic, several EU national competent authorities (NCAs) have recorded a significant increase in the number of investment accounts opened by retail clients and a surge in trading by retail clients. The regulator said this meant firms had "even greater duties" when providing investment or ancillary services to investors, especially when those investors were new to the market, or had limited investment knowledge and experience.

ESMA and the NCAs will continue to monitor retail clients' involvement in the financial markets as well as firms' compliance with their conduct of business obligations and related organisational requirements under MiFID II.

In the statement, ESMA reminded firms of their obligation to act honestly, fairly and professionally in accordance with the best interests of their clients. It said firms must comply with all relevant MiFID II conduct of business and related organisational requirements, and in particular with the product governance, information disclosure, suitability and appropriateness requirements.

An outline of the main issues discussed in the statement is set out below.

Product governance under MiFID II

The statement reminded firms that they must have adequate product governance arrangements in place to ensure financial instruments are only offered when they are in the interest of the client or potential client. Firms are required to determine the market they plan to target, and to assess it in an appropriate and proportionate manner, in accordance with the nature of the financial instrument and the investment service they plan to provide or offer, as well as the associated distribution strategy.

Information disclosure under MiFID II

The statement reminded firms of their obligations under MiFID II to provide information to clients or potential clients which is fair, clear and not misleading. In particular, firms must provide appropriate information in good time to clients or potential clients with regard to the firm and its services.

Furthermore, firms must provide information about the financial instruments in which their clients or potential clients may invest. This information must include an appropriate description of the nature and risks of financial instruments to enable the client to take investment decision on an informed basis. It should also explain whether the financial instrument is intended for retail or professional clients, taking account of the identified target market.

Suitability and appropriateness requirements

The statement also addressed the suitability and appropriateness requirements of firms under MiFID II, referring specifically to the suitability assessment, appropriateness assessment and the execution-only exemption:

Suitability assessment — firms which provide investment advice or portfolio management must obtain the necessary information regarding the client's or potential client's knowledge and experience; the client's financial situation, including the client's ability to bear losses; and the client's investment objectives, including the client's risk tolerance, to assess whether the financial instrument or service is suitable for the client. ESMA emphasised that firms should pay particular attention to the possible ramifications of the COVID-19 crisis for the client's personal situation and the risk profile of the client's financial instruments, to ensure that these financial instruments are suitable for the client.

Appropriateness assessment — firms which provide services other than investment advice or portfolio management must obtain information regarding the client's or potential client's knowledge and experience to assess whether the financial instrument or service is appropriate for the client. ESMA stressed that the appropriateness assessment is particularly important for new clients wishing to invest in complex financial instruments during period of heightened market volatility brought about by the pandemic. The statement further reminded firms of their obligation to categorise financial instruments correctly for the purpose of the appropriateness assessment.

Execution-only exemption — under certain conditions, when providing the investment services of execution or reception and transmission of client orders with respect to the financial instruments, firms are allowed to provide those investment services without the need to undertake an appropriateness assessment. The statement emphasised that firms which provide investment services which fall under this execution-only exemption are still required to comply with the other requirements outlined in the statement, especially the requirements relating to product governance and information to clients.

CySEC's announcement

Further to the statement, on May 11, 2020 the Cyprus Securities and Exchange Commission (CySEC) issued Circular 386, which mirrors ESMA's public statement, drawing the attention of Cypriot investment firms (CIFs) to the statement and requesting them to review their policies and arrangements to ensure they fully comply with the conduct of business obligations and related organisational
requirements under MiFID II.

The statement and CySEC's circular both reiterate that despite the working challenges created by COVID-19, regulators around Europe continue to expect full, or indeed heightened, compliance with financial services regulation under MiFID II.

Originally published by ThomsonReuters © ThomsonReuters.