The impact of MiFID II

Private equity firms that act purely as “advisors” – giving non-binding investment recommendations without actual management decision-making authority – are within scope of Markets in Financial Instruments Directive, because MiFID regulates the giving of financial advice. This is of sufficiently broad scope to include private equity advisors. Although this advice will usually be given to an affiliated manager or general partner, and although MiFID includes a group exemption (for those firms that “exclusively” provide services to their affiliates), UK private equity advisors have generally stepped into the Financial Conduct Authority’s regulatory perimeter, obtained authorization under MiFID and availed themselves of the EU passport for any activities they conduct in the EU. There is a different position for private equity advisors in the EU outside the UK, which have generally not sought authorization from their local regulator.

MiFID provides an investor protection framework for the giving of investment advice, covering matters such as whether or not the advice is provided on an “independent” basis (not typically the case with private equity advisors), full disclosure (with particular focus on costs and charges), “suitability” of the advice given and on-going reporting. Although these rules were not drafted with private equity “investment recommendations” in mind, they apply to the advice given by private equity advisors – although, in practice, can be applied with a light touch.

The directive also regulates the activities of fund distributors, applying, for instance, detailed disclosure requirements when selling products to investors. Although private equity firms and their placement agents are commonly authorized to perform this activity under MiFID, there is some doubt whether the interaction that private equity firms (and placement agents) have with institutional investors rises to the level of MiFID distribution (in particular, the actual handling of investor orders) that MiFID contemplates for the rules to apply.

MiFID also regulates house compliance matters, such as the treatment of “inducements” received by the firm (including entertainment received by the house staff) and staff conduct, such as their personal account dealing. The regulation also requires firms to record and monitor certain types of staff telephone calls. In practice, telephone recording is of particular regulatory focus in the context of trading on public markets, of limited relevance to private equity firms.  Few, if any, private equity firms recorded staff telephone calls as a compliance measure. Given MiFID II’s requirement to apply the obligation to corporate finance business (with the FCA expecting corporate finance advisors to record telephone conversations on key elements of a final M&A transaction), private equity advisors must consider putting in place a new telephone recording system – although it largely appears to date that advisors have relied on paper records to satisfy this obligation.

UK local authority pension schemes, active investors in private equity, have been re-categorised as retail clients under MiFID II. Marketing to any retail investor in the EU should always raise red flags within a firm, with implications such as the application of the onerous

Packaged Retail and Insurance-based Investment Products regulation. Fortunately, most local public authorities that currently invest in private equity have indicated their willingness to be opted-up as professional clients and the FCA has introduced a tailored opt-up test for this to take place.

Lastly, private equity advisors will need to consider the application of MiFID post-Brexit. Although the FCA will likely to continue to apply MiFID rules in a post-Brexit world, private equity advisors will need to consider whether their activities in the EU will continue to require the MiFID passport. Private equity firms that have opened branches across the EU on reliance on the passport will need to consider alternative structures. For firms that confine their EU activities to deal negotiations and investor relations, the continuing relevance of the passport is an issue of legal uncertainty – although it can safely be said that the passport provides legal certainty to conduct operations without satisfying local licensing requirements, especially for firms that conduct activities of scale.