UK Implementation of MiFID

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Slide 1 - Introduction

Good morning ladies and gentlemen. I thank the BBA for the opportunity to speak to you this morning on MiFID implementation. Through this year, implementation of the Directive will continue as a major challenge for regulators across Europe and for firms engaged in securities and investment business.

Slide 2 - Agenda

So my agenda this morning begins with some highlights on implementation in the UK and in Europe more generally. But I take care to leave room for the Clifford Chance presentation as regards continental Europe.

Outputs from CESR's Level 3 work programme are important in a number of areas. Good progress under most headings, which should help with consistency of application as firms have rightly been expecting.

Then, a few words on the state of play on the UK Article 4 notification made back in January.

Firms' implementation programmes are gathering pace, and I will share with you results from some recent thematic work we have done across different sectors.
Finally, as we have long recognised, there is role for industry guidance to provide useful, practical input implementation on the ground. In that context I will touch on the state of play regarding draft guidelines being prepared by MiFID Connect.

If time permits I could say a little on some of the opportunities that MiFID could bring for investment firms and securities markets. But I sense that today, with just 6 months to implementation, my contribution can best focus on the gritty realities and priorities rather than speculative or philosophical reflections on the potential benefits of MiFID. Our cost-benefit study published last autumn won some praise as a fair snapshot from that perspective, for those of you interested.

Slide 3 - Transposition Status

Transposition: UK and elsewhere

Member States were required to transpose MiFID by 31 January 2007. As you know, the UK met that deadline. That reflected excellent engagement by the industry – including notably the BBA and its members for which we are most grateful - and by other stakeholders in the heavy programme of Treasury and FSA consultations launched last year.

That enabled us to publish in January, two policy statements and accompanying Handbook text:

PS07/2 "Implementing the Markets in Financial Instruments Directive" that provided feedback on our July consultation paper, along with the MiFID essential elements of our October consultation papers on the reform of the conduct of business and financial promotion regimes. And
PS07/3 "Reforming the Approved Persons Regime" which confirmed the MiFID-driven changes to our approved persons regime.

Taken together, these papers finalised FSA's transposition of MiFID for firms and markets.

Complementing what we have done, and indeed essential to meet the UK's transposition obligations, was the Treasury's substantive secondary legislation under FSMA, all of which has now been made.

So, while uncertainties remain on interpretations and transitionals in some areas - to which I will return shortly – the basic framework of law and regulation is now settled.
Turning to implementation across Europe, the Commission has been taking stock of progress among other Member States. The results of a questionnaire-based survey, recently published on the Commission's website, show that while only the UK and Romania transposed on time, most other Member States plan to have done so by 1 November. While not guaranteed, the picture emerging should help to allay concerns about late or "staggered" implementation across Europe.

It remains possible that some Member States will implement late, which has raised concerns about validity of firms' passports in such states. We believe that there are valid arguments to say that if UK firms have an outward passport for investment business today, the fact that they passport into a Member State that has not implemented MiFID on time should not prevent their continuing to do business. We think there are also tenable arguments to deal with other scenarios, for example, new firms passporting from the UK which did not have an ISD passport, and firms passporting into the UK from Member States that have not implemented on time.

However, particularly for outward business from the UK, the key question may be whether other Member States will take the same approach. We cannot affect the way the law is applied in other Member States. While firms may have the ability to take errant Member States to the European Court of Justice, legal proceedings against national regulators are unlikely to be an attractive option in managerial terms. To deal with any eventual problems in this area, a pan European approach will be desirable and well ahead of November pragmatic solutions will need to be found.

Slide 4 - Close out of UK consultation

Before turning to progress at CESR level, I will say a few words about our remaining domestic programme in the run up to 1 November, focussing on material that should assist firms' implementation planning – which, with just six clear months to go, should now be in full swing.

We recently published, in PS07/5, our final version of PERG – Perimeter Guidance relating to MiFID – which provides helpful pointers for firms in assessing whether they fall within the scope of MiFID and CRD.

We plan to publish our guide to the changes required by MiFID to the information we hold on the business that firms do shortly. It covers various types of notification, changes to permission statements and other relevant data. These are the rather unglamorous but important issues that need to be addressed to ensure smooth practical transition (and to ensure that firms are correctly authorised from 1 November). Under a number of headings – including operation of the Article 3 exemption, client categorisation, tied agents, passporting, and so on – the guide will set out the practical steps that firms will need to take.

Wherever possible and consistent with our legal obligations, we shall be looking to use automated data transfer techniques – but this will not be possible in all cases. This means that, in a number of areas, there will be action for firms to take either to verify, or to provide afresh to us, information about their business under these various headings. The guide will explain the what, when and how of this.

A key area for many firms, for example, is client categorisation. Where firms' permission statements carry limitations on the types of client with whom they can do business, we have been exploring with HM Treasury the scope for transitional arrangements that would enable automatic updating of those statements where existing restrictions on client types map across to the MiFID categories. The Treasury looks to consult shortly on draft regulations to effect that. But where direct mapping is not possible, or where changes in limitations are planned, then firms will need to apply to vary their permission statements.

Slide 5 - CESR Level 3 work programme

As I indicated in my opening remarks, the conclusions of the CESR Level 3 programme are important for all our planning. I will trip lightly over the current state of play as Carlo Comporti will cover that in more detail straight after lunch.
For the record, back in February, CESR published final recommendations and guidelines on the list of minimum records and on market data consolidation, with which we were broadly content.

On best execution and transaction reporting CESR consultation is all but complete and we expect final conclusions shortly.

Slide 6 - Best execution

On best execution, as many of you will know, CESR has sought Commission guidance on the scope of the MiFID obligation. The Commission's view is now available and - in essence – is that best execution will only apply in dealer markets where the firm is acting on its client's behalf when executing an order. This offers a pragmatic and workable solution to a problem that was seen by many as intractable just 2 or 3 months ago.

Our impression is that the industry believes it can work with the Commission's view on scope, and that work by CESR on the matter is not sensible at this stage. So, the way seems clear for CESR to finalise its recommendations on delivery of the best execution obligations, which we expect to be set out in Q&A form shortly.
From a UK perspective, we will use our forthcoming policy statement to update our previous communications in this area.

Slide 7 - Transaction reporting

On transaction reporting, domestically we have sought to maintain the current regime save for the changes required to implement MiFID. The only new feature not required by MiFID is a separate instrument flag for credit default swap transactions – which is warranted given the importance of this market. As with the rest of the Directive, we delivered on our commitment to incorporate the transaction reporting requirements into our rule-book by the end of January. We are now working with the industry to draw up a detailed Transaction Reporting User Pack to help firms understand and comply with their obligations, which we expect to be available in final form in the summer.

Progress at the CESR level has been slower. And while the Level 3 guidance has yet to be signed off by the CESR chairs, welcome consensus has been reached at working level on two key issues.

The first concerns where branches should direct their transaction reports. Industry has been understandably keen to avoid a requirement for split reporting, (some directed to the branch's host authority and some to the home authority of the parent entity). I am pleased to report that the proposition before CESR chairs is expected to be that – at the firm's option - all transactions conducted by branches may be reported to the host authority and that no further sign-off for such arrangements from individual CESR members will be required.

The test to determine where the trade is done is expected to be the location of the person committing the firm to the transaction and not where the transaction may be "booked". So if a trader in London is doing the transaction, the report is made to the FSA under the FSA's rules. We think this is a sensible outcome.

The scope of the reporting obligation has been more contentious: what is meant by 'execution of a transaction'? CESR members such as ourselves who collect client ID information wanted to ensure we could continue to obtain transaction information to enable us to identify the ultimate client. Other CESR members collect, as a matter of routine, only 'market-facing' transaction reports. The emerging solution is an interim solution under which regulators can, but are not obliged to, collect reports of the client-facing leg of a transaction as well as the market-facing leg. CESR would review this once the MiFID transaction reporting regime has been in full operation for a year, with a view to producing convergence.

The finalised Level 3 CESR guidance on transaction reporting should, at last, be published next month. We know the delay in producing definitive guidance has caused difficulty for firms. So, while we will implement the new transaction reporting rules on 1 November as required, I emphasise that we are prepared to discuss any transitional problems which firms may face. We have maintained a close dialogue with the industry on our plans for the transaction reporting regime and will continue to do so as we move to implementation.

On inducements it is fair to say that in continental Europe, unaccustomed to transparent disclosure requirements covering commission payments paid on retail sales of UCITs, the CESR consultation triggered some strong push-back as it highlighted for firms the impact of the Level 1 and 2 requirements. Given the controversy, CESR reconsulted on 13 April, with some useful clarifications but, obviously, no derogations from what Levels 1 and 2 require. Going the extra mile should not affect CESR's aim to publish final guidelines to its members in the course of May.

Slide 8 – Passporting: Home-Host

On passporting, where the CESR consultation closed in February, the key issue has been – and for the moment remains – the respective role of home and host states in respect of conduct of business done by branches. Industry has been very clear that its desired outcome is that as far as possible only a single set of requirements should be applied to a branch on a day-to-day basis.

Oversimplifying, the core issue is whether the home or host regulator is responsible for oversight of investment business done by a branch with clients outside the host jurisdiction. Discussions on this continue with the Commission, within CESR and between Member States and are by no means straightforward.

There appears to be some recognition of the downside of artificial and narrow sub divisions of branches' patterns of business. That could leave gaps in consumer protection, fuel disagreements over which regulator is responsible for what elements of the service provided and drive up firms' costs. To keep effective oversight of the major volumes of investment business done by London branches, we believe it essential that the FSA have the right powers.

The Directive's preamble focuses on the effectiveness of supervision and recognises that the local supervisor is best placed to oversee the activities of the branch – reflecting the practical advantages of physical proximity. The directive makes no reference to the proximity of the supervisor to the client. This makes good sense - if the location of the client rather than the location of the firm's operations were the main condition for effective supervision the directive would have also given the host state responsibility for purely cross borders services – but it did not.

However, we see both home and host regulators as having standing for branch business having an international element, which complements the home regulator's general responsibility for systems and controls. Of course home and host are free to rely on each other's oversight for particular classes of business and we are keen to encourage such cooperation to reduce the practical burdens for firms and regulators alike.

Slide 9 – Article 4

As most of you will know, at the end of January, we submitted notifications under Article 4 of the Level 2 Directive to the Commission setting out certain existing rules that were minded to retain. The areas covered were clearly flagged in CP 06/19 – Reforming conduct of business regulation – last October, but were not among the rules made in January because, as national requirements, they do not form part of our transposition as such.

The cases we put forward were well-argued and properly respected the Article 4 criteria. We are of course now considering carefully the comments of respondents to CP 06/19 in relation to the relevant matters. We also stand ready to discuss our Article 4 cases in more detail with the Commission, and expect to do so early in May. If necessary, we will defer rule-making in these areas beyond May - when we plan to publish the main feedback statement on Newcob - and finalise those decisions in the summer. While this is not ideal for implementation planning, firms should already be operating in compliance with existing requirements that were the subject of the notifications.

Within the single-market and harmonising thrust of MiFID, Article 4 is an important safety valve, subject to proper conditions, for local measures required to address issues particular to national markets. We intend to make proper use of the mechanism in cases where – under our statutory objectives relating to consumer protection, clean markets and so on – such measures are required to keep our regime up-to-date. In future, for the sake of all stakeholders in the UK markets we need to be making flexible responses to relevant new developments, in a timely way.

Slide 10 – Firms' preparations and progress

Turning now to firms' preparedness, you may have seen a report run by the FT last month on a survey conducted by a software group active in the financial services market. It found - and I quote:

"Almost one-third of UK-based financial institutions and firms are not expected to meet the MiFID compliance deadline of November 2007. In the whole of Europe, the situation is worse, with almost two-thirds of financial firms expected not to be compliant."

However you view this type of report, it does at least suggest that UK firms are relatively well-prepared, reflecting no doubt higher levels of awareness in the UK and the degree of certainty that we have been able to give the market through timely transposition of the MiFID requirements.

But let me share with you some findings of our own from thematic supervision work and dialogue with firms over the course of the last year.

Starting at the wholesale end of the market, in the UK-based wholesale investment bank sector, most major firms are on their second or third progress review meeting with us. Steering groups are well-established; gap analyses done; and work-streams identified, allocated and fully under way in most cases. MiFID may initially have been seen as a compliance-led project, but many firms have now put ultimate responsibility for implementation with the business. Some firms have already taken strategic decisions opened up by MiFID while others have decided to defer such decisions until post-implementation.

For wholesale banks and investment firms, we have taken a risk-based approach concentrating – in "ARROW" terms - on High and Medium-High impact firms. MiFID preparations have been tracked through a mix of close and continuous contact, regular reporting and ad hoc discussions. Most firms have established project teams to take forward their MiFID preparations – though we had to prompt a few that were behind the curve. Again, most firms have undertaken gap analyses and relatively few, now, have yet to assess properly the implications of MiFID - though we have a sense that smaller firms are finding it harder going than larger firms.

On the retail side, we have taken a similar approach to assessing firms' preparedness. Our major retail groups division sent a questionnaire to their firms in Q4 2006, asking them for a self-assessment of their overall preparedness. Overall, using a standard "traffic light" system, 80% of firms assessed their readiness as "amber", the remainder as "green" and none as "red". Unsurprisingly, firms saw changes in best execution and transaction reporting requirements as having the highest impact on their business.

For small retail investment firms we have made sample inquiries, and held a number of "surgeries" last autumn. A special MiFID Roundtable for small firms was held in March. For other retail firms, we have assessed overall preparedness with a questionnaire-based survey, the results of which are still being assessed. In both sectors, firms' concerns have focussed on the practical consequences of changes on issues like best execution and client classification. But the overall position was encouraging.

So while there are signs of good progress, there is of course no room for complacency, with 1 November approaching fast. And, without dwelling on the point, I should just remind you that legal exposures will arise for firms after that date – the European timetable being fixed.

In terms of our supervision effort, we signalled in our business plan our intention to begin in Q1 2008 a risk-based review of how firms' implementation of the MiFID requirements has progressed. We shall be sharing with trade associations our thinking on how best to structure that work. Our aim will be to focus on areas where there looks to be appreciable risk of firms' compliance being seriously deficient, and where that could mean significant detriment to consumers and risk to the FSA delivering on its own objectives.

Slide 11 – Industry Guidance

A brief, concluding word about our work with trade associations on relevant industry guidance. You will recall that in DP06/5 – published last November – we commented on the potential role for industry guidance, confirmed by the FSA, as a "sturdy breakwater". Such confirmation would have a binding effect on the FSA but nobody else. We expect to reach decisions on the issues raised in the paper, and publish our feedback, in the third quarter.

At the same time, we have been considering with MiFID Connect the scope for FSA confirmation of a number of draft guidelines, early versions of which were released as exposure drafts on the MiFID Connect website early in January. Draft guidelines are well advanced on outsourcing and on suitability & appropriateness. After thorough and careful review, following the framework sketched out in the November DP, we expect to be able to give FSA confirmation to the outsourcing guideline by the end of this month. That on suitability and appropriateness can, we hope follow shortly thereafter. Guidelines on conflicts of interest and investment research are under review in draft.

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