22 October 2010

CESR publishes Technical Advice to the European Commission in the context of the MiFID Review – Client Categorisation

In a letter to the European Commission (Commission) dated 19 March 2010, CESR said that its response to some of the Commission’s questions (which were set out in a letter from the Commission in March 2010) concerning the review of the Markets in Financial Instruments Directive 2004/39/EC (MiFID) might be delayed because of the need to consult.  CESR consulted on its response to on client categorisation of the Commission’s questions because it raised significant policy issues, including some which go beyond the confines of the question asked, on which it was necessary to have stakeholders‟ comments before responding.

Overall, respondents  felt that the current MiFID rules on the categories of  clients, and the obligations attaching to each, are generally appropriate and do not need changing. Several respondents specifically stated their strong concerns about the possibility of the client categorisation regime being subject to amendment.

As set out in its Technical Advice on client categorisation (Ref. CESR/10-1040), CESR agrees with the majority of respondents that the client categorisation regime does not require significant change. While supporting the Commission’s initiative to review MiFID, in order to adapt current provisions to recent developments of the financial and capital markets, most respondents said that MiFID’s client categorisation regime is largely working well. In the context of the wider MiFID review, this majority respondent view indicates that the client categorisation regime does not need radical review.

Most respondents commented that the current tiered client categorisation regime already largely reflects an appropriate balance to provide adequate investor protection to retail and professional clients, and that as MiFID already allows clients to opt down at any time, those who are not comfortable with their classification can, and do, request additional regulatory protection. Many respondents pointed out that this is an important safety feature already built into the process and that it should not be overlooked by the Commission in proposing any changes to the client categorisation regime. Respondents pointed out that the anecdotal evidence suggests that the regime is working well: that is, there has been no significant increase since MiFID implementation in customer complaints about mis-classification; there are very few issues on this subject that have been posted on the Q&A section of the Commission’s website - which possibly reflects the fact that the current regime is well understood by market participants; and there are no widespread practical problems in the day-to-day business of industry players that would make significant change necessary.

While agreeing that per se professional clients and eligible counterparties (ECPs) include entities presenting differences in their nature, their size and the complexity of their businesses, a few respondents pointed out, and CESR agrees, that these differences do not necessarily suggest differences in their respective capabilities to properly assess the risks of the financial markets in which they participate or in asking for more protection where they have doubts. In setting criteria, there is a risk that those that should be included have been left out, and vice versa. But many respondents considered that the current flexible regime strikes the right balance on this front. Also, there is little evidence that the current criteria are perceived by clients as being set too low, as there are not significant numbers of clients requesting greater levels of regulatory protection.

In spite of the majority opposition by respondents to major amendments to the regime, most respondents supported clarifications to the relevant definitions and terms in MiFID where there may be some ambiguity (for example, “locals” and/or “other institutional investors”). As set out in its Technical Advice, CESR does not rule out the possibility of future work at Level 3 to provide guidance or explanations as to what some terms mean in this context.

In the same vein, many respondents considered (and CESR agrees) that it would be helpful to clarify that local authorities do not fall within the scope of “public bodies that manage public debt”; and that, when dealing with ECPs, investment firms have to (i) act honestly, fairly and professionally, and (ii) communicate with ECPs in a way that is fair, clear and not misleading (especially as these standards are consistent with the way in which firms already seek to act in the marketplace).

On the issue of costs and benefits, many respondents pointed out that the current client categorisation regime was implemented (fairly recently) at great cost to the industry. In the absence of any widespread market failure, and against the background of a principle-based regime that already allows for the customised treatment of different advice or selling situations and the accumulated experience with this regime so far, and without any persuasive evidence to the contrary, many respondents considered that there are no grounds that may justify a revision of the client categorisation rules.

Client categorisation is part of a larger system of investor protection that consists also, amongst other rules, of suitability and appropriateness tests for certain services; client information rules; and fitness and propriety tests for prospective directors. Some respondents said that the intention of the client categorisation regime is not to regulate the sale of investment products. These respondents suggested that evidence of mis-selling to per se professional investors is limited to specific sectors and products, and that, therefore, any change in the client categorisation rules should be seen in this context and in the context of the present system that, generally speaking, works well. Many respondents requested that the Commission take into account the fact that any attempt to address the perceived problem by altering the current regime is likely to have another large, and perhaps disproportionate, cost impact on firms (for example, as a result of changes to client take-on procedures, business practices and record-keeping systems).

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