AFM report on deficiences in MiFID II compliance by investment firms that provide investment services to professionals
On 10 December 2019 the AFM published a report with its findings following from an investigation into MiFID II compliance by ten investment firms that provide investment services to professional clients and eligible counterparties in the Netherlands. The report focuses on three main areas: (i) cost transparency, (ii) product governance and (iii) inducements. For a copy of the report (available in Dutch only) see AFM report on MiFID II compliance.
The AFM report provides important information on non-compliance and also on misunderstanding by investment firms on (the scope of) the requirements investigated. It may be expected that this investigation will be followed-up by AFM action and that is why investment firms, that provide investment services to professional clients and eligible counterparties, should pay attention to the AFM findings and take action to the extent necessary. This also goes for foreign investment firms active on the basis of a European passport and investment firms from the U.S., Switzerland and Australia acting on the basis of exemption, as the requirements addressed by the AFM largely also apply to these investment firms.
Some key findings
Without aiming to be complete, the following findings may be highlighted:
- Ex ante information on costs by phone only is insufficient as it must be in writing, also in case time is of the essence.
- In line with ESMA Q&A and contrary to what some investment firms suggest, for the purpose of annual ex-post cost transparency the mere holding of a trading account for execution only transactions suffices for the existence of an ongoing relationship and transactions do not need to be related for that purpose.
- Cost transparency requirements cannot be applied on a proportional basis. In a limited number of circumstances it is however allowed to explicitly agree with the client that certain information will not be provided. This is not possible in case of portfolio management or investment advice to professional clients or in case derivatives are involved. Implicit consent or a clause on consent in general terms is not sufficiently explicit.
- Reporting obligations in respect of portfolio management do not replace or make it unnecessary to provide annual ex-post transparency. Both periodic reports need to be provided to the client (but may be provided together).
- Reception and transmission of orders, execution of orders, portfolio management and even investment advice are all included in the concept of a ‘distributor’ and consequently, investment firms that provide any of these investment services to professional clients must meet the respective product governance requirements for distributors.
- The suitability test does not replace or make it unnncessary to comply with the product governance requirements for distributors including the five target market categories that follow from the ESMA Guidelines on MiFID II product governance requirements (type of client, knowledge and experience, financial situation, risk tolerance and client’s objectives and needs).
- The target market has to be identified at the level of the financial instrument and not at the level of the client portfolio, even with portfolio management and investment advice. Identifying a target market may take place on the basis of a cluster of financial instruments provided that the financial instruments have sufficient similar aspects. Clusters like hedge funds or derivatives are normally not acceptable as they may include different types of strategies or products.
- Minor non-monetary benefits are limited to those set out in the Commission Delegated Directive 2017/593. This is a limitative list and investment firms are not at liberty to independently determine what qualifies as a minor non-monetary benefit, thereby expanding this list. As a result, anything outside the scope of this limitative list (e.g. promotional gifts) qualifies as a prohibited inducement. The old de minimis threshold of €100 no longer applies.
- In case an investment firm is not able to pinpoint the inducement to a specific investment service, the most stringent inducement regime applicable to the investment services and clients of the investment firm applies. This is for example the case if more than one investment service is provided and it is impossbile to determine to which investment service an inducement relates.
- The concept of investment research has to be interpreted broadly also if a more narrow definition is used in policies and procedures of investment firms.
For all AFM findings and explantions please see the report.
The AFM report shows that steps have to be taken by the investment firms investigated to comply in full with the requirements discussed. The AFM concludes the report by stating that it expects all investment firms providing investment services to professional clients and eligible counterparties to make the necessary changes. The AFM also notes that this is not limited to the areas investigated, but it also relates to all MiFID II requirements. For an overview of the relevant changes focused at investor protection the AFM refers to AFM overview of MiFID II changes on investor protection.
As a result, it is advisable to revisit your policies and procedures as well as your client materials in order to assess whether the respective requirements are met, notably the ones investigated by the AFM but preferably also those other changes that follow from MiFID II.