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Covid MiFID Recovery Directive: relief for investment firms, to help the recovery from the Covid-19 crisis

By
Paul Foley
Directive (EU) 2021/338[1] (Covid MiFID Recovery Directive) was finally adopted on 16 February 2021 and effects amendments to Directive (EU) 2014/65 (MIFID II) legal regime to assist the EU’s economic recovery from the COVID-19 pandemic. By 28 November 2021, member states must adopt and publish the regulations necessary to comply with the directive, immediately communicate the text of those measures to the Commission and apply those measures from 28 February 2022.

June 17 2021:

Directive (EU) 2021/338  (Covid MiFID Recovery Directive) was finally adopted on the 21st of January 2021 and effects amendments to Directive (EU) 2014/65 (MIFID II) legal regime to assist the EU’s economic recovery from the COVID-19 pandemic. By 28.02.2022, Member States must have implemented this directive into their respective national laws. Set out below are the main amendments to the MiFID II regime adopted in the Covid MiFID Recovery Directive.

(Quick links to topics in this report):

Exemptions for certain Bonds >

Delay in provision of costs and charges information >

Research and execution services: new rules >

Providing an exemption from the cost and charges information disclosure requirements for eligible counterparties and professional clients >

Providing Investment information electronically >

Switching of financial instruments >

Suspending the requirement to publish best execution reports >

Transactions executed with eligible counterparties >

MiFID II Exemptions – commodity derivatives, emission allowances >

Commodity derivatives and net position limits >

Where the requirements on net position limits will not apply >

ESMA’s Obligations and Commodity Derivatives >

Member State obligations as regards trading venues which trade commodity derivatives >

Exemptions for certain Bonds

Bonds with no embedded derivative other than a make-whole clause are generally considered safe and simple products that are eligible for retail clients. Product governance requirements should therefore no longer apply to bonds with no other embedded derivative than a make-whole clause. In addition, eligible counterparties  are considered to have sufficient knowledge of financial instruments. It is therefore justified to exempt eligible counterparties from the product governance requirements applicable to financial instruments exclusively marketed or distributed to them.

An investment firm will be exempted from the requirements set out in the second to fifth subparagraphs of Article 16(3) and in Article 24(2), where the investment service it provides, relates to bonds with no other embedded derivative than a make-whole clause or where the financial instruments are marketed or distributed exclusively to eligible counterparties. 

Delay in provision of costs and charges information

Provision of investment services via telephone requires ex-ante information on costs and charges When a client wants to place an order on the phone, the service provider is obliged to send the cost details before the transaction is executed, a requirement which may delay the immediate execution of the order. Further, MiFID II/MiFIR requires all telephone communications between the investment firm and its clients that may result in transactions to be recorded. Due to this requirement, several banks argue they have ceased to provide telephone banking services altogether.

The Covid MiFID Recovery Directive provides:

“Where the agreement to buy or sell a financial instrument is concluded using a means of distance communication which prevents the prior delivery of the information on costs and charges, the investment firm may provide the information on costs and charges either in electronic format or on paper, where requested by a retail client, without undue delay after the conclusion of the transaction, provided that both of the following conditions are met: (i) the client has consented to receiving the information without undue delay after the conclusion of the transaction; (ii) the investment firm has given the client the option of delaying the conclusion of the transaction until the client has received the information. In addition to the requirements of the third subparagraph ie Article 24(3), the investment firm shall be required to give the client the option of receiving the information on costs and charges over the phone prior to the conclusion of the transaction.”

Research and execution services: new rules

MiFID II/MiFIR, put in place rules on unbundling of research and execution services, to ensure that the cost of research funded by the client was not linked to the volume or value of other services or benefits or used to cover any other purposes, such as execution services. There has been confusion for some time, as to what constituted “research” for the purposes of the MiFID II unbundling requirements. Research is now defined in the Covid MiFID Recovery Directive

In its review of MiFID II/MiFIR, the Commission noted “research coverage relating to Small and Medium-size Enterprises (‘SMEs’) seems to suffer an overall decline. One alleged reason for this decline is the introduction of the unbundling rules. Less coverage of SMEs may lead to less SME investments, less secondary trading liquidity and less IPOs on Union’s financial markets”.

The Covid MiFID Recovery Directive provides “Investment firms should be allowed to pay jointly for the provision of research and for the provision of execution services provided certain conditions are met”. 

To that end, the Covid MiFID Recovery Directive requires member states, to “ensure that the provision of research by third parties to investment firms providing portfolio management or other investment or ancillary services to clients is to be regarded as fulfilling the obligations under Article 24 (1) if:

  • (a) before the execution or research services have been provided, an agreement has been entered into between the investment firm and the research provider, identifying the part of any combined charges or joint payments for execution services and research that is attributable to research;

  • (b) the investment firm informs its clients about the joint payments for execution services and research made to the third party providers of research; and

  • (c) the research for which the combined charges or the joint payment is made concerns issuers whose market capitalisation for the period of 36 months preceding the provision of the research did not exceed EUR 1 billion (as expressed by end-year quotes for the years when they are or were listed or by the own-capital for the financial years when they are or were not listed)” .

Providing an exemption from the cost and charges information disclosure requirements for eligible counterparties and professional clients

The call for evidence, launched by ESMA on the impact of inducements and costs and charges disclosure requirements under MiFID II and the public consultation conducted by the Commission, both confirmed that professional clients and eligible counterparties do not need standardised and mandatory costs information as they already receive the necessary information when they negotiate with their service provider. The information provided to professional clients and eligible counterparties is tailored to their needs and often more detailed.

Services provided to professional clients and eligible counterparties should therefore be exempted from the costs and charges disclosure requirements, except with regard to the services of investment advice and portfolio management because professional clients entering into investment advice or portfolio management relationships do not necessarily have sufficient expertise or knowledge to allow such services to be exempted from those requirements.

Accordingly the Covid MiFID Recovery Directive, provides that the requirements laid down in point (c) of Article 24(4) shall not apply to services provided to professional clients except for investment advice and portfolio management.

Providing Investment information electronically

In order to facilitate communication between investment firms and their clients and thus facilitate the investment process itself, investment information should no longer be provided on paper but should, as a default option, be provided electronically. Retail clients should however be able to request the provision of that information on paper.

The Covid MiFID Recovery Directive provides new rules related to providing information in electronic format by a new Article 5a inserted into Article 24 of MiFID II, which is reproduced at footnote 30 below.

Switching of financial instruments

Investment firms are currently required to undertake a cost-benefit analysis of certain portfolio activities in cases of ongoing relationships with their clients in which financial instruments are switched. Investment firms are thereby required to obtain the necessary information from their clients and to be able to demonstrate that the benefits of such switching outweigh the costs. As that procedure is overly burdensome with regard to professional clients, who tend to switch on a frequent basis, services provided to them should be exempted from that requirement. Professional clients would, however, retain the possibility to opt in. As retail clients need a high level of protection, that exemption should be limited to services provided to professional clients.

Accordingly the Covid MiFID Recovery Directive goes on to provide “The requirements laid down in the third subparagraph of Article 25(2) and in Article 25(6) shall not apply to services provided to professional clients, unless those clients inform the investment firm either in electronic format or on paper that they wish to benefit from the rights provided for in those provisions” .

Suspending the requirements to publish best execution reports

MiFID II (Article 27(3))  introduced reporting requirements for trading venues, systematic internalisers and other execution venues on how orders were executed on terms most favourable to the client. The resulting technical reports contain large amounts of detailed quantitative information about the execution venue, the financial instrument, the price, the costs and the likelihood of execution. They are rarely read, as is evidenced by the very low numbers of views on the websites of trading venues, systematic internalisers and other execution venues. As they do not enable investors and other users to make any meaningful comparisons on the basis of the information they contain, the publication of those reports should be temporarily suspended.

The Covid MiFID Recovery Directive provides that the periodic reporting requirement to the public laid down Article 27(3) of MiFID II in this paragraph shall not apply until 28 February 2023. The Commission shall comprehensively review the adequacy of the reporting requirements laid down in Article 27(3) and submit a report to the European Parliament and the Council by 28 February 2022.

Transactions executed with eligible counterparties

Member States must ensure that investment firms authorised to execute orders on behalf of clients, and/or to deal on own account, and/or to receive and transmit orders, have the possibility of bringing about or entering into transactions with eligible counterparties without being obliged to comply with Article 24, with the exception of paragraph 5a thereof, Article 25, Article 27 and Article 28(1), in respect of those transactions or in respect of any ancillary service directly relating to those transactions.’

MiFID II Exemptions – commodity derivatives, emission allowances 

MiFID II allows persons that trade in commodity derivatives or emission allowances or derivatives thereof on a professional basis to make use of an exemption from the requirement to obtain authorisation as an investment firm, when their trading activity is ancillary to their main business.

These exemptions have been made simpler by the Covid MiFID Recovery Directive. Persons now entitled to avail of these exemptions are persons:

“(i) dealing on own account, including market makers, in commodity derivatives or emission allowances or derivatives thereof, excluding persons who deal on own account when executing client orders; or

(ii) providing investment services, other than dealing on own account, in commodity derivatives or emission allowances or derivatives thereof to the customers or suppliers of their main business; provided that: for each of those cases individually and on an aggregate basis, the activity is ancillary to their main business, when considered on a group basis, those persons are not part of a group the main business of which is the provision of investment services within the meaning of this Directive, the performance of any activity listed in Annex I to Directive 2013/36/EU (MiFID II), or acting as a market maker for commodity derivatives, those persons do not apply a high-frequency algorithmic trading technique, and those persons report upon request to the competent authority the basis on which they have assessed that their activity under points (i) and (ii) is ancillary to their main business.”

By 31st of July 2021, the Commission will adopt by a delegated act, supplementing the Covid MIFID Recovery Directive, the criteria for establishing when an activity is to be considered to be ancillary to the main business at group level. The criteria will take account of those elements specified in Article 2(4) of the Covid MiFID Recovery Directive.  Certain transactions are excluded from these elements as specified in Article 2(4).

Commodity Derivatives and net position limits

Currently, competent authorities have to set and apply limits on the size of a net position which a person can hold at all times in commodity derivatives traded on trading venues and in economically equivalent over-the-counter (EEOTC) contracts.

The recitals to the Covid MiFID Recovery Directive provide reasons for the new rules on net position limits:

  • the current position limit regime has proved to be unfavourable for the development of new commodity markets. Position limits should only apply to critical or significant commodity derivatives (as defined) that are traded on trading venues, and to their EEOTC contracts

  • due to the critical importance of agricultural commodities for citizens, agricultural commodity derivatives and their EEOTC contracts will remain under the current position limit regime

  • MiFID II does not allow hedging exemptions for any financial entities. That hedging exemption should be available where, within a predominantly commercial group, a person has been registered as an investment firm and trades on behalf of that commercial group. However the exemption should only apply to the positions held by such financial entity that are objectively measurable as reducing risks directly relating to the commercial activities of the non-financial entities of the group

  • Even in liquid contracts, only a limited number of market participants typically act as market makers in commodity markets. When those market participants have to apply position limits, they are not able to be as effective as market makers. Therefore, an exemption from the position limit regime should be introduced for financial and non-financial counterparties for positions resulting from transactions undertaken to fulfil obligations to provide liquidity;

  • securitised derivatives must be excluded from the application of position limits and reporting requirements. Recital (16) explains why;

  • The amendments as regards the position limit regime are designed to support the development of new energy contracts, and do not seek to relax the regime for agricultural commodity derivatives;

  • Since the entry into force of MiFID II, no same commodity derivative contracts have been identified. The reference to ‘same contract’ in Directive 2014/65/EU should be deleted. Competent authorities should be able to agree that the commodity derivatives traded on their respective trading venues are based on the same underlying and share the same characteristics, in which case the central competent authority within the meaning of the first subparagraph of Article 57(6) of Directive 2014/65/EU (MiFID II) should set the position limit.

The new rules require member states to set and apply limits on the size of a net position (note below where the position limits do not apply), which a person can hold at all times in agricultural commodity derivatives  and critical or significant commodity derivatives that are traded on trading venues, and in economically equivalent OTC contracts. The methodology they are required to use is determined by ESMA under Article 57(3) of MiFID II.  

The limits must be set based on all positions held by a person and those held on his or her behalf at an aggregate group level in order to: (a) prevent market abuse; (b) support orderly pricing and settlement conditions, including preventing market distorting positions, and ensuring, in particular, convergence between prices of derivatives in the delivery month and spot prices for the underlying commodity, without prejudice to price discovery on the market for the underlying commodity.

Where the requirements on net position limits will not apply

The position limits referred to in Article 57(1) will not apply to:

  • (a) positions held by, or on behalf of, a non-financial entity, and which are objectively measurable as reducing risks directly relating to the commercial activity of that non-financial entity;

  • (b) positions held by, or on behalf of, a financial entity that is part of a predominantly commercial group and is acting on behalf of a non-financial entity of the predominantly commercial group, where those positions are objectively measurable as reducing risks directly relating to the commercial activity of that non-financial entity;

  • (c) positions held by financial and non-financial counterparties for positions that are objectively measurable as resulting from transactions entered into to fulfil obligations to provide liquidity on a trading venue as referred to in point (c) of the fourth subparagraph of Article 2(4);

  • (d) any other securities as referred to in point (c) of point (44) of Article 4(1) which relate to a commodity or an underlying as referred to in Section C.10 of Annex I. (part of new Article 57 (1) inserted into MiFID II by the Covid MiFID Recovery Directive. (See also this note).

ESMA’s Obligations and Commodity Derivatives

  • to develop draft regulatory technical standards to determine a procedure by which a financial entity that is part of a predominantly commercial group may apply for a hedging exemption for positions held by that financial entity that are objectively measurable as reducing risks directly relating to the commercial activities of the non-financial entities of the group;

  • to determine a procedure setting out how persons may apply for an exemption for positions resulting from transactions entered into to fulfil obligations to provide liquidity on a trading venue. ESMA shall submit the draft regulatory technical standards referred to in the third and fourth subparagraphs to the Commission by 28 November 2021;

  • to draw up a list of critical or significant commodity derivatives referred to in Article 57(1) and develop draft regulatory technical standards to determine the calculation methodology that competent authorities are to apply when establishing the spot month position limits and other months’ position limits for physically settled and cash settled commodity derivatives based on the characteristics of the relevant derivative concerned. When drawing up the list of critical or significant commodity derivatives,

  • when drawing up the list of critical or significant commodity derivatives, to take into account the factors set out in new Article 57(3) and submit the draft regulatory technical standards to the Commission by 28 November 2021. Power is delegated to the Commission to supplement the Covid MiFID Recovery Directive by adopting the regulatory technical standards referred to in Article 57(1) the first subparagraph of this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010

  • to settle any dispute arising from a disagreement between competent authorities in accordance with its powers under Article 19 of Regulation (EU) No 1095/2010 that arise between competent authorities in the context of the application of new Article 57(6) of MiFID II.  

  • to monitor at least once a year the way competent authorities have implemented the position limits set in accordance with the calculation methodology established by ESMA under paragraph 3. In doing so, ESMA shall ensure that a single position limit effectively applies to the agricultural commodity derivatives and critical or significant contracts based on the same underlying and sharing the same characteristics irrespective of where they are traded in line with paragraph 6 (ie new Article 57(6) of MiFID II). 

  • to develop draft regulatory technical standards to specify the content of position management controls ( required under new Article 57(8) of MiFID II), thereby taking into account the characteristics of the trading venues concerned. ESMA shall submit those draft regulatory technical standards to the Commission by 28 November 2021.

Position limits must specify clear quantitative thresholds for the maximum size of a position in a commodity derivative that persons can hold .

Obligations of competent authority:

set position limits for critical or significant commodity derivatives and agricultural commodity derivatives that are traded on trading venues, based on the calculation methodology laid down in the regulatory technical standards adopted by the Commission. Such position limits must include economically equivalent OTC contracts;

must review the position limits, where there is a significant change on the market, including a significant change in deliverable supply or open interest, based on its determination of deliverable supply and open interest, and reset those position limits in accordance with the calculation methodology laid down in the regulatory technical standards adopted by the Commission pursuant to new Article 57(3) of MIFID II.

Competent authority where trading is occurring in more than one jurisdiction

Where agricultural commodity derivatives based on the same underlying and sharing the same characteristics are traded in significant volumes on trading venues in more than one jurisdiction, or where critical or significant commodity derivatives based on the same underlying and sharing the same characteristics are traded on trading venues in more than one jurisdiction, the competent authority of the trading venue where the largest volume of trading takes place (“central competent authority”) shall set the single position limit to be applied on all trading in those derivatives.

Where position reporting is not applicable

Position reporting will not be applicable to any other securities as referred to in point (c) of point (44) of Article 4(1)  that relate to a commodity or an underlying as referred to in Section C.10 of Annex I.  See also this reference.

Trading outside a trading venue

Member States shall ensure that investment firms trading in commodity derivatives or emission allowances or derivatives thereof outside a trading venue provide, on at least a daily basis, the central competent authority referred to in Article 57(6) or where there is no central competent authority, the competent authority of the trading venue where the commodity derivatives or emission allowances or derivatives thereof are traded, with a complete breakdown of their positions taken in economically equivalent OTC contracts and, when relevant, in commodity derivatives or emission allowances or derivatives thereof traded on a trading venue, as well as of those of their clients and the clients of those clients until the end client is reached, in accordance with Article 26 of Regulation (EU) No 600/2014 and, where applicable, of Article 8 of Regulation (EU) No 1227/2011.

Member State obligations as regards trading venues which trade commodity derivatives

Member States must ensure that an investment firm or a market operator operating a trading venue which trades commodity derivatives applies position management controls, including powers for the trading venue to:

  • (a) monitor the open interest positions of persons;

  • (b) obtain information, including all relevant documentation, from persons about the size and purpose of a position or exposure entered into, information about beneficial or underlying owners, any concert arrangements, and any related assets or liabilities in the underlying market, including, where appropriate, positions held in commodity derivatives that are based on the same underlying and that share the same characteristics on other trading venues and in economically equivalent OTC contracts through members and participants;

  • (c) request a person to terminate or reduce a position, on a temporary or permanent basis, and to unilaterally take action to ensure the termination or reduction of the position where the person does not comply with such request; and

  • (d) require a person to provide, on a temporary basis, liquidity back into the market at an agreed price and volume with the express intent of mitigating the effects of a large or dominant position.

Reporting of potential or actual infringements, through a specific independent channel

Member States must require investment firms, market operators, APAs and ARMs authorised in accordance with Regulation (EU) No 600/2014 that have a derogation in accordance with Article 2(3) of that Regulation, credit institutions in relation to investment services or activities and ancillary services and branches of third-country firms to have in place appropriate procedures for their employees to report potential or actual infringements internally through a specific, independent and autonomous channel.


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