What exactly is MiFID?
Crown: The Markets in Financial Instruments Directive (“MiFID”) established a regulatory framework for the provision of investment services in financial instruments (e.g. brokerage, investment advice and discretionary management) and for the operation of regulated markets (e.g. stock exchanges).
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The Directive, first implemented by EU member states in 2007, was subject to mandatory post-implementation review. Accordingly, late last year the European Commission issued a raft of new proposals for revising MiFID – these proposals are referred to as “MiFID II”.
I should note the proposals are in part a response to new market developments (for instance the rise of high frequency trading) and adjust those provisions which have not met their original objectives – for example exemptions to trading transparency requirements are to be modified to increase the level of disclosure to market participants. As part of that process the Commission has also published a new EU Regulation mainly covering transparency and market integrity issues (“MiFIR”).
Is MiFID relevant to private equity firms?
Some private equity firms are not subject to MiFID. To be more specific, when a private equity firm is the manager and operator of a fund, it will be exempt from MiFID as long as it does not provide any other services to which MiFID applies. For such firms, MiFID II and MiFIR should be of little direct consequence and the major source of regulatory change will be the Alternative Investment Fund Managers Directive.
Similarly, some private equity firms operate on the basis of being an advisor based in an EU member state, while providing investment advice to a non-EU discretionary manager, with advisor and manager being in the same group. The onshore advisor and offshore manager would not usually be subject to MiFID.
Some UK private equity firms operate under “Exempt CAD” status, which is essentially a licence to perform only a limited number of MiFID activities (i.e. investment advice and reception and transmission of orders), in return for which such firms are not subject to the regulatory capital requirements that apply to investment firms which are fully subject to MiFID. Such firms are subject to some aspects of MiFID, on the grounds that they are authorised to provide some MiFID services.
A firm with “Exempt CAD” status has one significant advantage over a firm that is not subject to MiFID: Exempt CAD firms are “MiFID investment firms” and so they have rights to provide investment services on a passported basis throughout the EU.
Finally, a firm may operate a private equity business by means of an investment firm which is fully subject to MiFID. This would be the case, for example, if the firm has discretionary management mandates with funds of which it is the operator (not MiFID business) but also has discretionary mandates for clients which are not funds (this would be MiFID business). Accordingly, MiFID (as amended by MiFID II) will be relevant to such firms – however such firms are in the minority in the private equity sector.
So what kind of impact will MiFID II and MiFIR have on private equity firms?
A few things to note:
• National implementation of MiFID requirements in many cases did not distinguish between “MiFID” and “non-MiFID” business. Accordingly, as it is likely that this same approach will be taken again, some of the reforms will affect regulated firms, whether or not they conduct MiFID business – but the greatest direct impact will be on firms which do conduct MiFID business;
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• Strengthening of corporate governance requirements, in particular in relation to the responsibilities of directors of firms, with the aim of ensuring that management of firms has appropriate levels of knowledge and experience;
• Revisions to the regulatory framework for the provision of investment advice and portfolio management, particularly in respect of the receipt from third parties of inducements and a new requirement to provide a jus Q&A: tification of the suitability of investment advice (which is not limited to the provision of advice to retail clients);
• Strengthening requirements in respect of the safekeeping of client assets and client money. For example, MiFID II proposes that safekeeping of financial instruments for clients becomes a MiFID investment service. This would mean that firms which are not authorised as custodians because they rely on national exemptions from licensing in respect of their custody of fund assets (e.g. the trustee exemption in the UK), would no longer be able to rely on such exemptions; and
• Firms should be aware of the proposals to introduce a regime imposing restrictions on when non-EU entities can deal with investors and others in the EU. This will create a very limited exemption available to non-EU firms that are subject to regulation in their home state which is equivalent to EU standards (but only if the firm’s home state gives reciprocal treatment to EU firms). If adopted in its current form, this could adversely affect the extent to which non-EU entities in a private equity group could interact with persons in the EU. However, this is likely to be one area where there will be significant changes in the legislative process.
When GPs should start worrying then?
The text of the proposed Directive and Regulation must now be negotiated and agreed by the Council of Ministers and the European Parliament. The text is likely to be agreed towards the end of 2012 or early in 2013. For the most part, it is intended that the new rules will apply to firms after a delay of two years, i.e. from late 2014 or early 2015.
In the intervening period, there will be action by the Commission, the new European Securities and Markets Authority (“ESMA”) and national regulators and legislators to consult on and adopt implementing rules. However, the new structure will leave a lot less discretion to national regulators and legislators on how to implement the revised framework, making the EU level legislative and implementation process of even more practical importance. Nevertheless, the national implementation process will still be important and those private equity firms which do not conduct MiFID business will need to be alert to national implementation provisions which apply to both MiFID and non-MiFID business.
Simon Crown is a partner at Clifford Chance LLP, specialising in financial services regulation.
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