The MIFID Framework

Local public authorities and municipalities are now categorised as retail clients (RC), which will determine the type of products and services available to them. They may however request to opt up to elective professional counterparties (PCs) but will not be able to opt up to eligible counterparties (ECPs) once they are elective PCs.

ⁱ This includes the 28 EU member states and, once incorporated into the EEA Agreement and transposed into national law, Iceland, Norway and Liechtenstein.

• Client data is required to meet multiple obligations (e.g. LEIs, information relating to suitability and appropriateness and trade reporting data)
• In-scope clients will need to agree new and updated legal documentation; and clients who trade with multiple financial institutions will have to undertake a comprehensive repapering exercise with each firm

Uncertainties

Member States may adopt specific criteria to assess the knowledge and expertise of local public authorities and municipalities; and their capacity to opt-up to the PC category.

LEI

The Legal Entity Identifier (LEI) is a 20-character, alpha-numeric code, utilised to uniquely identify legal entities that engage in financial transactions.

The European Securities and Markets Authority (ESMA) and the Financial Conduct Authority (FCA) prohibit investment firms from offering services to clients when they do not have an LEI.

Therefore, HSBC is not able to trade any in-scope financial instrument with a legal entity that does not have an LEI.

If you don’t already have an LEI, please apply for one as soon as possible via the Global Legal Identifier Foundation (GLEIF) portal (www.gleif.org).

Please use the following HSBC LEIs for your trade reporting requirements:

HSBC Bank PLC: MP6I5ZYZBEU3UXPYFY54
HSBC Bank Malta Plc: 549300X34UUBDEUL1Z91
Trinkaus & Burkhardt AG: JUNT405OW8OY5GN4DX16
HSBC France: F0HUI1NY1AZMJMD8LP67
HSBC Bank USA, National Association: 1IE8VN30JCEQV1H4R804
The Hongkong and Shanghai Banking Corporation Limited: 2HI3YI5320L3RW6NJ957
HSBC Bank Middle East Limited: 549300F99IL9YJDWH369
HSBC Bank Bermuda Limited: 0W1U67PTV5WY3WYWKD79
HSBC Bank AS: 5493000LVYTQWA3M5N66
HSBC Bank (RR) LLC: 213800RIKWMIPY1ZV607

Governance

Product governance in relation to design, distribution and life-cycle management will be formalised.

Terms of business

Terms of business are required when co-manufacturing with a non EU entity and there are changes to our terms of business with distributors to reflect updated roles and responsibilities.

Manufacturers and distributors

• Governance process to be formalised (product design, distribution & life-cycle management).
• Product-specific testing to inform the manufacturing process.
• Product reviews and information-sharing requirements to capture investor feedback.
• Changes to terms of business with distributors to reflect updated roles and responsibilities and formalise the revised governance process.
• Terms of business required when co-manufacturing, including with a non-EU entity.
• Manufacturers and distributors to formally consider the appropriate target market for products they manufacture / distribute.

Uncertainties

• Definition of target market is not set in stone
• Feedback loop process
• Definitions of events which are material and ‘scenario analysis’ testing

• Independent advisers and asset managers cannot receive inducements unless they are “minor non-monetary benefits”, or they pay for them. The list of “minor non-monetary benefits” is prescriptive and includes generic information, corporate issuer research and de minimis hospitality. Minor non-monetary benefits include:
  • Information relating to a financial instrument or investment service, (generic in nature or personalised to reflect the circumstances of the individual client).
  • Market colour and non-research short-term sales materials are considered minor non-monetary benefits which can be received.
  • Materials from issuers to promote new issuances / ongoing materials.
  • Participation in training events on the benefits and features of a specific financial instrument or investment service.
  • Hospitality of a de minimis value.
  • Other reasonable and proportionate non-monetary benefits specified by the relevant member state.
• For independent advisers and asset managers, substantive research is an inducement unless it is paid for from a firm’s own funds or through a client funded research payment account and disclosed to clients (see related topic ‘Research unbundling’).
• The quality enhancement and client best interest test, as well as the disclosure of the inducement, remain from MiFID.

Uncertainties

• Jurisdictions may differ in the way the rules are implemented e.g. Member States can specify additional minor non-monetary benefits.
• Some services may be difficult to qualify as inducements or non-monetary benefits.
• Interpretation as to what qualifies as enhancing the quality of service.

Independent advisers and portfolio managers can only receive research and sales if both are paid for either:

• directly out of their own resources (hard dollar / P&L); or
• through a client funded Research Payment Account (RPA).

Practically, this will mean:

• conclusion of agreements relating to the operation of RPAs; and
• research and sales to be paid separately from execution (unbundled costs and charges).

Uncertainties

• How will agreements for RPAs be used to accommodate rules?
• The FCA’s latest consultation paper suggests that in the UK the regulation will be extended to cover a broader range of firms e.g. collective portfolio managers.
• Regulatory conflicts with other regulation e.g. US rules mean that under MiFID II, EU asset managers cannot receive US research.

Suitability

MiFID II brings in more onerous obligations on investment firms to determine suitability (including of bundled packages of products).

Appropriateness

• Appropriateness requirements apply to the provision of execution-only services.
• MiFID II widens the range of 'complex' products, for which an appropriateness assessment is required.
• Appropriateness requirements do not apply when dealing with eligible counterparties nor do they apply when providing execution-only services for non-complex products.

The three pillars of Appropriateness

Client categorisation

• If you are re-categorised as an RC, we may need additional information to carry out our appropriateness tests.
• If you are an ECP, there will no change and we can continue to act towards you as we currently do.

Product complexity

• MIFID II lowers the threshold of what is considered a 'complex' product. All products which embed a derivative are considered complex.
• For bundled products / services, the overall package must be appropriate.

Execution method

• DEA execution channel requires appropriateness tests to ensure a client possesses the relevant knowledge and experience to trade electronically.

• All products and services are in scope of the costs and charges requirements.
• Costs related to underlying market risk are excluded.
• In specified circumstances, some limited application may be agreed, for example, it may be possible to agree a narrower application for eligible counterparties.
• Investment firms are obliged to provide clients with pre-trade and post-trade disclosures:
  • costs and charges to be aggregated into a percentage and cash amount; and
  • an itemised breakdown can be requested by clients
• Clients must be informed of any anticipated spikes, or fluctuations in costs.

Uncertainties

• A practical interpretation has yet to be agreed by industry forums.
• How mark-ups will be treated in cost and charges disclosures is subject to industry debate.

Systematic Internaliser (SI) Regime

• SIs are investment firms that deal on own account when executing client orders on an ‘organised, frequent, systematic & substantial basis’ outside of a trading venue.
• Specific volume thresholds under MiFID II have been introduced to determine whether a firm is an SI.
• In some cases, firms may also elect to become an SI for commercial reasons, even when not obliged to do so.
• Pre-trade transparency publication obligations apply to trades conducted by SIs in liquid products below volume thresholds.

Exchanges & Trading Venues

• The transparency obligations for Multilateral Trading Facilities (MTFs) (a venue which existed under MiFID I) has been extended from shares to cover a wider range of products.
• MiFID II introduces the new venue “Organised Trading Facility” (OTF) for non-equity instruments.
• All venues will be subject to pre-trade and post-trade transparency requirements.

Trading Obligations

• Shares must be traded on a RM, MTF or through an SI.
• Standardised derivatives mandated for both central clearing under EMIR and trading under MiFIDII must be traded on venues (MTF, OTF or RM).

Uncertainties

• The range of instruments that will be subject to the derivatives trading obligation.
• The list of instruments that are ‘Traded on a Trading Venue’ (TOTV) and therefore subject to the SI transparency regime/share trading obligation.
• Third Country trading venue equivalence.

Algorithmic trading and DEA

• MiFID II prescribes new rules for firms engaging in algorithmic trading. They must have effective systems and risk controls to ensure trading systems are resilient, have enough capacity, are subject to thresholds and limits which prevent sending erroneous orders.
• Where HSBC is a DEA provider its obligations will include:
• Implementing policies to ensure DEA clients comply with trading venue rules
• Applying controls (similar to those mentioned above for algo trading) to the DEA flow
• Carrying annual due diligence of DEA clients
• Requiring DEA clients who delegate their access to have equivalent due diligence requirements in place

Clock sync & High Frequency Trading

• For information, trading venues and their members and participants are required to synchronise business clocks to varying degrees of granularity depending on what is traded.
• Additional time-sequenced record-keeping applies to HFT activity.

Uncertainties

• Provision of algo ID and personal data for transaction reports.
• Disparate venue certification approach.

• Top 5 execution venues by MiFID II product classification must be published annually (‘RTS 28’ reporting). This includes the reporting of Securities Financing Transactions (SFTs).
• Where a Systematic Internaliser (SI), liquidity provider or market maker, HSBC must publish data relating to the quality of execution on a quarterly basis (‘RTS 27’ reporting).
• Uptick to ‘sufficient steps’ must be taken to ensure the best possible results when acting on behalf of clients. The following considerations must be taken into account:
  • the price, costs and speed
  • the likelihood of execution and settlement
  • the nature of the order
• The proposed price for OTC products, including those which are bespoke, must be based on market data; and compared to similar products where possible. Additional consideration must be given to whether the order involves a securities financing transaction.
• The trade collection dates for Top 5 Venue reporting (RTS 28) are challenging.

Uncertainties

• Further regulatory guidance might be released.

• Broader scope of financial transactions now need to be reported.
• Both counterparties (investment firms) to a trade must report transactions data (65 fields, which include investor details) to regulators.
• Reportable data includes information on the person or algorithm responsible for the investment decision and execution.
• Transaction Reporting may be done through an investment firm’s own arrangements, an Approved Reporting Mechanism (ARM) or by the trading venue through which the transaction was completed no later than the close of the following working day.