2 February 2011 By Email: [email protected] Interest Representatives Register ID: 24418535037-82

Dear Sirs

Re: CLLS Regulatory Law Committee response to the European Commission consultation: Review of the Markets in Financial Instruments Directive (MiFID)

The City of London Law Society ("CLLS") represents approximately 14,000 City lawyers through individual and corporate membership including some of the largest international law firms in the world.

This response to the European Commission consultation: Review of the Markets in Financial Instruments Directive ("MiFID") has been prepared by the CLLS Regulatory Law Committee (the "Committee"). Members of the Committee advise, often on complex, multi jurisdictional legal issues, a wide range of firms across and outside Europe who operate in or use the services provided by the financial markets, These include clients on all sides of the market as well as market infrastructure providers and in our individual capacity we may be private clients of investment firms.

The Committee wishes to comment on certain legal issues and to respond to certain of the questions raised in the Commission’s consultation on MiFID which we regard as important to our members and the financial market participants that we advise. We do not generally comment on matters of policy where there will be different views from market participants depending on their business line. Our comments are therefore largely directed to issues of certainty, although we do offer some reflections based on our own knowledge and experience of issues that need to be taken into account in considering some of the proposals. We also emphasise in a number of areas the need for more analysis, impact assessment and cost-benefit research, in our experience these are a necessary component of a good legislative process, i.e. one that does not produce unexpected consequences.

2 1. INTRODUCTION

As a matter of principle we support a review of MiFID. If such a review is to be successful in providing appropriate protection for investors and enabling European firms to compete globally it needs to be based on thorough analysis of the implications and impacts of the proposals, and we encourage the Commission to commit resource to such an analysis.

Legal texts and legal certainty

We seek to draw attention to areas where proposals lack clarity or certainty and consequently may have unintended adverse effects unless the resulting legislation is carefully framed. Our interest is in trying to ensure that any resulting law is clear, so that it may be evenly applied across Europe and so that firms have the certainty they need without suffering unnecessary legal risk. Even apparently technical updating of existing provisions could have profound and, potentially, unintended consequences for the operation of the financial markets.

We would therefore urge the Commission to provide an opportunity for further consultation on the terms of any draft legislative text taking forward the proposals set out in the review. It is important to allow time for legislative texts to be reviewed and commented upon; it is not sufficient for a consultation on high level proposals to move directly to legislation without further consultation.

As a general principle, clear law is a fundamental need of any civilised society. Legal uncertainty may result in the less scrupulous firms pushing the boundaries of regulation at one extreme, relying on the lack of clarity, while, at the other extreme, more scrupulous firms are deterred from providing useful services or acting in the most efficient way to serve their clients needs because of perceived legal risk arising from uncertainty. At a more pragmatic level legal uncertainty harms investment firms and their clients by generating additional costs for legal advice which would be unnecessary if the law was clearer. Moreover, the greater the legal uncertainty the greater the risk of subsequent legal decisions which are contrary to the understanding of both regulators and market participants and therefore severely disrupt the market and effective regulation.

If the legislative timetable will not allow for a further consultation period, we would alternatively urge the Commission as far as possible to enable the granular shape of these proposals to be settled, and thereby sufficiently debated, at Level 2.

We would also welcome the appointment of one or more expert groups to consider and consult on the more technically complex areas of the Commission’s proposals prior to

3 any legislative text being finalised; this approach has been constructive in other legislative contexts. In particular we believe that expert groups to examine pre- and post-trade transparency, and measures specific to the commodity markets, would be welcomed.

Need for cost/benefit analysis

We recognise that some of the developments proposed in the consultation are intended only to bring regulatory policy up-to-date with rapidly developing market practices, for example in relation to new trading methods. Insofar as changes to legislation are of a technical nature to address developments of this nature, the Committee would in principle be supportive of the Commission’s objectives.

The Committee is nevertheless concerned that certain of the measures proposed go much further and in some cases could amount to an overly-prescriptive and rigid response to perceived areas of investor or market detriment. Quite apart from the policy concerns which may arise, the measures risk creating legal uncertainties both for participants in the affected markets, and in respect of the relationship between EU and national regulatory authorities.

The proposal as published provides little by way of empirical evidence or justification, and is not yet supported by a cost-benefit analysis. When undertaking a review of this scale and importance it is critical that there is clarity as to the cost as well as the benefit of new measures, and that an appropriately holistic view of the interaction between different proposals (both within MiFID and in other Directives) can be taken. This is necessary to avoid, for example, the creation of potentially conflicting legal obligations or other unintended and unhelpful consequences.

It is essential that the process for effecting changes to the regulatory framework for European investment markets allows sufficient time for the industry to consider fully and respond to the proposals, and for policy-makers to take account of the potential harms as well as the perceived benefits of the changes that have been proposed.

Market interventions

Finally, the Committee wishes to record its concern at the notion, evident in a number of places throughout the consultation and particularly in section 9 (Reinforcement of supervisory powers in key areas), that the Commission considers that national regulators should be empowered to intervene in markets and to seek to micro-manage the trading strategies and conduct of investment firms and their clients, rather than to focus on supervising the conduct of those firms and the markets in which they operate more effectively. A fundamental change to the manner of regulatory supervision of this

4 nature would represent a major step away from the core free market principles that have enabled European capitals to become leading, deep and liquid global financial centres. It does not appear to the Committee that this call for a more interventionist approach to regulatory supervision has been justified, and nor would it be consistent with DG Markt’s core single free market objectives. It must also risk exposing regulators to legal action, and not necessarily from within the EU.

Some key concerns

The following highlight some of our greatest concerns in the consultation, each of which is discussed more fully in the main body of this response:

 We think that it is essential that fundamental uncertainties in the scope of existing MiFID investment services and activities are addressed before seeking to create new supervisory structures around those terms. For example, it is not always clear in the context of some current market practices as to when a person is "executing" an order, or "receiving and transmitting" an order, yet these terms will be used in defining the scope of a new category of "organised trading facility". We are concerned that legal uncertainty which arises when applying the existing MiFID text to firms' activities will be compounded if these basic issues are not first addressed. We know, from our own practices, that there is no consistency within or across Member States as to the scope of these terms.

 We are troubled by the proposition that equity market transparency could be transplanted into non-equity markets. We observe that this is not a proposal driven by failures highlighted in the financial crisis and requiring immediate attention; there has been extensive and contentious debate (pre-dating the MiFID review process) as to whether this proposal would in fact produce a desirable outcome, yet that debate is not properly aired in this consultation. There is a risk that dealing with this issue in the context of the broader review obscures the practical and legal difficulties in developing a transparency regime for markets, including in particular the bond market, which function in a very different manner to the equity market. A similar point can be made in relation to the separate proposal to apply a fundamentally equity-based transaction reporting model to non- equity markets.

 The Committee appreciates the logic of extending transparency requirements to shares which are admitted to trading only on MTFs, but we wish to rebut the Commission’s assumption that "the number of such shares is currently limited" with the implication that this modification would have a limited impact. Many MTFs, provide a trading venue for shares in a diverse range of issuers from around the world whose shares are not otherwise traded on a MiFID regulated market. Trading on the EU MTF may account for only a small portion of global trading in

5 those shares, and those shares will in most cases be subject to the transparency regime of their primary market. We must therefore question the investor benefit and general territorial appropriateness of applying EU transparency requirements in this way. The Committee therefore wishes to stress that any development in this area must be proportionate if a limited net investor protection benefit is not to damage the long-term attractiveness of the EU as a flexible and liquid capital market.

 We disagree with the Commission’s assumption that conduct of business rules "clearly apply" to the relationship between investors and the investment firms/credit institutions placing and underwriting securities. On the contrary, the Committee considers that such an assumption is counter to the way in which the markets function, underwriters and placing agents will typically make clear that no such relationship exists and investors generally have no expectation of any such relationship. Any move to enshrine this assumption in EU law risks causing severe disruption to the ability and willingness of financial institutions to facilitate the efficient operation of European capital markets, as well as leading to potentially irreconcilable conflicts of duties.

 A number of the proposals seem to imply additional responsibilities from investment firms to investors for which there is not any contractual basis or expectation on the part of the parties. For example, the ongoing obligations proposed under section 7.2.3 will not always be appropriate.

 We observe that many of the Commission's proposals merely impose granular requirements where there are already standards which would achieve the behaviours desired by the Commission, provided that those standards are complied with and that regulators exercise their supervisory powers to enforce them. If any clarity is required as to the impact of those standards in particular areas, for example in new product development, that can be addressed by guidance issued under the auspices of ESMA. It would be better for regulators to clarify and enforce existing standards than for more and more new law to be created.

 Finally, the Commission’s proposal in relation to third country firms is ambiguous but can be read to indicate that non-EEA firms in jurisdictions which do not qualify for "exemptive relief" (to be determined following a strict legislative equivalence assessment) would be barred from "access" to European wholesale markets. The equal and opposite consequence of barring access for third country firms is that European professional clients, i.e. large corporates, pension funds, asset managers etc, would be barred from accessing non-EU banks, brokers and markets. This would seem likely to have a deeply negative effect on the ability of European investors to spread and hedge investment risk and, perhaps more

6 importantly in the current climate, of European businesses, to access key global funding sources, particularly in Asia. If this is indeed the Commission’s intention, the point should be expressed clearly so that the practical and legal effect of the proposal can be properly assessed. We urge the Commission to prefer an approach which does not interfere with the rights of Member States, subject to compliance with the relevant Directives, to permit third country firms to access their national markets subject to authorisation as appropriate.

7 2. DEVELOPMENTS IN MARKET STRUCTURES

(1) What is your opinion on the suggested definition of admission to trading? Please explain the reasons for your views.

We welcome the proposal to include a definition of admission to trading. However, the appropriateness of the proposed wording will depend upon the use to which the term is put elsewhere in MiFID and in other Directives. The consequences of admission to trading should be proportionate to the venue on which the trading takes place, to allow for the fundamentally different nature of liquid regulated markets, on which an issuer elects for its securities to be admitted to trading, and internal broker systems which are little more than a means for secondary execution of trades between professional investors.

(2) What is your opinion on the introduction of, and suggested requirements for, a broad category of organised trading facility to apply to all organised trading functionalities outside the current range of trading venues recognised by MiFID? Please explain the reasons for your views.

Need to clarify other MiFID activities

There is no proposed definition of "organised trading facility" ("OTF") or much explanation as to the mischief which the concept is intended to regulate. It is therefore not possible to understand the potential implications of the introduction of the concept, or to know if the suggested requirements are appropriate. What is it that an operator of an OTF does that is not already regulated under MiFID? Could the concept catch firms which are not currently investment firms?

We think it is essential, for reasons of both legal certainty and consistency of approach across Europe, that before the Commission introduces a new trading related activity, it clarifies the scope of certain existing MiFID services/activities that might be carried out by an OTF operator. This requires a thorough analysis of the ways in which firms actually interact in order to give effect to client instructions.

If this is not done then the introduction of the concept of an operator of an OTF will only add another layer of confusion. Is the operator of an OTF also receiving and transmitting and/or executing orders? Could a firm be an OTF operator without carrying on either of these activities – we think not, but the position is not clear. The following is a simple example of the issues that can arise in applying current MiFID concepts.

8 (i) A small EU investment firm (ACO) advises a client to acquire a particular Japanese security and the client instructs the firm to acquire the security for the client.

(ii) ACO is authorised to receive and transmit orders and to execute orders.

(iii) ACO has no direct exchange or MTF memberships or relationship with non-EU brokers.

(iv) ACO, having regard to its "execution policy" instructs EU investment firm (BCO) to acquire the security. BCO treats ACO as its client, but knows that ACO is not buying the security as principal and selling it to its client, but rather is acting as agent for an undisclosed client.

(v) BCO instructs a Japanese broker based in Japan with whom it has a business relationship to acquire the security. The Japanese broker executes the order on the Tokyo Stock Exchange.

N.B. This is a chain of intermediaries – neither ACO or BCO acquires the security and sells it on as principal.

Questions (in relation to points (i) to (v) above)

(a) When ACO instructs BCO, is ACO receiving and transmitting an order or executing an order?

(b) When BCO instructs the Japanese broker is it receiving and transmitting an order or executing an order?

We know from our own experience of advising financial institutions of all types and size that, at present, there is no common understanding of the analysis of this and many other similar situations. The analysis applied differs across firms, within Member States and between Member States. In any but the simplest scenario there is scope for genuine debate as to the point at which an activity becomes "execution". It is not that we think firms try to "manipulate" a particular outcome, there is just genuine confusion and disagreement. This confusion may well be leading to an uneven application of the transaction reporting requirements, producing potentially misleading or less useful information.

The situation is not assisted by the use of other phrases such as "carrying out" an order, in other parts of the Directive. It is not clear whether "carrying out" covers both execution and receipt and transmission and again we believe there are genuine differences of interpretation. It is essential that these issues are clarified before another layer of regulation is applied.

9 Need for clarity of scope of any new activity

The new category of organised trading facility should be framed in such a way so that:

 It is clear as to the facilities that it is intended to cover, and the boundary with pure OTC trading, which is to continue.

 It is sufficiently flexible to permit the development of new forms of execution venue.

 Thresholds are established below which arrangements will not rank as OTFs.

System access

European firms will not only have European clients. It is important that any new rules can be justified because they may impede the competitiveness of European firms in third countries if they restrict the services they can offer to clients.

If the Commission is proposing to impose any restrictions on the types of persons that can access the system, these would need to be carefully framed to ensure that certain categories of persons who currently use systems caught by the definition are not excluded (for example persons who are not authorised under MiFID).

It is also unclear, in the context of a venue which need be neither multilateral nor involve non-discretionary rules, who exactly would "access" the system. Is the Commission trying to regulate the identity of clients of firms or prescribe who they must accept as clients, so that a broker has to have objective reasons to turn clients away?

For example, where a broker handling client orders operates an internal crossing system as one of the many ways in which it may, using its discretion, handle order flow, would a client of the broker be regarded as "accessing" the system if the broker determined to execute in this way? Is the rule on access intended to direct the broker to use its trading discretion in a particular way, such that its internal crossing system either is, or is not, used in particular cases? We do not believe that either of these outcomes would be appropriate or desirable, and the rules should be clarified in this regard.

(3) What is your opinion on the proposed definition of an organised trading

10 facility? What should be included and excluded?

It would be helpful if the Commission, when drafting the legislation, could provide some assistance with interpretation of the definition. For example, the definition refers to the bringing together of "buying and selling interests or orders relating to financial instruments". Is this intended to include indications of interests as well as firm orders and quotes? If so, how are indications of interest to be defined and identified? The wider the concept the more flexible the detail will need to be.

The core but undefined concept is that of an "organised" trading facility. If obligations are to be placed on the "operator" of such a system there is a clear implication that the trading on it is in some way "organised", i.e. "controlled", by the operator, as opposed to under the control of the participants. We think the Commission intends to distinguish between a system which provides an infrastructure for participants to interact (hence why it does not cover order- routing) and one in which the operator has a pivotal role in determining how or on what basis orders interact (similar to some concepts which already distinguish active and passive trading systems). This must be clarified, otherwise there is a risk of including systems where it would not be practicable, because of the very nature of the system, to impose obligations on the operator of the kind envisaged in the proposal.

Given the vast spectrum of systems within firms the proposals could cover, for example, order management systems that only occasionally cross client orders and are primarily routing systems (which are excluded). The Commission should consider including a materiality/quantative threshold in relation to business for European clients that a firm must meet before being caught by the regime.

We think that the Commission could also consider the following additional exclusions from the definition:

 an exclusion for trade publication services – the definition as drafted could potentially catch such persons and we assume it is not the Commission’s intention to do so.

 an exclusion for internal order flow on the assumption that the publication of such information would not aid increased transparency, or any of the other policy objectives that the Commission is likely to be pursuing.

11 Clarity in the definition will be important both because it will trigger compliance obligations for the operator, but also because participants will need to know that they have complied with any obligation for a particular eligible derivative to be traded on an OTF or other venue.

(4) What is your opinion about creating a separate investment service for operating an organised trading facility? Do you consider that such an operator could passport the facility?

This is not necessary if the operation of an OTF necessarily also involves one or more other investment services or activities (such as execution of orders), but this is not clear.

If there is a new activity which is wider in scope than the current MiFID activities then it must also carry the right to a passport. However whether this makes a substantive difference to the position in force today depends on whether an OTF operator is considered always to be receiving and transmitting and/or executing orders. We cannot see that it would be consistent with the basis for MiFID if a new activity were to be introduced which did not carry a passport.

(5) What is your opinion about converting all alternative organised trading facilities to MTFs after reaching a specific threshold? How should this threshold be calculated, e.g. assessing the volume of trading per facility/venue compared with the global volume of trading per asset class/financial instrument? Should the activity outside regulated markets and MTFs be capped globally? Please explain the reasons for your views.

Whether venues that exceed a specific threshold should be subject to additional regulation is a policy matter on which we express no comment. We do not however understand what is meant by "capped globally" or the "global volume of trading". If it means to refer to trading worldwide we do not see how this could ever be practical or calculated.

Classification of "large" OTFs as MTFs poses some issues, because OTFs will not meet the MTF definition, since, for example, they need not be multilateral. If the Commission pursues this proposal, some thought will need to be given to the practical implications for OTFs that are required to convert to being an MTF as, by definition, they will not in fact be an MTF. We assume that the Commission means that certain MTF obligations should apply, but it is not clear what these would be, or if they would be suitable for every type of OTF.

For example, the lack of clarity highlighted above about who "accesses" an OTF

12 would need to be resolved. Firms operating OTFs are likely to have a range of clients that are not all authorised firms. Converting from an OTF to an MTF is presumably not intended to mean those firms have to stop doing business with certain clients. In addition, for investment firms that operate on an agency basis there may be additional capital requirements for them in converting to an MTF. This would not seem appropriate as there is no change in the legal nature of what they do and therefore no change in the risks they face which capital is intended to cover.

(6) What is your opinion on the introduction of, and suggested requirements for, a new sub-regime for crossing networks? Please explain the reasons for your views.

We understand that there may be a policy rationale for treating internal broker systems in a specific way, on which we do not comment. The legislation will need to be very clear about the types of activities that are covered by the sub- regime.

Any new legislation would need to take into account the specific characteristics under which crossing systems within firms operate, and whether the proposals are appropriate for all such systems, including new structures which will inevitably develop in the future.

(7) What is your opinion on the suggested clarification that if a crossing system is executing its own proprietary share orders against client orders in the system then it would prima facie be treated as being a systematic internaliser and that if more than one firm is able to enter orders into a system it would be prima facie be treated as a MTF? Please explain the reasons for your views.

We support these proposals provided that the crossing system is assessed against the full definitions and criterion of SIs and MTFs, taking into account any applicable exemptions under those regimes. This should not undermine the basic premise that not every execution by definition takes place on a MiFID venue, and that some trades are appropriately regarded as OTC (as noted in MiFID Recital 53). We also note that Recital 53 is not an exhaustive definition of OTC trading and must not be taken as such.

(8) What is your opinion of the introduction of a requirement that all clearing eligible and sufficiently liquid derivatives should trade exclusively on regulated markets, MTFs, or organised trading facilities satisfying the conditions above? Please explain the reasons for your views.

13 The CLLS is concerned primarily with identifying and working to minimise sources of actual or potential of legal uncertainty and is not in a position to comment on whether, as a question of policy, the introduction of a requirement that all clearing eligible and sufficiently liquid derivatives should trade exclusively on regulated markets, MTFs, or OTFs is appropriate.

Scope of proposal lacks clarity

We are concerned that the use of the term "clearing eligible" in the proposed requirement could be a source of legal uncertainty. It is not clear how this requirement would interact with the operation of this concept under EMIR. For example how would this requirement apply to a derivatives contract which is determined to be eligible for mandatory clearing by ESMA, but which is not in fact required to be cleared either as a result of an exemption/carve out from the clearing obligation (e.g. where one of the counterparties is a non-financial counterparty below the clearing threshold) or because only one of the parties is an EU person?

Clarification is required as to whether all derivatives contracts which are determined to be eligible for clearing must be traded exclusively on OTFs or only clearing eligible derivatives contracts which are in fact cleared. If the former, such compulsory exchange or electronic trading could undermine the exemptions from the clearing obligation and introduce a clearing requirement by the back door.

The fact a contract is capable of being cleared does not automatically mean it is suitable for exchange or electronic trading. Similarly, standardisation does not in and of itself mean a particular derivatives contract is suitable for exchange or electronic trading – certain existing "standardised" products are not currently traded on exchange because the features inherent in the product or their use by market participants are inconsistent with such trading (e.g. FX options which have a large number of parameters for which it is impractical to publish continuous real-time pricing data, interest rate swaps which are novated by market participants daily and index CDS because of restructuring events).

CBA necessary

Liquidity is not the only additional factor relevant in considering whether cleared standardised derivatives should trade exclusively on organised venues. We note that the G-20 commitment refers to this being required "wherever appropriate". This seems to allow for the possibility that market participants have a variety of needs, and that these may vary from market to market and

14 from time to time (and indeed liquidity itself can vary tremendously). Accordingly, we think that a full impact assessment and cost-benefit analysis is required, not least as this will be necessary in order to define the products which justify mandatory exchange trading.

Where aggregate liquidity in a particular standardised product appears sufficient to support a viable on-exchange market, the mandating of exchange trading might not lead to all of that liquidity moving on-exchange, and the exchange traded market may well prove insufficiently liquid. There are numerous examples of exchange-traded products failing to attract sufficient liquidity, even where there is an active OTC market with relatively standardised products.

The Commission may be better to pursue measures which enhance standardisation and facilitate a trend to increased exchange trading – even if such measures are non-legislative such as the moves being coordinated through the Federal Reserve Bank of New York which have achieved significant success.

We also note that:

(i) there are a number of factors which affect whether trading of certain derivatives contracts on one or more OTFs is feasible and will be effective. These factors include: whether the contracts in question are sufficiently standardised as to economic/product terms and legal documentation to support trading on one or more OTFs and whether there is sufficient liquidity;

(ii) the increase in transparency of transactions and pricing associated with exchange and electronic trading may have a negative impact on hedging participants if the market moves against the hedging party in response to the taking or unwinding of certain positions;

(iii) the increased costs for all market participants associated with exchange and electronic trading may disincentivise the use of clearing- eligible derivatives contracts;

(iv) as a result, European corporates may be discouraged from hedging their risks or from using EU financial institutions or commodity firms for the purposes of hedging, with the consequence that a significant portion of these markets may move.

(v) a significant number of market participants and trade associations have expressed reservations on the mandating of exchange and electronic trading of derivatives. We make no comment on commercial matters

15 but it is essential that the Commission recognises that there will be valid points and concerns based on the reality of the markets and the requirements of users which deserve proper consideration.

(vi) the provisions in the proposed EMIR for clearing, trade reporting, trade repositories and appropriate procedures and arrangements for the management of operational and credit risk for derivatives appear to be a more appropriate and adequate mechanism for increasing transparency, market oversight and efficiency and risk reduction.

(9) Are the above conditions for an organised trading facility appropriate? Please explain the reasons for your views.

The concept of OTF could encompass a broad spectrum of trading and pricing models (e.g. inter-dealer, multi-dealer, single-dealer, order book, indicative executable, request for quotation, many to many, one to many). It is not clear to us that there is any benefit or need to include all such systems in the OTF definition. As stated above, if the concept is required at all, more clarity is required to ensure that only those systems which are organised by an operator are within scope. The definition and conditions for an OTF will need to be sufficiently broad and flexible to recognise the various models but not so broad as to create legal uncertainty as to whether a particular trading arrangement does or does not constitute an OTF for the purposes of MiFID. The challenge this presents is reflected in the complex and controversial discussions in the US relating to the definition of a "swap execution facility" and in this case the instruments concerned are of a limited class. The MiFID proposal is far wider in scope.

Providers of trading platforms, dealers, brokers and market participants must be able to determine easily whether a particular arrangement constitutes an OTF and to identify who is its operator. To this end the criteria described lack precision and are likely to give rise to uncertainty as to scope and application.

In addition the requirements for OTFs relating to authorisation, reporting, transparency, conflicts of interest, trade monitoring and other compliance and conduct of business rules may not be appropriate for all types of system (depending on the exact scope of the definition). They are also likely to have cost implications and may result in a withdrawal of investment firms, brokers and other trading platforms and providers from the market. Any such withdrawal could have a negative impact on liquidity and increase and concentrate systemic risk where trading is restricted to a limited number of trading platform providers.

16 Confidentiality issues will need to be considered in formulating any transparency driven criteria for OTFs. Exchange and electronic trading should not involve the public disclosure of the identity of market participants and confidential information as this would damage the integrity of markets and have a negative impact on the use of clearing eligible derivatives and liquidity.

In addition when formulating the conditions for an OTF we would expect the Commission to be conscious of the need to avoid creating opportunities for legal and regulatory arbitrage which may be detrimental to the European derivatives markets.

(10) Which criteria could determine whether a derivative is sufficiently liquid to be required to be traded on such systems? Please explain the reasons for your views.

There are a number of ways of defining and analysing liquidity. Liquidity is not a constant factor and will vary across and within classes of derivatives contracts (for example certain maturities of interest rate swaps are more liquid than other maturities) and during the term of the derivative contract (liquidity tends to decrease as contracts approach maturity). Liquidity is affected by a number of complex interconnected factors including market conditions (e.g. volatility), the number of participants in the relevant market and end user demand for particular products.

Any definition of "sufficiently liquid" and the related criteria will need to be clear, precise and should not give rise to legal uncertainty. The CLLS is concerned that this will prove not to be possible.

(11) Which market features could additionally be taken into account in order to achieve benefits in terms of better transparency, competition, market oversight, and price formation? Please be specific whether this could consider for instance, a high rate of concentration of dealers in a specific financial instruments, a clear need from buy-side institutions for further transparency, or on demonstrable obstacles to effective oversight in a derivative trading OTC, etc.

For exchange or electronic trading to be feasible: the legal documentation needs to be sufficiently standardised and support such trading; there need to be a sufficient number of market participants wanting to trade such products in such manner and in such frequency on an ongoing basis so as to provide sufficient liquidity; and the trading terms (including rules, membership/participation terms and individual contract specifications) of the

17 relevant exchange or electronic trading platform need to be acceptable to market participants, easily accessible and legally robust and unambiguous, and exchange systems and processes must also be robust, reliable and interface well with those of participants.

The fact that a particular class of contracts is capable of and is deemed to be eligible for clearing does not automatically mean that there will be sufficient participants placing orders and/or willing to make a market to ensure that there is sufficient liquidity in the product on the relevant trading platform to achieve the goals of transparency, competition, market oversight and price formation.

The CLLS is of the view that the provisions in the proposed EMIR for clearing, trade reporting, trade repositories and appropriate procedures and arrangements for the management of operational and credit risk for OTC derivatives will go a long way to increasing transparency, competition and market oversight. Mandating exchange trading will not necessarily result in better competition or price formation. For example, different price formation models appear to suit different markets and market participants (it can be very subjective) so it is dangerous to prejudge what factors will be most appropriate in making a decision about any particular product.

(12) Are there existing OTC derivatives that could be required to be traded on regulated markets, MTFs or organised trading facilities? If yes, please justify. Are there some OTC derivatives for which mandatory trading on a regulated market, MTF, or organised trading facility would be seriously damaging to investors or market participants? Please explain the reasons for your views.

The CLLS is not in a position to identify particular classes of OTC derivatives that could or should be required to be traded on OTFs. The CLLS notes the challenge of identifying and defining from the broad range of OTC derivatives contracts, those contacts which are capable of and appropriate for exchange or electronic trading on an initial and ongoing basis. There must be a transparent and precise process for ESMA to assess and decide whether a particular derivative must be traded exclusively on organised venues, and this must include clear definition of the derivative concerned in order to avoid any risk of legal uncertainty.

On timing, the Commission seems to envisage that ESMA may make these determinations each time it decides to require clearing under EMIR. However, the determination that OTC derivatives should be cleared does not imply that they are sufficiently standardised, and sufficiently liquid in the standardised form, for viable exchange trading.

18 (13) Is the definition of automated and high frequency trading provided above appropriate?

The proposal is to define such trading in a broad manner. We are not sufficiently expert in the use by firms of computer systems to know if this is appropriate, but it seems to us that as proposed it could cover systems used by a firm to research the best way to execute a trade and internal software used by firms to accept orders from clients, which the firm has itself set to certain parameters. If so, we think the definition would be broader in scope than the Commission intends. We suggest that the definition incorporates the concept that automated trading involves the entry of trading orders where computer algorithms determine all material aspects of the trade and where such entry is automatic and not subject to human intervention. (We note this is the idea expressed at the beginning of section 2.3 ).

We could not identify a definition of "high frequency trading" in the text.

(14) What is your opinion of the suggestion that all high frequency traders over a specified minimum quantitative threshold would be required to be authorised?

The majority of high frequency traders are likely to be already authorised and subject to MiFID organisational and risk management requirements etc, with the exception of some proprietary traders.

Requiring proprietary traders that are carrying out HFT but who are not currently required to be authorised, and therefore subject to MiFID requirements (e.g. on regulatory capital etc.) would seem unnecessary from a consumer protection policy perspective. Although it is a policy question considerable care needs to be exercised when considering whether proprietary traders of the kind that are not currently regulated should be regulated, and, if they should, in what way this should be done. If the main concern is perceived potential for market disruption it may be preferable to address this through market based measures. This is especially important given the proposals to enhance regulation of the firms through which unauthorised high frequency traders access the markets. Market integrity and systemic risk issues are already adequately addressed by the market abuse regime and through prudential regulation of the firms which guarantee trades.

(17) What is your opinion about co-location facilities needing to be offered on a non-discriminatory basis?

Although this is a policy issue, we are concerned that there has been little

19 attempt to justify an outright ban on treating different participants in different ways. We can conceive that there may be reasons to provide enhanced trading privileges to certain participants (e.g. market makers). So MiFID could instead proscribe inappropriate discrimination, and then ESMA could issue guidance on what types of factors may be an inappropriate basis for discrimination.

(18) Is it necessary that minimum tick sizes are prescribed? Please explain why.

It would be helpful if the Commission could explain their policy consideration behind this proposal, but tick sizes should be meaningful and appropriate to the market and its participants. Without further justification for Commission or ESMA intervention to set tick sizes, we would suggest that this is a matter best left to market operators, who may be expected to address this kind of issue in the context of their compliance with general standards for market operation.

(19) What is your opinion of the suggestion that high frequency traders might be required to provide liquidity on an ongoing basis where they actively trade in a financial instrument under similar conditions as apply to market makers? Under what conditions should this be required?

The proposals seems to assume that high frequency trading is effected by a firm acting as principal, this is not always the case and it would be inappropriate to place a market making obligation on persons not acting as principal, it might in effect cause them to breach their duties to their clients and/or put them under an obligation which legally they cannot fulfil.

We do not therefore agree with the proposal as such trading may be undertaken by a variety of institutions for a number of reasons and we do not understand the justification for the proposal. What is the difference between this situation and a firm entering a large single order that means that one must be a market maker but not the other?

We would be concerned at potential adverse impact from such a requirement. We recommend that the Commission first conduct an impact assessment before taking this proposal further.

(21) What is your opinion about clarifying the criteria for determining when a firm is a SI? If you are in favour of quantitative thresholds, how could these be articulated? Please explain the reasons for your views.

We welcome the proposals to clarify the criteria, in our experience some firms have had difficulties in applying the criteria to their business. Applying

20 quantitative thresholds would provide more clarity as to whether or not a firm falls within the definition than the current material commercial relevance test, but the thresholds themselves must be appropriate and would need to be assessed regularly in case they require updating to reflect market developments.

Any adjustments to the criteria for the SI regime should take into account the criteria for organised trading facilities, RMs and MTFs to ensure that they fit together and that it is clear for participants in each facility as to which regime they fall within.

(24) What is your opinion of the suggestion to require regulated markets, MTFs and organised trading facilities trading the same financial instruments to cooperate in an immediate manner on market surveillance, including informing one another on trade disruptions, suspensions and conduct involving market abuse?

Given the potentially very large numbers of facilities caught by the organised trading facility regime, some thought would need to be given as to how this might work in practice. Indeed it might be wholly impractical, depending on the ultimate scope of the OTF concept.

(25) What is your opinion of the suggestion to introduce a new definition of SME market and a tailored regime for SME markets under the framework of regulated markets and MTFs? What would be the potential benefits of creating such a regime?

(26) Do you consider that the criteria suggested for differentiating the SME markets (i.e. thresholds, market capitalisation) are adequate and sufficient?

It is really a policy question but we note that:

(ii) the OTF proposals, and the tightening of the obligations of MTFs, may themselves inhibit some valuable SME trading/liquidity facilities and/or their development

(iii) any regime would need to allow for SMEs becoming successful and growing without forcing them off the market/damaging the classification of the relevant market and thus inhibiting growth.

(iv) the proposed market capitalisation test, with its reference to the trading venues of the Member State of issuer, while more relevant and realistic than the simple SME test is going to produce some very odd results

21 where a Member State has few trading venues and/or trading venues on which the SMEs do not appear.

Although we have no views to express on the policy issues behind the introduction of a new regime for SME markets, we believe that the criteria and roles need to be carefully considered in order to avoid adverse impacts on existing markets and to achieve the desired objectives. We believe that flexibility should be available at Level 2 to change thresholds and quantitative criteria at least and, as with so many of the thresholds it is necessary to avoid hard thresholds which lead to markets, participants and/or traded securities flipping backwards and forwards between different categories (for example purely as a result of short term or cyclical changes in market capitalisation).

22 3. PRE- AND POST-TRADE TRANSPARENCY

(27) What is your opinion of the suggested changes to the framework directive to ensure that waivers are applied more consistently?

We welcome the proposal to make changes to the framework directive to ensure that waivers are applied more consistently. Our experience has been that the waivers have been drafted in a way which is unclear, allowing for different interpretation by firms and regulators. This, in turn, has created uncertainty in the market and is likely to have resulted in unintended consequences. Clearer and more transparent rules determining the scope of the waivers would therefore be helpful.

We would query the role of ESMA proposed in the consultation in relation to the use of waivers. The consultation contemplates that ESMA would be notified of waivers and report annually to the Commission about their use, which seems sensible. However, having ESMA publish an opinion about whether the use of a waiver is consistent with MiFID risks introducing a degree of discretion around the process, which would be less preferable than having clear and transparent rules in the first place. It also risks inconsistency over time, if ESMA's views change. It is also unclear what ESMA's opinion would achieve if individual competent authorities would be allowed to use the waiver even where to do so runs contrary to an ESMA opinion.

(28) What is your opinion about providing that actionable indications of interest would be treated as orders and required to be pre-trade transparent? Please explain the reasons for your views.

We have no view on the policy question of whether an actionable indication of interest should be treated as an order for the purposes of the pre-trade transparency rules. However, it is important that market participants have certainty as to what constitutes an actionable indication of interest for these purposes.

The consultation states that an indication of interest is actionable if it is "an indication of interest that includes all necessary information to agree on a trade". This in itself is not particularly clear: any rule subjecting actionable indications of interest to the transparency requirements should define what is the "necessary information" to agree on a trade for this purpose, so as to give market participants certainty as to whether, in relation to any particular market, and any particular indicator of interest on that market, the transparency requirements apply. It is also important that there are exemptions for private

23 indications of interest (as opposed to those that are distributed widely) so that commercial negotiations between a seller and potential buyers can take place on a confidential basis.

(33) What is your opinion about extending transparency requirements to depositary receipts, exchange traded funds and certificates issued by companies? Are there any further products (e.g. UCITS) which could be considered? Please explain the reasons for your views.

Whilst we have no view on the policy question as to whether, as a matter of principle, transparency requirements should be extended to equity-like instruments, we have various concerns on the scope of the proposal in the consultation.

We welcome the recognition that differentiation is likely to be needed when producing a transparency regime for equity-like instruments to take into account specific differences in the nature of the instruments. It is likely, however, that it is not just differences in the nature of the instruments that will need to drive differentiation, but also differences in the nature of the markets on which they trade – see further question 35.

Depositary receipts

Depositary receipts are instruments which repackage an exposure to an underlying security. That security is commonly, but not necessarily, a share. Accordingly, if the policy intention is to capture depositary receipts where these are equity-like instruments, the application to depositary receipts should be limited to depositary receipts whose underlying is shares admitted to trading on a regulated market (as there are also depositary receipts admitted to trading on a regulated market where the underlying security is not traded on a regulated market).

Certificates issued by companies

We are concerned by the proposal to include certificates issued by companies as equity-like instruments. There is no definition or common understanding of "certificates" in the European framework or in the financial markets of which we are aware.

The definition set out in the consultation is "securities issued by a company that rank above ordinary share holders but below unsecured debt holders for the repayment of the investment". This would capture preference shares, which one would anticipate being treated in the same way as ordinary shares. It

24 would also capture subordinated debt, which one would not ordinarily consider as being equity-like, and would not generally be expected to be traded in the same way as equities.

We presume it is not the intention of the Commission to cause subordinated debt to be treated in the same way as equity for transparency purposes, given that it is not treated in the same way as equity for other purposes (for example, Prospective Directive disclosure).

It is also not clear what the proposed position and treatment would be if the “certificate” evidenced an obligation the calculation of which was closer in nature to a derivative, such as a contract for differences.

(34) Can the transparency requirements be articulated along the same system of thresholds used for equities? If not, how could specific thresholds be defined? Can you provide criteria for the definition of these thresholds for each of the categories of instruments mentioned above?

See our response to question 33.

(35) What is your opinion about reinforcing and harmonising the trade transparency requirements for shares traded only on MTFs or organised trading facilities? Please explain the reasons for your views.

It is a policy question whether transparency requirements are desirable (and if so, to what extent) for shares traded only on an MTF or OTF. As indicated above, there are likely to be substantial differences between markets for shares admitted to trading on regulated markets and for those which are not, but which are admitted to trading on an MTF or OTF. This will include the differences between:

 the nature (and in particular risk tolerance) of the investors on the relevant market;

 degree of disclosure relating to the shares and their issuers – both on an initial and ongoing basis;

 the volume of shares traded;

 the depth of liquidity in the market;

 the type of liquidity provision (quote, rather than order, based).

25 Given the key rationale for transparency set out at the beginning of section 3, it seems clear that a differentiated approach to shares whose markets bear the different characteristics would be appropriate.

In addition, the practical consequences associated with widening the transparency regime should be considered. Although there is no master consolidated list of all shares admitted to trading on regulated markets available from regulators, such information is maintained by data vendors. Extending transparency requirements for shares admitted to trading on MTFs would require that firms have access to up-to-date information on precisely which shares were, or were not, traded on MTFs at any time. This would, in turn, require MTFs to make this information available. The same would be true for OTFs. However, given the very wide-ranging preliminary definition of the term OTF set out in the consultation, there may be practical difficulty assessing whether shares are, or are not, traded on OTFs or indeed identifying all relevant OTFs. This might have the effect of causing some firms, for want of data proving the position, to assume that all shares are traded on OTFs to avoid the risk of sanction in the event that they are incorrect. This in turn will produce inconsistent approaches both within Member States and across Europe.

(36) What is your opinion about introducing a calibrated approach for SME markets? What should be the specific conditions attached to SME markets?

See our responses to questions 26 and 35.

(37) What is your opinion on the suggested modification to the MiFID framework directive in terms of scope of instruments and content of overarching transparency requirements? Please explain the reasons for your views.

It is a policy question whether modifications to the MiFID framework directive to extend transparency requirements are justified. However, we believe that changes should only be made where proportionate and justified by reference to cost-benefit analysis. Although there has been repeated consultation by the authorities, both in individual Member States and Europe, as to the possibility of extending transparency requirements to non-equity markets, no cost benefit analysis has been undertaken. Further, the consultation is insufficiently detailed as to the likely scope and application of the proposed transparency regime for non-equities to enable cost-benefit analysis to be undertaken. We would urge that, prior to introduction of any such arrangements, there be full consultation on detailed rules which allows cost-type benefit analysis to be undertaken.

As to the detail of the proposal, there is insufficient detail to allow meaningful

26 comment on the likely legal implications of a non-equity market regime. However, the application of the requirement to "bonds and structured products with a prospectus or admitted to trading either on a regulated market or MTF" raises scope questions: firstly, what bonds and structured products are in scope (and in particular what is meant by "structured products"); and secondly, what sort of prospectus is covered within the requirement: only prospectuses under the Prospectus Directive, or also prospectuses which are outside the scope of the Prospectus Directive?

We would also query the assertion in the consultation that bonds or structured products with a prospectus are more liquid and more frequently traded: many listed bonds and structured products have little or no secondary market liquidity. The existence of a prospectus is not a good proxy for liquidity.

At a more general level we note that in our experience there has been considerable market difficulty in interpreting and applying even the current pre- and post- trade reporting obligations - to the extent that legal advice has frequently been sought in an area one would expect to be well within market competence, and outside that of lawyers. It is very important that any new specific transparency requirements (whether relating to equity or to any other type of instrument) are very thoroughly discussed with market participants before application in order to ensure as far as possible the information required is consistent with that used and understood in the market.

(39) What is your opinion about applying requirements to investment firms executing trades OTC to ensure that their quotes are accessible to a large number of investors, reflect a price which is not too far from market value for comparable or identical instrument traded on organised venues, and are binding below a certain transaction size? Please indicate what transaction size would be appropriate for the various asset classes.

The proposal to mandate transparency on OTC dealers in non-equities raises questions as to whether transparency may compromise liquidity: others are better placed to comment on whether mandating pre-trade transparency is an appropriate and proportionate measure in light of the structure of the non-equity markets. However, assuming such an approach is taken it is imperative that the requirements are carefully constructed to achieve the policy aim and in particular give clarity as to the scope and nature of the transparency obligation. This will require considerably greater detail as to which firms are caught, what is meant by being "willing and interested to quote or receiving a request to quote which it agrees to meet", the levels at which a firm would have to quote, whether quotes would be one- or two-sided, and whether any exceptions would

27 exist (for example, presumably it would not be the intention that firms which do not make markets in the relevant non-equity instrument would be caught, although this is not expressed in the consultation).

(40) In view of calibrating the exact post-trade transparency obligations for each asset class and type, what is your opinion of the suggested parameters, namely that the regime be transaction-based, and predicated on a set of thresholds by transaction size? Please explain the reasons for your views.

See our response to question 41.

(41) What is your opinion about factoring in another measure besides transaction size to account for liquidity? What is your opinion about whether a specific additional factor (e.g. issuance size, frequency of trading) could be considered for determining when the regime or a threshold applies? Please justify.

As indicated above, we believe that the transparency regime should take into account, and be appropriate to, the market to which it applies. It may well be that other measures in addition to transaction size would be appropriate as determinants of the regime. However, we would caution against using historical data such as issuance size. It would be appropriate for measures to be determined and collaborated by regulators at quite a granular level to ensure appropriateness for the markets and products concerned.

28 4. DATA CONSOLIDATION

We have no comments on this section of the consultation.

29 5. MEASURES SPECIFIC TO COMMODITY DERIVATIVE MARKETS

5.1 Specific requirements for commodity derivative exchanges

(60) What is your opinion about requiring organised trading venues which admit commodity derivatives to trading to make available to regulators (in detail) and the public (in aggregate) harmonised position information by type of regulated entity? Please explain the reasons for your views.

We recognise that regulators might find detailed position information helpful, and that it is appropriate that they have power to gather the information necessary to exercise their supervisory powers. However, we have four main concerns:

 Any position information reporting should complement and be gathered in a way which is consistent with other reporting mechanisms, such as the reporting of OTC derivatives under EMIR. Costly and duplicative information gathering mechanisms should be avoided;

 There are dangers in reporting according to formal regulatory classification or other categorisation: reporting firms need not know the EU regulatory classification of their counterparty and in any event such information would present a misleading picture where firms were reporting all non-EU counterparties as "commercial traders"; firms may not know whether or not a client is entering into a transaction in order to hedge, and forcing firms to ask this would more likely lead to business (particularly non-EU source business) being routed indirectly or to non- EU markets;

 Introducing any new scheme whereby firms must gather additional standardised data on existing and new clients is a major logistical and IT exercise, and accordingly (i) sufficient time must be allowed for transition, and (ii) a scheme which is as consistent as possible with data already held by firms, if that data is relevant and appropriate, would minimize the cost and disruption of this initiative. Any categorisation could lead to misleading data, but categorisation based on the nature of the client as used for client classification under MiFID would at least have the advantage of being defined in a way which is relatively clear cut and with which organisations are familiar.

If firms were to report simply on the basis of client classification under MiFID, the same client might be categorised differently by different

30 firms. However, a reporting scheme based on a simplified use of terms underlying client classification (for example, basic terms used in Article 24.2 or Annex II of MiFID) could be the simplest to apply, assuming that firms will have, in respect of most clients and eligible counterparties, some record of the reason for the classification (although they do not generally record whether the client /counterparty is regulated under EU legislation and, if so, which legislation).

We recommend that categorisation basis for reporting be determined at level 2.

 In any event, there are dangers, too, for market participants and ultimately for markets themselves, in public dissemination of aggregate position data broken down into categories of participant because of the ease with which the positions of specific participants can be deduced. The risks are even greater in less liquid markets and markets where there are only one or a few regular participants in a particular category, this is particularly. Even if such deductions are not definitive or always accurate, they may themselves lead to speculation and distorting market activity.

Accordingly, any publication scheme would need to take this into account, and this might require a different approach in relation to different markets and products, depending upon such factors as their liquidity and the nature of their participants – and there would need to be sufficient flexibility to adjust the scheme as individual markets changed

(61) What is your opinion about the categorisation of traders by type of regulated entity? Could the different categories of traders be defined in another way (e.g. by trading activity based on the definition of hedge accounting under international accounting standards, other)? Please explain the reasons for your views.

Please see our response to Question 60.

(62) What is your opinion about extending the disclosure of harmonised position information by type of regulated entity to all OTC commodity derivatives? Please explain the reasons for your views.

We are concerned at the lack of a substantial rationale for position reporting in relation to bespoke OTC contracts – contracts that are by definition non-

31 standardised and insufficiently liquid to be traded on an organised venue.

Regulators will have various sources of information about activity in commodity derivatives markets:

 Position reports from organised trading venues (including Regulated Markets, MTFs and other organised trading facilities) as discussed above;

 Access to information under EMIR in respect of OTC derivatives contracts, whether cleared or uncleared;

 Regulators already receive transaction reports in respect of commodity derivatives traded on a Regulated Market;

 The Commission proposes the extension of this transaction reporting to MTFs and other organised trading facilities.

Even leaving aside the possible transaction reporting of other commodity derivatives (i.e. those not traded on a Regulated Market, MTF or organised trading facility), which we question in our response to Question 70 below, we wonder whether regulators will gain significant additional benefit from position reports in respect of truly OTC instruments. Given their bespoke nature, aggregated data may be of little use, so that there may be little information of value to be derived beyond that apparent from contract data available from trade repositories. Accordingly, we recommend that a cost-benefit analysis be conducted in order to assess whether this proposal should be taken forward.

(63) What is your opinion about requiring organised commodity derivative trading venues to design contracts in a way that ensures convergence between futures and spot prices? What is your opinion about other possible requirements for such venues, including introducing limits to how much prices can vary in given timeframe? Please explain the reasons for your views.

We are concerned at the lack of justification put forward for proposals to require convergence, circuit-breakers or similar price controls. Such granular requirements would represent an unnecessarily detailed interference in and control on the way trading venues conduct their business. Exchanges are generally subject to higher level requirements: for example, that their rules and procedures provide for fair and orderly trading, and minimise the extent to which it can be used for market abuse and, in relation to the introduction of new products, that they are capable of being traded in a fair orderly and efficient

32 manner and that derivatives are designed to allow for orderly pricing and effective settlement. There may be a case for setting further high level standards of this kind, looking to IOSCO standards and regulation in the US and in the UK and certain other EU Member States for examples.

Exchanges typically (except in emergency situations) consult with their supervisors as well as their members and market participants before introducing or changing contracts terms of derivatives contracts, and a high level standard of this kind could be introduced.

Given the number of different issues that can arise, we believe effective regulation is more likely to be achieved through the setting of high level standards like those just mentioned, with supervisors (a) themselves pursuing vigorously cases of market abuse, and (b) holding exchanges accountable for meeting those standards.

5.2. MiFID exemptions for commodity firms

(64) What is your opinion on the three suggested modifications to the exemptions? Please explain the reasons for your views.

We have three general concerns about these proposals, and a number of comments about the specific changes proposed to the exemptions.

General concerns:-

In developing changes to the exemptions, the Commission should recognise the costs and potential adverse impact on the real economy if persons whose businesses are essentially physical are captured by financial regulation or they become unable efficiently/cost effectively to manage their risk – this has implications both for end-users of derivatives and for physical commodities suppliers who provide ancillary hedging and risk management services;

 In this connection, the Commission should recognise also:

(i) The significant implications for the management and operation of non-financial businesses of being captured as "investment firms" ;

(ii) The significant implications for entities which remain exempt if the concept of "financial instrument" is defined too widely, given the extensive cross-referencing to the term in other legislation;

(iii) Extension of the licensing regime may make it more important to consider the breadth of the term "commodity" as defined in Article

33 2.1 of Commission Regulation 1287/2006/EC: as goods markets develop, it is increasingly possible that such "goods" as processed foodstuffs, chemical products; manufactured items such as rivets, ball bearings, silicon chips/processors, and car parts for which trading markets might exist, would come within the definition and thereby bring MiFID, MAD and other EU financial legislation into play in inappropriate circumstances with severely adverse and unintended consequences.

Although MiFID (in Article 65.3(a) and (d)) provided for both a review of the exemptions in Article 2.1(i) and (k), this was always intended to be linked to the development of appropriate capital requirements for commodities firms, and we think it would be inappropriate to restrict or terminate the exemptions before the regime envisaged by Article 48.2 of the recast capital requirements Directive (2006/49/EC) comes into force;1

In light of the above factors, and given the conclusions of the CESR-CEBS Technical Advice, we believe that the Commission must justify taking a substantially different approach from that technical advice, and accordingly recommend the Commission to conduct a detailed updated review of the operation of the commodities markets and these exemptions and the relevant definitions in particular (or request ESMA to do so).

Specific comments on proposed change to exemptions:-

Article 2.1(i): We have two broad comments, each involving some detailed points:

 When an energy supplier (such as a utility or oil company) or other commodity seller provides risk management services (such as hedging) to a customer, this will frequently (perhaps usually) involve the supplier in dealing on its own account. The supplier is then able to manage its overall risk and, to the extent it needs to hedge, can do so more efficiently than if it were required to execute each customer hedge in the market. Various pricing structures in commodity supply contracts may, in effect, embed the provision of a hedge – some would argue that this is the case whenever the contract price is not based on the market price

1 As the CESR-CEBS "technical advice to the European Commission on the review of commodities business" of 15 October 2008 (the "CESR-CEBS Technical Advice") noted (at paragraph 213):" The exemptions in Articles 2(1)(i) and (k) of MiFID were intended, at least in part, to provide a temporary solution to the lack of a specific capital regime for specialist commodity derivatives firms. It is therefore appropriate that the exemptions should be revised in conjunction with the development of an appropriate capital regime for such firms."

34 at the time of supply. For example, a fixed price supply contract may be analysed as a market price supply plus an embedded swap, and some suppliers will disaggregate the swap, for their own or the customer's benefit. We do not express a view on the policy question whether "dealing on own account" part of the exemption should be deleted, but merely observe that:

(i) Deletion may result in many more physical commodities businesses requiring a licence as an investment firm and a contraction in the risk management services available to end-users of commodities as some commodity suppliers withdraw their services;

(ii) The CESR-CEBS Technical Advice proposed a restriction rather than deletion of the dealing on own account part of this exemption.

35  So far as the second part of the exemption is concerned, we favour some clarification but are concerned that the proposed restrictions may render the exemption useless or result in the customers of firms which provide ancillary services receiving a poorer service:

The CESR-CEBS Technical Advice proposed "In respect of the incidental provision of services, the intention would be to have an exemption which was available only to entities which were not otherwise providing investment or banking services. Such entities would be able to remain exempt from MiFID if they provide investment services in relation to commodity derivatives to someone with whom they have a business relationship and where the provision of the investment services is connected to the provision of other non-financial services." Although they recommended interpreting the exemption in a narrow way, nothing in their comments suggests the imposition of additional conditions. Those which the Commission proposes seems somewhat arbitrary, and without the Commission seeking to justify by reference to any particular benefit;

Quantitative criteria would need to be calibrated quite carefully, and perhaps different for different markets – despite CESR-CEBS conclusion that there was no general need " to differentiate the regulatory regime based on the underlying commodity". Whilst we believe that the Commission has not properly justified the introduction of such criteria, we believe that the flexibility required means that the detail should be a matter for Level 2 legislation.

Whilst we can see that some qualitative criteria, perhaps in the form of Level 3 guidance, would facilitate the interpretation of the exemption, hard criteria of the kind proposed are (i) inconsistent with the nature of the exemption, and (ii) potentially counter-productive, in that we would expect that firms which have dedicated resource would be able to provide a more expert and better service.

It is by no means clear that the exemption in Article 2.1(d), particularly if changed pursuant to the proposals in section 7.2.8 of the Consultation Document, would be adequate to cover the activities of a business merely seeking to manage its own risk (and the changes seem to exclude the possibility of reliance on this exemption to provide on own account basic, ad hoc risk management services to clients).

36 Article 2.1(k)

We would make three main comments:

(i) The Commission has failed to justify such a radical change, and indeed the argument in section 5.2(c) of the Consultation Document seems misconceived. Although a number of entities that rely on this exemption may be described as "commodity derivatives trading houses", there are many that are essentially physical commodity businesses that use this exemption at the margin for certain activities which do not easily fall within the scope of the exemptions in Article 2.1(d) and (i).

(ii) The CESR-CEBS Technical Advice stated (at paragraph 214): "Deletion of the exemptions in Articles 2(1)(i) and (k) could have unforeseen consequences. There is a danger that because other exemptions do not take full account of the specificities of commodity derivatives markets and their participants, some primarily non-financial firms which do not raise similar regulatory issues to MiFID investment firms would be brought inside the scope of the directive." We think the Commission must produce a detailed and rigorous impact assessment and cost-benefit analysis before making a legislative proposal in direct conflict with this advice. The Commission has produced no argument of regulatory failure nor evidence to support change.

(iii) We would re-iterate the concern that current capital requirements are inappropriate for the firms which would need licences if this exemption were to be curtailed or deleted, and accordingly any change should not pre-date the introduction of an appropriate regime following the review and proposal development mandated by Directive 2006/49/EC.

5.3 Definition of other derivative financial instrument

(65) What is your opinion about removing the criterion of whether the contract is cleared by a CCP or subject to margining from the definition of other derivative financial instrument in the framework directive and implementing regulation? Please explain the reasons for your views.

The extent to which MiFID should apply to underlying commodities markets is a policy question on which we express no view. However, we are concerned that deletion of the clearing/margining criterion would have inadvertent consequences, some of which may be unforeseeable. MiFID (including the Implementing Regulation 1287/2006/EC) sets out a fairly simple regime to distinguish physically settled contracts that are not for commercial purposes.

37 Some jurisdictions provide a longer or more detailed list of factors, which may result in less clarity but are more calibrated to determining true commercial purpose.

We expect that there remains substantial advantage to EU and global markets in allowing spot and forward trading in physically-settled contracts for the sale of fungible goods to continue OTC and on less formal venues (i.e. outside Regulated Markets and MTFs) without the instruments, venues and participants being subject to regulation under MiFID (or to the uncertainty as to whether MiFID does apply). General economic advantage can arise from standardisation, and we would question whether it is appropriate for this to result in regulation merely because there is an equivalent contract traded on a regulated Market, MTF or similar third country facility where none of the other hallmarks of financial trading is present – clearing or margining for example.

In this connection we would refer you to the Market Submissions referred to in our response to question 8 which provide some useful examples of situations in which regulatory capture of spots and forwards might arise.

Accordingly, we would counsel the Commission against this change or at least first to conduct (or request ESMA to conduct) a detailed impact assessment and cost-benefit analysis before any such change is proposed in legislation.

5.4. Emission allowances

(66) What is your opinion on whether to classify emission allowances as financial instruments? Please explain the reasons for your views.

We agree that the Commission should conduct a more in-depth study of this issue before reaching any conclusions, including an impact assessment and cost-benefit analysis. Among the factors we consider should be taken into account in the study and analysis are:

 the effect on liquidity in the carbon markets of imposing financial regulation on the underlying as distinct from derivatives;

 whether a different form of regulation, for example by DG Climate Change, would be more appropriate – especially given that, in any event, the Market Abuse Directive applies and (following its review) will have a more extensive application to address potential abuse;

 the issue raised above in respect of the inadvertent or unnecessary

38 and costly impact of financial regulatory capture of non-financial firms and non-financial activity, such as:

(i) such firms trading physical emissions allowance having to become regulated investment firms with significant implications for the management and operation of the whole entity and businesses of being captured as "investment firms" ;

(ii) potential impact of other legislation which cross-references the MiFID concept of "financial instrument".

39 6. TRANSACTION REPORTING

6.1 Scope

(67) What is your opinion on the extension of the transaction reporting regime to transactions in all financial instruments that are admitted to trading or traded on the above platforms and systems? Please explain the reasons for your views

(68) What is your opinion on the extension of the transaction reporting regime to transactions in all financial instruments the value of which correlates with the value of financial instruments that are admitted to trading or traded on the above platforms and systems? Please explain the reasons for your views.

(70) What is your opinion on the extension of the transaction reporting regime to transactions in all commodity derivatives? Please explain the reasons for your views.

(71) Do you consider that the extension of transaction reporting to all correlated instruments and to all commodity derivatives captures all relevant OTC trading? Please explain the reasons for your views.

Proposed extensions in scope must be clear and provide sufficient certainty as to what is covered. The approach taken in the proposals does not achieve that clarity in every respect.

Before extending reporting requirements to a particular asset class or market the Commission (or ESMA) should assess that this meets the desired objectives – for example, it may not be worthwhile for commodity, foreign exchange and certain other derivatives where exchange position reports may be a better tool to monitor for market abuse.

We note the policy to seek to capture transactions that directly reflect or influence the trading in instruments whose trading is directly protected by the Market Abuse Directive (the "MAD"), but consider that the proposals could usefully be clarified further. In particular the concept of "correlation" does not encapsulate the degree of linkage or relationship appropriate to justify the extension in transaction reporting. A mere statistical correlation does not demonstrate a causal link and thus does not in itself imply real linkage between the value or pricing of the instruments. MiFID currently incorporates the idea of "relationship" when outlining the scope of "derivative" instruments. If the Commission considers that it is appropriate to elaborate on the matter, we strongly suggest that it does so in those terms and not a measure that may be

40 no more than a mere statistical coincidence.

We were surprised to see the suggestion that the MAD may be extended to non-financial markets. This was not an approach proposed in the recent consultation on that directive – indeed it contemplated a specific anti-abuse regime in the context of energy-related markets. The current proposals do not articulate any justification for this extension nor any consideration of the range of impacts that it might have, bearing in mind the differences between the ways in which markets operate.

(72) What is your opinion of an obligation for regulated markets, MTFs and other alternative trading venues to report the transactions of non-authorised members or participants under MiFID? Please explain the reasons for your views.

The need for this is not made out clearly in the consultation document and it is impossible to identify whether the proposal is proportionate to the issue – in particular it does not set out any evidence that there is a significant issue to address. The CESR advice on which this appears to be based does not provide any data to support the proposition, nor does it begin to address the question of how many additional transactions might be reported (or whether there is an increased likelihood of double-reporting, cited as a problem elsewhere in the consultation). It appears simply that CESR and the Commission have recognised the inevitability that not all transactions executed in financial instruments involve an investment firm. We agree but note that the proposal cannot achieve 100% capture of such transactions for that very reason – for example there will be transactions executed outside the EU/EEA, and transactions executed between private parties, neither of which would be subject to a reporting requirement. We therefore question the extent to which this additional obligation will add meaningfully to the data capture.

(73) What is your opinion on the introduction of an obligation to store order data? Please explain the reasons for your views.

(74) What is your opinion on requiring greater harmonisation of the storage of order data? Please explain the reasons for your views.

We expect that the introduction of an obligation to store order data would entail major investment and ongoing costs with no clear benefit, and would duplicate data which in many cases is already stored (at least for the period during which it is most likely to be relevant – for example, until a trade is confirmed or otherwise documented). Accordingly, we believe that the Commission should

41 produce a cost benefit analysis before pursuing this proposal.

6.2 Content of reporting

(75) What is your opinion on the suggested specification of what constitutes a transaction for reporting purposes? Please explain the reasons for your views.

The basic concepts for triggering transaction reporting are not all adequately precise. However, we consider that addressing the concept of "transaction" does not overcome the key question. In our experience, the key issue is the potential for uncertainty as to what amounts to "execute" in this context. We note that the CESR – CEBS Technical Advice recognised this very issue. For example a chain of intermediaries between a client and a regulated market will have different roles for equity transactions compared with derivatives transactions – the latter typically will involve a chain of multiple individual contracts in financial instruments in which each step involves a separate purchase and sale (albeit back-to-back, principal-to-principal transactions which are essentially mirror images of each other and therefore with an intended net zero position risk for intermediaries, and thus no economic change for the intermediaries except credit exposures inherent in intermediating in a principal capacity), the former may involve an instrument(s)being bought and sold in what is in essence a single transaction effected through a chain involving a number of firms who are not dealing as principal, as we illustrate elsewhere.

It seems to us, additionally, that the proposals make even less clear than at present how to analyse the aggregation/allocation of multiple client orders by an intermediary for execution through a further investment firm.

Much more though and guidance is needed in this area if transaction reports are to be reliable sources of information.

(76) How do you consider that the use of client identifiers may best be further harmonised? Please explain the reasons for your views.

(77) What is your opinion on the introduction of an obligation to transmit required details of orders when not subject to a reporting obligation? Please explain the reasons for your views.

(78) What is your opinion on the introduction of a separate trader ID? Please explain the reasons for your views.

(79) What is your opinion on introducing implementing acts on a common European transaction reporting format and content? Please explain the reasons

42 for your views.

The Commission proposal differs markedly from the CESR – CEBS Technical Advice. CESR refers to the passing of client ID information and not the full detail for the reporting obligation. CESR also recognised the potential for interference in and disruption of legitimate commercial activity to the detriment of the firms not executing.

While we support the need for regulators to have information from which they can fulfil their supervisory responsibilities, the obligations are required to be proportionate. Provided that regulators have access to client ID information from the firms concerned they have the ability to substitute internally allocated/EU standardised IDs in place of the firm's own without requiring sensitive commercial information to be passed between firms competing for the same clients.

The proposal appears to be modelled on simple cash equity transactions and then applied across all other relevant markets without further analysis. Even in relation to equity markets the analysis is, we believe, incomplete. As outlined above, where chains of intermediaries are involved their roles are not necessarily the same between chains, or even within a single chain. As well as the examples mentioned above, we are aware of chains in which intermediaries may pass orders to another firm which then (acting as agent either for the first firm or for the client depending on the circumstances) places the order with another to achieve execution.

The proposal also assumes that an order transmitted by a firm which transmits orders is transmitted to another EU investment firm. This is not necessarily the case.

Additionally the concept of a single decision maker as contemplated in the proposal may not always hold, so that its use in the manner suggested could provide less rather than more useful data to counter market abuse issues. For example, a firm may advise on a transaction and then execute the client's transaction – the client is the decision maker even though he may have been prompted by the firm.

We suggest that clarity in what amounts to execution would assist greatly in improving the quality of data reported. This could be combined with passing of information that is sufficient for regulators to identify underlying clients (but not to identify them to other firms in the chain unless that is the commercial agreement in place). We cannot see that there is an evidential basis provided

43 to justify the proposals beyond this as proportional responses to a real regulatory issue.

6.3 Reporting channels

(80) What is your opinion on the possibility of transaction reporting directly to a reporting mechanism at EU level? Please explain the reasons for your views.

(81) What is your opinion on clarifying that third parties reporting on behalf of investment firms need to be approved by the supervisor as an Approved Reporting Mechanism? Please explain the reasons for your views.

(82) What is your opinion on waiving the MiFID reporting obligation on an investment firm which has already reported an OTC contract to a trade repository or competent authority under EMIR? Please explain the reasons for your views.

(83) What is your opinion on requiring trade repositories under EMIR to be approved as an ARM under MiFID? Please explain the reasons for your views.

We agree that there are advantages to be gained from reducing the possibility of multiple reporting obligations for the same transaction. This has potential to save costs and improve the quality of data.

Whilst trade repositories may wish to be ARMs, because that seems likely to confer benefits to them and deliver market efficiencies, we think that the Commission should hesitate before imposing particular business models on what is essentially a relatively new kind of business. In the interests of third country access and equivalence, the ARM requirements should not be such as to preclude non-EEA trade repositories being approved as ARMs or rendering it extremely unattractive for them to obtain that status, such that there is a distortion of competition between trade repositories.

44 7. INVESTOR PROTECTION AND PROVISION OF INVESTMENT SERVICES

7.1 Scope of the Directive

1.1.1 Optional exemptions for some investment service providers

(84) What is your opinion about limiting the optional exemptions under Article 3 of MiFID? What is your opinion about obliging Member States to apply to the exempted entities requirements analogous to the MiFID conduct of business rules for the provision of investment advice and fit and proper criteria? Please explain the reasons for your views.

This is a policy question but we are not aware that any significant problems have arisen by reason of leaving this narrowly defined area to national discretion.

1.1.2 Application of MiFID to structured deposits

(85) What is your opinion on extending MiFID to cover the sale of structured deposits by credit institutions? Do you consider that other categories of products could be covered? Please explain the reasons for your views.

We note that there is, as yet, no settled definition of what is considered to be a "structured deposit". As we have said in our response to the PRIPs consultation, we support the use of option 2. Option 1 is, in our view, a simple deposit (albeit with an interest rate that may fluctuate differently to mainstream bank base rates or inter-bank rates), whereas option 2 bears a much stronger resemblance to a financial instrument. As noted in the PRIPs consultation document the use of option 2 has the benefit of consistency with work on deposit guarantee schemes. We also suggest that there is a particular difference in investor protection issues between a product in which the invested capital is subject only to the credit risk of the institution to which it is paid (i.e. true deposit taking activity), and a product in which the invested capital is subject to other risks, notably market risk. This is a further reason for supporting the approach of option 2.

We did not identify in the MiFID proposals any analysis of whether the products are sold in these forms, as opposed to, for example, listed debt instruments reflecting the kinds of returns referred to in the PRIPs document. To the extent that debt instruments are being sold, we consider that such products are already within the MiFID scope. To the extent that option 2 products are being distributed in that form we consider that MiFID already applies to such instruments – being a hybrid containing a financial derivative – although we can

45 see that a hybrid instrument can result in lack of certainty, which would support a degree of clarification.

In relation to option 1, the instrument is not a financial instrument within the scope of MiFID, and would raise the prospect of including within MiFID all deposit sales, the case for which is not made out. Alternatively it raises the prospect of an unsatisfactory, and potentially arbitrary, divide between different expressions of interest rates as to whether MiFID applies or not. Even if a policy decision is made to apply MiFID protections beyond the scope of financial instruments to the "sale" of pure deposit products, we question whether all protections are required or whether the marketing rules would suffice.

1.1.3 Direct sales by investment firms and credit institutions

(86) What is your opinion about applying MiFID rules to credit institutions and investment firms when, in the issuance phase, they sell financial instruments they issue, even when advice is not provided? What is your opinion on whether, to this end, the definition of the service of execution of orders would include direct sales of financial instruments by banks and investment firms? Please explain the reasons for your views.

We agree with the analysis relating to the provision of advice in this context. Equally, we consider that MiFID protections apply if the firm concerned is actually acting on behalf of clients as well as being the issuer, for instance if it advises clients to buy the instruments, structures an instrument specifically to meet the needs of a client or exercises investment management powers to buy the instrument for the client. However, in our view the crucial matter therefore is to identify whether the institution is providing an investment service to investors as opposed to acting purely as issuer of the instruments in question. The Commission's proposal appears to suggest that this is (or ought to be treated as) an inevitable consequence of the purchase by investors of the financial instruments in question. In our experience it is typical for issuing financial institutions to make clear whether they are providing a service and (if so) to whom. This can be a consequence of a firm's consideration of the potential conflicts of interest that could arise, which can only be wholly avoided (given that the firm is the issuer) by refraining from providing a service to investors and thus acting in the same manner as other (non-financial) issuers. It is not reasonable to treat a bank raising capital for its business in a completely different way from a commercial company or, indeed, a government raising money by the issue of bonds.

We consider that the comment made by CESR in the CESR – CEBS Technical

46 Advice of 29 July 2010 is correct in its approach that:

"It cannot have been the intention of European legislators to leave investors unprotected in circumstances where they would have a reasonable expectation that an investment firm is acting on their behalf."

This recognises that there are circumstances in which it is not reasonable (and as indicated above, could not be) for an investor to have that expectation. The key is that an investment firm's role should be clear to its clients, potential clients and any other investors in products which it is providing, and that the firm's communications (whether written or oral) and actions should be consistent with that role, and there should be some clear communication describing the role. This seems to us essentially inherent in the requirement to act honestly, fairly and professionally. To the extent that regulators are concerned that this is not well understood, it is, we suggest, apt for guidance at Level 3 or (on a coordinated basis) at national level.

7.2 Conduct of Business Obligations

1.1.4 "Execution-only" services

(87) What is your opinion of the suggested modifications of certain categories of instruments (notably shares, money market instruments, bonds and securitised debt), in the context of so-called "execution-only" services?

In our view, it is important that there is a clear distinction between financial instruments that are considered complex and those that are considered non- complex. This distinction must be easily understood by both investment firms and clients. In our view, creating sub-categories of particular financial instruments is likely to lead to confusion. For example, it is not always clear whether, or when, a share has become admitted to trading on an MTF. What would the position be of a share that was admitted to trading but, for some reason, became suspended? We think that shares, UCITS, money market instruments, bonds and securitised debt should continue to be treated as non- complex financial instruments provided they meet all aspects of the definition (which, we note, already contains language relating to products that embed a derivative or incorporate structures which make it difficult for the client to understand the risk involved).

We accept that issues of liquidity may be relevant to risk, though not necessarily to complexity. We consider that the existing risk disclosure requirements would, where relevant, require a firm to provide a warning of such risks, although the

47 Commission may wish to consider if further guidance is required on this issue, i.e. on the disclosure of risks in respect of various kinds of non complex instruments,.

(88) What is your opinion about the exclusion of the provision of "execution- only" services when the ancillary service of granting credits or loans to the client (Annex I, section B(2) of MiFID) is also provided?

We understand the reasoning behind this proposal, although we think it would be more straightforward to say that clients who require credit or loans in order to purchase financial instruments should benefit from an appropriateness assessment, rather than saying that the involvement of a loan automatically makes the transaction complex. However, we consider that such protection is only necessary in relation to Retail Clients.

(89) Do you consider that all or some UCITS could be excluded from the list of non-complex financial instruments, in the case of a partial exclusion of certain UCITS, which quite clearly could be adopted to identify more complex UCITS within the overall population of UCITS?

For the reasons set out in our answer to question 87, we think that all UCITS should be treated as non-complex financial instruments, and we think it is very important that both investment firms and clients understand which products are treated as complex and which non-complex. Sub-categories of product will not aid clarity in this area.

If there are to be distinctions between different UCITS instruments, then there should be rules to ensure that these distinctions are very clear in provider information (including Key Investor Information document), placing the obligation on providers to ensure the category is transparent.

(90) Do you consider that, in the light of the intrinsic complexity of investment services, the "execution-only" regime should be abolished?

We do not agree that execution-only services should be abolished, not even in relation to Retail Clients. To do so would be to reduce choice for investors in a major way. Some investors may wish to acquire financial instruments without the added cost of receiving advice and without the delay involved in the undertaking of a suitability or appropriateness assessment. The consultation refers to on-line brokerage and this has become a typical channel for this kind of service because it enables investors to make investment decisions in the quickest and most cost-effective manner.

48 Investors, such as Retail Clients, who wish to receive a different level of service can always choose to do so. Many of the members of this Committee will, from time to time, use execution–only services in their personal capacity, we find them valuable in that they provide investor choice – what matters is that investors understand that they are not receiving advice on the suitability or appropriateness of the transaction. The onus for ensuring that investors understand this should be on the investment firm. The need to buy/sell investments may be driven by personal tax planning or even a need to pay debts – in the first case the investment firm may not have the capability to provide the advice, the client will have obtained it elsewhere, in the second adding to the cost (which the proposal would do) may not be in the best interest of the client, who knows what he must do.

1.1.5 Investment advice

(91) What is your opinion of the suggestion that intermediaries providing investment advice should: (1) inform the client, prior to the provision of the service, about the basis upon which advice is provided; (2) in the case of advice based on a fair analysis of the market, consider a sufficiently large number of financial instruments from different providers?

We consider that clarity as to the basis upon which investment advice is provided is important. We think it is reasonable to assume that an investment firm that holds itself out as independent in the provision of its advice should be obliged to assess a sufficiently large number of financial instruments of different types and from different providers before they can make such a claim. However, it is important that some flexibility is included, depending upon the scope of advice which the firm purports to provide (or impliedly provides) and the scope of the advice sought by the client. Investment firms should not be required to consider types of financial instrument that are not relevant to the advice being provided before they can claim to provide independent advice. For example, an investor has decided that they wish to invest in a UCITS product. An investment firm ought to be able to claim to provide independent advice on UCITS if their advice is based upon an assessment of a sufficiently large number of UCITS from different UCITS managers. That firm should not also be required to provide expert advice on unrelated financial instruments, such as pensions, before they can claim that their advice in relation to UCITS is independent.

In relation to a prohibition on accepting payments or benefits from product providers, see our response to section 7.2.4 on Inducements.

49 (92) What is your opinion about obliging intermediaries to provide advice to specify in writing to a client the underlying reasons for the advice provided, including the explanation on how the advice meets the client's profile?

In our view, the general obligation to report to clients on the services provided is sufficient to meet the Commission's objectives. The proposal to prescribe the medium in which these reports should be made, and the information that should be included, seems excessively detailed, particularly for Level 1.

We also note, though there is no specific question, the proposal to clarify that investment advice may be provided through distribution channels. This is an area with a number of complexities and the exact drafting of any such provision will be critical. It must not accidentally blur the line between personal recommendations and other communications.

(93) What is your opinion about obliging intermediaries to inform the client about any relevant modifications in the situation of the financial instruments pertaining to them?

(94) What is your opinion about introducing an obligation for intermediaries providing advice to keep the situation of clients and financial instruments under review in order to confirm the continued suitability of the investments? Do you consider this obligation to be limited to longer term investments? Do you consider this could be applied to all situations where advice has been provided or could the intermediary maintain the possibility not to offer this additional service?

We disagree with this proposal. Investment advice is provided at the time it is delivered to the client. A distinction should be made, as is the case at present, between situations where the investor contracts to receive an ongoing advisory review service which involves a continuing relationship and updating of relevant information about the client's circumstances, and situations where “one-off” advice is given on a particular transaction at a particular time, either because the client requests that advice on that occasion or because the firm is required to give it as part of its regulatory consideration of suitability and appropriateness.

A client may want investment advice in a particular circumstance, and may in the future choose not to update that advice, or to go elsewhere for further advice. It should be free to do so. Where a firm is asked to provide advice to a client, the firm may not necessarily know whether the client has subsequently chosen to follow that advice, or the advice remains relevant in the future or even

50 know how to contact the client in future. There would be a significant financial burden on firms, with no compensating protection provided to clients, if firms were required continually to report to clients on the performance of financial instruments that were the subject of the initial advice and/or continually to seek further information about the client's contact details and changing circumstances in order to update advice when the client has not chosen to entrust the firm with a continuing mandate. For advice to be of any merit a firm would need updated information and the capability to provide the full range of advice then needed. There is no difference in these circumstances between complex and non-complex products. It is important that clients are not overwhelmed with data, and are able to find the most important information provided to them by investment firms. The continued and repeated provision of updated information relating to instruments that may no longer be relevant to the client will not assist clients.

1.1.6 Informing clients on complex products

(95) What is your opinion about obliging intermediaries to provide clients, prior to the transaction, with a risk/gain and variation profile of the instrument in different market conditions?

(96) What is your opinion about obliging intermediaries also to provide clients with independent quarterly valuations of such complex products? In that case, what criteria should be adopted to ensure the independence and the integrity of the valuations?

(97) What is your opinion about obliging intermediaries also to provide clients with quarterly reporting on the evolution of the underlying assets of structured finance products?

(98) What is your opinion about introducing an obligation to inform clients about any material modifications in the situation of the financial instruments held by firms on their behalf?

In our opinion, further legislation in this area is unnecessary. Investment firms are already subject to the "know your customer" obligation and detailed requirements follow as to suitability and appropriateness. If a risk/gain or valuation profile of an instrument assists the firm to meets its suitability or appropriateness requirements, then it will already be providing them under the existing rules. If a risk/gain or valuation profile, for whatever reason, is not necessary under the existing regime, then no further requirements in this area should be introduced.

51 Any requirement to provide independent quarterly valuations of such complex products would introduce significant costs that would, at least in part, be borne by clients. Where clients require such valuations, they can request them, or choose not to invest in products that do not provide them.

We cannot see why any obligation on custodians, who hold client financial instruments, to inform clients of material modifications in the "situation" of those instruments should be introduced. The role of the custodian should be to concentrate on keeping the assets safe. A custodian would not necessarily be aware of any such modifications. If the modification was within the contemplated scope of the instrument at the time at which it was acquired by the investor, then presumably it would be within the contemplation of the investor that such a modification might occur. We are not clear as to the type of "material modification" the Commission has in mind, nor the type of service being provided by the investment firm that might trigger an obligation in this regard. For example, if the investment firm had provided advice at a particular point in time, and the investor chose to acquire an instrument, we cannot see how it would be realistic or cost-effective to expect the investment firm to continue to monitor the situation of each instrument upon which it provided advice unless the firm has an ongoing formal investment management role (discretionary or non-discretionary) or at least also executed the purchase of the instrument for the client, because otherwise (i) that advice is only provided at one point in time and (ii) the investment firm would not necessarily know whether or not the investor had followed that advice. See further our opinion on questions (91) to (94) above.

In terms of types of modifications, the Commission should make clear whether it intends to capture changes to the terms of the product (to the extent that is permissible under the original terms of the product), exercise by the product provider or others of powers under the terms of the product, or changes in value which are material (which would need to be defined) or which affect the operation of the product (such as triggering a provision in the terms of the product).

(99) What is your opinion about applying the information and reporting requirements concerning complex products and material modifications in the situation of financial instruments also to the relationship with eligible counterparties?

We think it is important that there remains a category of clients to whom such duties are not owed. Eligible Counterparties are supposed to be able to deal with each other on an equal footing. Any firm that does not feel comfortable in

52 this position can always request categorisation as a Professional Client in order to obtain greater protection. It would be inappropriate, for example, to expect Deutsche Bank to provide this type of protection when dealing with Barclays.

(100) What is your opinion of, in the case of products, adopting ethical or socially oriented investment criteria, obliging investment firms to inform clients thereof?

We do not consider that any legislation is required in this regard. Clients who wish to obtain such information can ask investment firms to provide it. We are not aware of any market failure in this regard.

1.1.7 Inducements

(101) What is your opinion of the removal of the possibility to provide a summary disclosure concerning inducements?

Given the breadth of the inducement concept and the fact that at the outset of a long term relationship a firm may not know the details of potential inducements, only their characteristics, we think it is essential that this possibility is maintained.

(102) Do you consider that additional ex-post disclosure of inducements could be required when ex-ante disclosure has been limited to information methods of calculating inducements?

In our opinion, a summary disclosure concerning inducements should contain sufficient information to enable an investor to consider the potential inducement before making an investment. Clients can request further information on an ex- post basis if they are interested in so doing. In our opinion, ex-post disclosure of inducements in all cases will be difficult to provide and of limited relevance to potential investors. In particular, as inducements can only be accepted where they are to the benefit of the investor, it is important that such a benefit is not lost in the costs to the client of additional reporting requirements. We do not consider that implementing acts clarifying the technical details of different items or a template for disclosure would help given the great range of potential inducements that may exist, and the circumstances in which they come about. Sufficient comfort should be taken from the existing requirements on the conditions for inducements.

(103) What is your opinion about banning inducements in the case of portfolio management and in the case of advice provided on an independent basis due to the specific nature of these services? Alternatively, what is your opinion

53 about banning them in the case of all investment services?

It is frequently the case that investment firms need to co-operate in order to obtain the best outcome for mutual clients. In the circumstances of such co- operation, firms need to share the benefits accruing, or the costs involved, in order to provide these services to their client on the best basis. This may be the case in relation both to portfolio management and advice. The existing legislative protections requiring "comprehensive, accurate and understandable" disclosure and relating to the need for the inducement to both enhance the quality of the service to the client and not be contrary to the client's best interests; should together provide sufficient protection. If these conditions are met , it must be in the client's best interests to permit it to continue. If they are not, the inducement is already prohibited. So, in the absence of a much more detailed cost-benefit analysis identifying specific cases of investor detriment, we oppose the banning of inducements either for specific investment services or generally.

1.1.8 Provision of services to non-Retail Clients and classification of clients

(104) What is your opinion about retaining the current client classification regime in its general approach involving three categories of clients (Eligible Counterparties, Professional and Retail Clients)?

Generally we believe that the existing client classification regime is appropriately structured to distinguish between different types of client and the different services and investments. It is has sufficient flexibility for them to move between different categories either generally or in relation to particular types of investment or service. In particular, Eligible Counterparties can request treatment as Professional Clients. However, for this categorisation to work correctly, in our opinion the Eligible Counterparty category should be one where conduct of business rule protection is not applicable. Therefore, we oppose changes to the execution-only regime that would mean that, for complex products, Eligible Counterparties became Professional Clients and obtain unnecessary customer protections – especially given that the Eligible Counterparty categorisation already applies only to execution services (by virtue of Article 24 of MiFID) and not to advisory or discretionary management services (see questions (87)-(90) above).

One point which could helpfully be clarified in any revision of MiFID is the distinction between Eligible Counterparties, who are clients because the investment firm is providing a service to them, and entities which are merely counterparties facing each other in market dealings. These distinctions are

54 particularly important because not only should the obligations under Articles 19, 21 and 22(1) of MiFID be disapplied in market dealings with counterparties who are not clients, but also certain other obligations do not and should not apply in dealings with such counterparties – for example, there is no reason why a firm should not deal with a non-client counterparty without seeking to manage any conflicts it has in relation to that counterparty, nor disclosing such conflicts.

These distinctions would be relevant, for example, where two investment banks enter into transactions with each other where both are dealers, or where a dealer buys or sells a financial instrument in a transaction with a broker (although the broker will in turn be acting for its client and have best execution obligations) because in these situations no service is being provided. On the other hand, an inter-dealer broker is likely to be providing a service to the counterparties on each side of the transaction even though those counterparties are typically sophisticated and of a kind that can be treated as an Eligible Counterparty.

To the extent that the Commission considers that this flexibility is not being appropriately applied so that clients are classified for all products when a more limited change of classification would be appropriate, or clients are failing to exercise their rights to change classification, that is a matter which is best addressed through the supervision of firms, guidance and proper application of the existing MiFID provisions rather than further regulation or the removal of the current classifications and differentiation.

There is, however, one aspect of the classification process which does not appear to us properly to fulfil its intended function. In view of the great range of different types of investment covered by MiFID the Directive includes many types of investment where it is entirely inappropriate for an investor to carry out in excess of 10 transactions a quarter. Clearly that provision in Section II.1 of Annex II relating to the identification of clients who may be treated as clients on request, was originally drafted with liquid listed equity markets in mind not with a view to longer term investments. Indeed even in the equity markets the provision risks encouraging short term trading or speculation and discouraging more thoughtful long term investors whose experience and expertise may be at least as deep, and possibly deeper, than that of a frequent trader. The effect is that such people are excluded from classification as professionals unless they have been employed in the financial sector. This no doubt unintended consequence is important and needs correction under MiFID but becomes even more relevant when the MiFID definition is adopted, as it has been, in other Directives such as the Alternative Investment Fund Managers

55 Directive where the asset or investment class in question is inherently unsuitable for frequent trading.

We respectfully suggest that in addition to the questions the Commission has raised relating to client classification it should consider resolving the anomaly that the Directive client classification rules tend to encourage a short termism in investment activity which we do not believe to be its intention and exclude true professionals in certain asset classes, such as business angels in the venture capital field. We can see a number of ways this might be addressed, for instance:

(a) making satisfying 2 out of the three criteria a "safe harbour" rather than a minimum test;

(b) making the minimum test satisfaction of 1 (rather than 2) out of the three criteria;

(c) amending the first (10 transactions in a quarter) criterion to add at the end "or such other frequency over such other period as is appropriate for the type of transactions concerned"; or

(d) deleting the minimum criteria altogether and relying solely on the qualitative assessment obligation. If the firm does not carry out the assessment properly the client will be by default be able to claim that it is a Retail Client.

Whichever approach is adopted we believe it is important for the Commission, ESMA and national regulators to stress to firms the importance of the first qualitative test, which is not constrained by these arbitrary criteria, but requires an "adequate assessment of the expertise, experience and knowledge of the client which gives reasonable assurance in light of the nature of the transactions or services envisaged, that the client is capable of making his own investment decisions and understanding the risks involved." We believe that properly applied that test is a high threshold to cross - indeed the minimum criteria add little to it and arguably could be deleted they risk diverting firms into relying solely on these formal criteria (which would also be the risk of a "safe harbour" approach).

(105) What are your suggestions for modification in the following areas: (a) introduce, for Eligible Counterparties, the high level principle to act honestly, fairly and professionally and the obligation to be fair, clear and not misleading when informing the client; (b) introduce some limitations in the Eligible Counterparties regime. Limitations may refer to entities covered (such as non- financial undertakings and/or certain financial institutions) or financial

56 instruments traded (such as asset backed securities and non-started OTC derivatives); and/or (c) clarify the list of Eligible Counterparties and Professional Clients per se in order to exclude local public authorities/municipalities?

In relation to 105(a) and (b), see our response to question 104 above. We do not think that the introduction of conduct of business-style protections in relation to business between Eligible Counterparties, nor to changes relating to the size of the Eligible Counterparty or the instrument traded is necessary. Eligible Counterparties can request treatment as Professional Clients if they so wish and, by definition, Eligible Counterparties should understand the circumstances where such changes may be necessary.

(106) Do you consider that the current presumption covering the Professional Client's knowledge and experience, for the purpose of the appropriateness and suitability test, could be retained?

We consider that this presumption should be retained. A Professional Client should be presumed to have the knowledge and experience of a "professional client". Many Professional Clients will be unwilling to discuss their level of experience and knowledge to enable an unnecessary know your customer test to be undertaken. In our opinion, the existing regime works properly in this regard.

In relation to 105(c), we appreciate that different local public authorities and municipalities have different levels of expertise but they should all be sufficiently competent to assess the level of protection they require. There is sufficient flexibility within the current client classification system and the ability to contract for additional protections to mean that smaller or less expert municipalities can adjust their classification without a wholesale change to the client classification system, which may exclude large expert bodies from the investments and services they need.

1.1.9 Liability of firms providing services

(107) What is your opinion on introducing a principle of civil liability applicable to investment firms?

(108) What is your opinion of the following list of areas to be covered: information and reporting to clients, suitability and appropriateness test, best execution, client order handling?

In our opinion, the Commission needs to be very careful in considering whether, and if so how, to introduce such a principle. Many of MiFID's rules are drafted

57 as requirements imposed upon firms by their regulators. They are drafted so as to give some flexibility in interpretation by regulators. They are not drafted with the certainty of legal rules. It would be unacceptable for measures that were drafted in this way to give rise to civil liability. If civil liability were to be introduced, this would make the proposal, negotiation, and adoption of implementing measures far more difficult. In the U.K., where there is civil liability to private persons, the FSA rules indicate which rules may give rise to such liability. Firms would be likely to expect sufficient legal certainty in all proposed conduct rules to enable them to assess the risks of breach and potential incidence of civil liability. It would, in our view, be preferable for there to be more flexibility in the drafting and implementation of rules, and no principle of civil liability. Each jurisdiction will have a method by which complaints can be made. This may range from claims for breach of a statute, breach of a civil code or the bringing of a court action in negligence or misstatement. Member States typically provide Ombudsman services to enable disputes against firms to be handled without resort to the complexities of local law and potential costs of litigation that may be beyond the grasp of certain Retail Clients. In these circumstances, additional overlapping civil liability for breach of rules that were often not drafted with such a potential outcome in mind would be unsatisfactory. If any such regime is introduced, we strongly suggest it is limited to Retail Clients

1.1.10 Execution quality and best execution

(110) What is your opinion of the requirements concerning the content of execution policies and usability of information given to clients should be strengthened?

The Commission raises a number of points relating to execution policies (distinction between types of instrument, clients and order; use of internal matching engines; use of single execution venues) that are adequately covered by the existing MiFID requirements. Execution policies must adequately describe the methods used by firms and we would expect these points to be covered where they are relevant. In our opinion, further legislation, or indeed a template for disclosure, is unnecessary and proper supervision of the existing requirements by regulators should be the means by which the Commission meets its objectives.

1.1.11 Dealing on own account and execution of client orders

(111) What is your opinion on modifying the exemption regime in order to clarify that firms dealing on own account with clients are fully subject to MiFID

58 requirements?

(112) What is your opinion on treating matched principal trades both as execution of client orders and as dealing on own account? Do you agree that this should not affect the treatment of such trading under the Capital Adequacy Directive? How should such trading be treated for the purposes of the systematic internaliser regime?

We consider that firms who deal on own account with clients should be within the scope of the MiFID regime, but we would qualify this in two ways:

 It should be clear that an entity can enter into transactions in financial instruments with another entity without either being the client of the other; and

 as noted in our comments on Section 5 of the consultation document, persons (who by definition are not investment firms under MiFID) should be able to deal on own account with clients in the limited circumstances of Article 2.1(i) – in other words we do not agree that the first part of that exemption should be deleted entirely but, rather, should be more limited – and, until an appropriate capital regime is in place, under Article 2.1(k).

In addition, the Commission should conduct a cost/benefit analysis to assess the impact that this change will have on the numbers of entities requiring registration as investment firms and their consequent demand for capital of different qualities, given the increasing demand for equity capital by banks and investment firms in light of Basel III (and implementation of CRDs 2-4) and the expected decrease in supply of capital in light of changes in the prudential regimes for institutional investors such as insurance companies (under Solvency 2) and occupational pension schemes.

The Commission will need to ensure that sufficient guidance is given on the remaining scope of the exemption to ensure that end users of financial services are not caught.

It is important that matched principal trades are treated either as the execution of client orders or as dealing on own account, not as both. Treating a single action as involving multiple services will lead to unnecessary complexities. In our opinion, when a firm is acting in a back-to-back capacity, it is likely to be executing an order on behalf of a client and not dealing on own account and this is (and should be treated as) a service within Section A(2) of Annex I. As a result, conduct of business protections such as best execution should

59 potentially apply. Such trading should fall outside the systematic internaliser regime as it does not involve the commitment of a firm's proprietary capital to trade in a means that takes that trade away from a Regulated Market or MTF – the firm's capital merely supports its credit exposure if the firm is acting as principal. (When a firm is acting in a back-to-back capacity, the second leg of the transaction will generally be undertaken on a Regulated Market or MTF (or, on a facility which is likely to become an OTF), or are transactions in non- admitted securities or non-standardised derivatives and therefore both parties should fall outside the systematic internaliser regime.).

It is important that any re-categorisation should not affect the treatment of such trading under the Capital Adequacy Directive.

7.3 Authorisation and Organisational Requirements

1.1.12 Fit and proper criteria

(113) What is your opinion on possible MiFID modifications leading to the further strengthening of the fit and proper criteria, the role of directors and the role of supervisors?

We agree with the general principles underpinning these proposals.

We would however urge the Commission to avoid imposing overly- prescriptive/rigid requirements – recognising that boards of directors typically (and appropriately) comprise individuals with a range of different (albeit complementary) skill-sets and experience. For example, it would be undesirable if, as an unintended consequence of any new requirements, well- qualified individuals were deemed unfit/improper (or indeed deterred from applying for the role) simply because they did not satisfy specific (and unduly narrow) criteria, which had little (if any) relevance to that individual’s proposed role and/or the business of the firm, or if the pool of individuals qualified to serve were unduly restricted. One of the lessons of corporate governance reviews following the financial crisis is the need to avoid "group think": this militates in favour of appointing a diverse group of individuals, including perhaps some from outside the financial services industry.

1.1.13 Compliance, risk management and internal audit functions

(114) What is your opinion on possible MiFID modifications leading to the reinforcing of the requirements attached to the compliance, risk management and internal audit function?

60 Whilst we agree in principle with these proposals, we would expect that (a) they should be applied by firms in a proportionate manner, having regard to, inter alia, their size, business activities and overall risk profile; and (b) they should be expressed in high level or generic terms, to allow for considerable flexibility in the way they are implemented and complied with.

1.1.14 Organisational requirements for the launch of products, operations and services

(115) Do you consider that the organisational requirements in the implementing directive could be further detailed in order to specifically cover and address the launch of new products, operations and services?

A detailed prescription of organisational requirements would unnecessarily restrict the way in which firms develop new products, operations and services. New requirements are unnecessary since existing high level requirements already apply to all aspects of an investment firm's investment services and activities – for example the organisational requirements in Article 13 of MiFID and in the MiFID Implementing Directive.

While it would be possible to add further detail – we would make the following observations:

 The more detail which is added to organisational requirements in specific areas the more it tends to detract from the overall organisational requirement on firms to run the whole of their business efficiently and properly rather than focussing on specific points.

 If any additional detail were added it would be important for firms to have the ability to apply any more detailed requirements proportionately, having regard to, inter alia, their size, particular products and business activities and overall risk profile.

 We also suggest that the term "new products" (7.3.3 f)) be clarified in such a way as to render a product as "new" only where, say, it has materially different (risk-related) characteristics to those of existing products in the market or provided by or through the firm concerned.

(116) Do you consider that this would imply modifying the general organisational requirements, the duties of the compliance function, the management of risks, the role of governing body members, the reporting to senior management and possibly to supervisors?

61 Yes - as concerns the duties of the compliance function.

Sub-paragraph 7.3.3 b) proposes a strengthening of "the duty of the compliance function to ensure that procedures and measures are in place to ensure the product, service or operation complies with all applicable rules including those relating to disclosure, suitability/appropriateness, inducements and proper management of conflicts of interest (including remuneration)".

This would, it seems, represent a (total or, at least, partial) re-allocation of a key (and core) responsibility of senior management to the compliance function; and would therefore conflict with:

(a) Article 9.1 of the Implementing Directive (2006/73/EC), which clearly allocates responsibility for regulatory (MiFID) compliance to senior management and, where appropriate, the supervisory function; and

(b) Article 6.2 of the Implementing Directive, which envisages the typical monitoring, advisory and adequacy assessment roles for the compliance function.

In consequence, sub-paragraph 7.3.3 b) effectively challenges (and is inherently inconsistent with) the governance/risk frameworks currently employed by firms, which are underpinned by the fundamental principle that senior management/the supervisory function remains ultimately responsible for regulatory compliance. If implemented, this would likely have far-reaching implications both for regulated firms and the wider financial services industry. For example, roles and responsibilities would need to be re-defined, policies and procedures re-drafted and governance frameworks re-configured.

Furthermore, the proposal runs a serious risk of creating legal and/or regulatory uncertainty as to where responsibility lies, and of undermining the compliance function – because, for example, senior management and other levels of management and client facing staff will be able to abdicate their responsibilities for compliance to the compliance function rather than taking on individual responsibilities to comply and (in the case of management) to ensure compliance.

The existing regime does not of course preclude the involvement of, or input from, the compliance function, where that is considered appropriate and it generally will be when it is question of setting up the procedures for complying with rules. However, for the reasons articulated, we consider that it would be undesirable to impose a duty to ensure that certain things happen upon the compliance function.

62 1.1.15 Specific organisational requirements for the provision of the service of portfolio management

(117) Do you consider that specific organisational requirements could address the provision of the service of portfolio management?

In light of the pre-existing relevant organisational2 and conduct of business3 requirements, we see no substantive benefit in the introduction of specific provisions of the type proposed.

1.1.16 Conflicts of interest and sales process

(118) Do you consider that implementing measures are required for a more uniform application of the principles on conflicts of interest?

We do not necessarily agree that the firm in the example cited (which creates strong incentives for its sales staff to sell certain products, e.g. through internal bonus structures) would be unlikely to be able to demonstrate MiFID- compliance. For example, there will inevitably be circumstances in which the said product is in fact the most suitable for that particular client’s requirements, notwithstanding that the salesperson has an extra incentive – always assuming, of course, that the incentive arrangements are properly disclosed to clients in advance. It would in our view lead to a perverse outcome if a client in this scenario was effectively deprived of the opportunity to acquire the product to which it was best-suited.

In the absence of any cogent justification, we are not persuaded that there would be any material benefit in introducing any additional implementing measures, in the conflicts of interest context. Furthermore, such measures could not necessarily be presumed to ensure consistent application of the relevant principles – and indeed, may have the opposite effect.

1.1.17 Segregation of client assets

(119) What is your opinion of the prohibition of title transfer collateral arrangements involving retail clients’ assets?

We are very concerned that the inability to engage in TTCA with Retail Clients will in practice deny such clients access to products in respect of which TTCA are an integral element – for example, stock lending and repos. Where such

2 Article 13 Directive 2004/39/EC and article 19 of Directive 2006/73/EC 3 Including, inter alia, the suitability requirement, the clients’ best interests rule, information requirements and client reporting obligations

63 products are governed by industry standard terms which provide for TTCA, it is unlikely that firms will modify the products to remove TTCA. Indeed there are legal and practical difficulties in making any such change. Accordingly, the result is likely to be that firms will withdraw these products from Retail Clients.

When presented with a choice between products affording client money protection and products utilising TTCA, we understand that clients will often opt for the TTCA products on the basis that they are commonly available at preferential rates.

We believe that relevant evidence of "indiscriminate application" (and related Retail Client detriment) and a cost-benefit-analysis are essential before considering these measures any further. Unless and until there is a sound and reasoned justification for curtailing client choice in this way, we view this proposal as unnecessary and potentially detrimental to the very persons it purports to protect.

It is also important in this context to have regard to the relevance of firms’ pre- existing suitability and appropriateness obligations; which, if duly discharged, should eliminate any prospect of the type of client detriment at which this proposal is aimed.

The Commission might however usefully consider a requirement for enhanced disclosure of the credit risk inherent in TTCA, rather than an outright and disproportionate prohibition.

(120) What is your opinion about Member States be[ing] granted the option to extend the prohibition above to the relationship between investment firms and their non retail clients?

The Commission does not provide any rationale(s) for this proposal, which, in the absence of any persuasive evidence to the contrary is, in our view, unnecessary. Furthermore such discretion would likely lead to inconsistency in application across Member States – directly contrary to one of the stated reasons for the Commission’s review4 and to the single market principle – and deprive investment institutions in some Member States from access to well established investment and financing products.

In summary, we see no merit or justification in granting Member States optionality to exclude TTCA in the case of Professional Clients and Eligible Counterparties.

4 See final bullet point on page 7 – minimisation of discretions across Member States

64 (121) Do you consider that specific requirements could be introduced to protect retail clients in the case of securities financing transaction[s] involving their financial instruments?

In the absence of any evidence to the contrary, we consider that the existing provisions of the Implementing Directive (Article 19 Directive 2006/73/EC), if properly observed, should suffice to afford retail clients the requisite degree of protection.

The Commission may however consider that it would be appropriate to introduce a requirement for enhanced disclosure prior to the obtaining of the client’s express general consent to TTCA – we think that express consent on the transaction-by-transaction basis would be disproportionately burdensome.

(122) Do you consider that information requirements concerning the use of client financial instruments could be extended to any category of client?

Yes – if there is sufficient evidence supporting (and justifying) such a measure.

(123) What is your opinion about the need to specify due diligence obligations in the choice of entities for the deposit of client funds?

We are supportive, in principle.

However, it will be important to ensure that any such obligations are; (a) implemented and enforced on a consistent basis across Member States; and (b) do not result in an unduly onerous additional administrative burden.

1.1.18 Underwriting and placing

(124) Do you consider that some aspects of the provision of underwriting and placing could be specified in the implementing legislation? Do you consider that the areas mentioned (conflicts of interest, general organisational requirements, requirements concerning the allotment process) are the appropriate ones?

As a general matter, we consider that due compliance with the relevant aspects of the existing MiFID framework – such as conflicts of interest (including the requirement for an effective conflicts policy), record-keeping and clients’ best interests – should ensure that firms behave appropriately vis-à-vis their clients, in the placing/underwriting context.

We are concerned that the Commission has not provided empirical evidence which supports the necessity, or benefit, of more specific or detailed

65 requirements. In the absence of such justification, we are strongly of the view that no such additional specific prescription is necessary and that any attempt to introduce more prescriptive requirements risks creating uncertainties and loopholes rather than solving a problem.

66 8. FURTHER CONVERGENCE OF THE REGULATORY FRAMEWORK AND OF SUPERVISORY PRACTICES

1.1.19 Tied Agents

(125) What is your opinion of Member States retaining the option not to allow the use of tied agents?

We support the proposal to remove the option for Member States not to allow the use of tied agents.

(126) What is your opinion in relation to the prohibition for tied agents to handle clients' assets?

Again, we are generally supportive of this proposal. However, it is worth clarifying a number of points:

(a) The term "to handle clients’ assets" could cover a wide range of activities, from merely receiving a cheque from a client and forwarding it on (e.g. to an investment firm or to an issuer), or holding a mandate over a client’s account with a credit institution or using their credit or debit card details, or being authorised to give instructions to a third party custodian, to the safeguarding and administration of financial instruments and holding funds belonging to clients. There may be some activities (e.g. forwarding a cheque) which may be carried on by the tied agent without any undue risks arising, and so the Commission should be clear as to which activities it seeks to prohibit.

(b) It also needs to be clear that this prohibition only relates to clients assets that may be handled pursuant to MiFID business. For example, a tied agent that handles client assets in the course of carrying on an unregulated business or that is permitted to handle client assets under a separate regulatory regime (e.g. for insurance mediation business) should not be affected by this prohibition. For example, the FSA already prohibits tied agents (appointed representatives) of UK firms from holding client money in relation to investment business, but permits client money to be held by tied agents (under strict rules) in relation to insurance mediation business.

(127) What is your opinion of the suggested clarifications and improvements of the requirements concerning the provision of services in other Member States through tied agents?

We are generally supportive of all of these clarifications and improvements

67 which seem sensible and proportionate.

(128) Do you consider that the tied agents regime require any major regulatory modifications? Please explain the reasons for your views.

No. We do not consider that the tied agents regime requires any major regulatory modification.

However, there is one issue in relation to tied agents that has caused confusion and may be worth clarifying. Articles 4.1(25) and 23(1) of MiFID on the definition of "tied agents" and their permitted activities have been interpreted by national regulators in some Member States as prohibiting tied agents from transmitting orders to, soliciting business for and promoting the activities of, investment firms other than the investment firm which has appointed the tied agent. We consider that the correct interpretation of MiFID is that such activities are permitted subject to the investment firm that has appointed the tied agent accepting responsibility for the activities in question (e.g. the introduction of clients by a tied agent to another investment firm). This is the interpretation that has always been applied in the U.K. Under any other interpretation there is a risk that the tied agent will not be able to fulfil obligations relating to proper advice and execution.

(129) Do you consider that a common regulatory framework for telephone and electronic recording, which should comply with EU data protection legal provisions, could be introduced at EU level? Please explain the reasons for your views.

Yes, we are in favour of a common regulatory framework to harmonise the position across the EU. The UK currently has detailed rules on telephone and electronic recording, in order to detect market abuse and insider dealing and so preserve market integrity. It seems appropriate that investment firms in other Member States are subject to similar requirements.

(130) If it is introduced do you consider that it could cover at least the services of reception and transmission of orders, execution of orders and dealing on own account? Please explain the reasons for your views.

Yes. The principal aim of the recording requirements must be to detect market abuse and insider dealing, and so "reception and transmission of orders, execution of orders and dealing on own account" would capture the relevant services and activities that might be involved.

We note that the Commission considers that the recording requirements should

68 apply with respect to activities and services in relation to "all financial instruments". We do not think this is necessary to ensure the detection of market abuse and insider dealing. It would be more appropriate to restrict the recording requirements to those activities and services involving relevant financial instruments only (i.e. financial instruments which are or will be admitted to trading on a regulated market or, following revisions to the Market Abuse Directive, on an MTF, or other directly related financial instruments such as equity derivatives) and not those financial instruments where the risk of market abuse or insider dealing does not arise (e.g. units in most collective investment schemes).

In addition, we would urge the Commission to consider a de minimis threshold for those investment firms who do not routinely carry out such activities or services. For example, if a portfolio manager only occasionally receives an instruction from one of its clients to buy or sell a relevant financial instrument or only occasionally instructs firms outside the EU, it would be disproportionate to require it to record all of its communications with clients.

(131) Do you consider that the obligation could apply to all forms of telephone conversation and electronic communications? Please explain the reasons for your views.

Yes, subject to one point. If an investment firm is communicating with another investment firm which accepts responsibility for the recording obligation, it should not be necessary to duplicate recordings which would increase the costs involved. Practically speaking, this means that portfolio managers and other "buy side" firms should be exempted from any recording obligation for communications with "sell side" firms subject to the recording obligation. This is currently the position under the UK rules on telephone and electronic recording.

(132) Do you consider that the relevant records could be kept at least for 3 years? Please explain the reasons for your views.

This depends on whether most cases of market abuse and insider dealing are investigated very soon after the event. If so, we do not consider that a three year retention period is necessary (assuming the aim of the recording obligation would be to detect market abuse and insider dealing). A six month period (as is the case in the UK) would be adequate.

1.1.20 Additional requirements on investment firms in exceptional cases

(133) What is your opinion on the abolition of Article 4 of the MiFID

69 implementing directive and the introduction of an on-going obligation for Member States to communicate to the Commission any addition or modification in national provisions in the field covered by MiFID? Please explain the reasons for your views.

While we are generally supportive of the need to harmonise EU legislation and regulation, we also recognise the need of individual Member States to respond to exceptional issues and concerns arising in their jurisdiction. Although the Article 4 process has been used infrequently (by France, Ireland and the UK), it ought in theory to provide transparency on, and reassurance as to the necessity of, the additional measures adopted by individual Member States. It would be disappointing to return to a position where individual Member States have considerably different rules on the same issues, undermining the level playing field for investment firms which MiFID was designed to enhance. We support the retention of Article 4 as, if properly applied, it imposes a discipline on Member States which is necessary to support the internal market and to ensure that investment firms are not subjected to unnecessary hurdles or costs in exercising their passport rights.

8.1 Supervisory powers and sanctions

(134) Do you consider that appropriate administrative measures should have at least the effect of putting an end to a breach of the provisions of the national measures implementing MiFID and/or eliminating its effect? How the deterrent effect of administrative fines and periodic penalty payments can be enhanced? Please explain the reasons for your views.

Yes, we consider that national regulators and/or other governmental authorities ought to have effective powers to impose financial penalties and other sanctions that act as a credible deterrent to breaches of national measures implementing MiFID and end such breaches/eliminate their effect. The FSA in the UK has such powers, and has been vigorous in exercising them.

(135) What is your opinion on the deterrent effects of effective, proportionate and dissuasive criminal sanctions for the most serious infringements? Please explain the reasons for your views.

Criminal sanctions against individuals (and firms) for the types of infringements highlighted by the Commission (e.g. providing investment services without authorisation or making false statements to obtain authorisation) would seem to be appropriate. However, criminal sanctions require a higher burden of proof and inevitably involve time consuming and costly proceedings, and so should

70 be reserved for the most serious infringements, rather than extended simply to provide a more effective deterrent against less serious infringements. The Commission has not made a case for, and we are not convinced that, the imposition of criminal sanctions for breaches of MiFID implementing provisions needs to be harmonised between Member States.

(136) What are the benefits of the possible introduction of whistleblowing programs? Please explain the reasons for your views.

Any scheme which protects whistleblowers against victimisation (including unfair dismissal) by their employers would be well recognised by most investment firms. In the UK, we have had such a scheme through the Public Interest Disclosure Act 1998. However, we are not clear why the Commission is proposing to use MiFID as a means of piloting an incentive scheme for whistleblowers which raises difficult issues across other areas of law (employment, administrative and human rights). We would urge the Commission to consider and consult on this proposal in much more detail, and in relation to a range of businesses (or at least covering the range of financial services regulated under EU legislation), before taking it any further.

(137) Do you think that the competent authorities should be obliged to disclose to the public every measure or sanction that would be imposed for infringement of the provisions adopted in the implementation of MiFID? Please explain the reasons for your views.

We consider that competent authorities ought to disclose such a measure or sanction only where it is the result of a formal administrative procedure rather than, for example, a step taken by a firm at the simple request of the regulator. Even then, a regulator should retain some discretion not to disclose every measure or sanction imposed for infringements where there are good reasons not to do so. For example, disclosing relatively minor infringements by a firm or number of firms may unnecessarily undermine public confidence in that firm or the sector as a whole. From a practical perspective, competent authorities may also find firms challenging adverse findings more vigorously (or worse, not disclosing potential infringements to the authorities) if this results in adverse publicity.

8.2 Access of third country firms to EU markets

(138) In your opinion, is it necessary to introduce a third country regime in MiFID based on the principle of exemptive relief for equivalent jurisdictions? What is your opinion on the suggested equivalence mechanism?

71 We consider that the existing third country regime works well, with individual Member States being left to determine if and how third country firms may provide investment services in their particular jurisdiction and the conditions upon which they may do so. Third country firms with an EEA branch are subject to equivalent conduct of business regulation in the host Member State as a result of the non-discrimination provisions within MiFID. There is also the Article 15 process for relations with firms and markets from third countries which do not provide comparable access to EU firms and markets. Put simply, the existing MiFID regime for third country firms and markets does not seem in need of any major reform.

We are also unclear as to what the Commission is actually contemplating with its proposal for "exemptive relief" for third country firms (following the "equivalence" assessment). Does this apply to EEA branches of third country firms and, if so, why are they being restricted to non-retail business only? Is the Commission trying to impose some form of minimum harmonisation "passport" system for third country firms and markets, to operate alongside individual Member States own regimes if a third country firm or market does not wish to take advantage of this passport system? Unfortunately, the Commission proposal here lacks sufficient clarity for any of these issues to be considered in detail.

Our concern is that the Commission’s proposals could be read to suggest that third country firms and markets which do not qualify for exemptive relief could in effect be barred from "access" to European markets. The risks of such an approach for EU businesses are significant, likely affecting their access to the rest of the world. The prospect of retaliatory action would be extremely damaging for Europe . The consequences of this approach include:

 that European professional investors (including large corporates, pension funds, asset managers and insurance companies) are unlikely to be able to deal with many third country firms or access their markets, either at all or without additional costly and unnecessary layers of intermediation – so that the continued pursuit of investment opportunities in non-EEA emerging and developed markets would be severely curtailed or cease altogether; and

 that European corporates would be restricted in accessing a variety of overseas markets for their equity and debt finance.

This would seem likely to have a deeply negative effect on the ability of European businesses to access key global funding sources, particularly in Asia. If this is the Commission’s intention, this point should be expressed definitively

72 so that both the legal and economic effects of the proposal can be properly assessed and understood.

We do not think that a uniform approach to the arrangements for dealing with third country financial institutions can be pursued across quite different sectors of the financial services industry – so that the arrangements for markets in financial instruments must be very different from those for investment funds (under the AIFM Directive, for example) or insurance companies (under Solvency 2).

(139) In your opinion, which conditions and parameters in terms of applicable regulation and enforcement in a third country should inform the assessment of equivalence? Please be specific.

As stated above, our position is that the existing regime does not require any reform.

(140) What is your opinion concerning the access to investment firms and market operators only for non-retail business?

As stated above, we do not understand the rationale for restricting access to non-retail business only, unless this is part of some sort of passport regime to sit alongside the national rules of individual member states. What happens to existing retail business (e.g. as a result of reverse solicitation or passive marketing)? We strongly urge the Commission to leave the existing regulatory framework intact in this area.

(141) [Blank]

73 9. REINFORCEMENT OF SUPERVISORY POWERS IN KEY AREAS

The Committee is concerned that the proposals for new powers of regulatory intervention are not clearly defined, are not justified and do not yet envisage safeguards to ensure the proper functioning of markets. These proposals are therefore of significant concern to us.

Fundamentally our concern is two-fold. First, as a general rule it should not be the role of national regulators (or indeed ESMA) to intervene in financial markets and/or seek to control at an institution or product level the conduct of financial services within the single market.

Second, it is unclear how the proposals are intended to interact with the powers already conferred on ESMA. There is a passing reference to ESMA’s powers being considered in footnote 280 but this does not bring sufficient clarity to what is otherwise a sweeping and potentially draconian and market-disruptive proposal.

The Committee would be concerned at any approach which delegated to the Commission or to ESMA powers to take, in effect, permanent legislative action, e.g. to introduce specific product regulation (via the introduction of a ban), without undertaking the proper consultation and process otherwise required for European legislative measures. We believe there would be a question as to whether any such approach would be compatible with the Treaty.

The Committee foresees three immediate issues in relation to the creation of extensive powers of intervention of this nature:

 First, there is a risk that any exercise of these powers at an EU level could cause severe disruption and damage to European investment firms and markets, especially where an EU-wide ban is triggered by concerns which apply only to practices which are prevalent in some Member States (or some market sectors) but not all.

 Second, any exercise of these powers at a Member State level risks causing both practical and legal complications, as well as confusion for markets, if one but not all Member States seeks to impose a temporary prohibition on particular activities or products (as experienced during the period when some Member States unilaterally took action to ban short-selling in certain sectors). Moreover it is not clear whether such an approach would be compatible with Article 4 of the MiFID Level 2 Directive.

74  Third, in light of the two issues identified above, unless these powers are clearly and narrowly drawn and the processes which lead to their exercise embody adequate debate, challenge and subsequent review, the mere existence of the powers has the potential to cause legal uncertainty and therefore a loss of confidence in European markets.

Interaction with powers of intervention already granted to ESMA

In summary, ESMA has the following relevant powers:

 Under Article 9(5) of the ESMA Regulation, temporarily to "prohibit or restrict certain financial activities that threaten the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in the Union" (emphasis added). These powers must be exercised only as specified in the sector legislation, primarily MiFID.

 Under Article 9(5), final paragraph, to inform the Commission of any "need to prohibit or restrict certain types of activity".

 Under Article 18, to take certain actions in the case of any emergency which may "seriously jeopardise" the orderly functioning of markets or financial stability. This power is triggered by a decision of the Council and is primarily considered to be a co-ordinating role, with back-up powers to bypass (defaulting) national regulators to enforce directly applicable EU measures (i.e. those measures legislated by means of a Regulation).

Given the existence of these extensive ESMA powers, the Commission should be very clear as to whether its proposals are additional or supplementary. In particular; the proposed Commission power to ban or restrict activities or products appears to, but is not stated to, interact with ESMA’s advisory power mentioned at the second bullet point above. As this ESMA power appears to contemplate the possibility of permanent (or certainly long-lasting) bans or restrictions (as opposed to the "emergency" intervention contemplated in the first part of Article 9(5)), it is not possible to comment meaningfully and constructively on such a draconian new power without far greater detail of the safeguards that would be provided.

Although the consultation paper refers only to the need for consultation, appropriate evidence of risks and a cost/benefit analysis, the Commission must appreciate that generic powers of this kind do little to assure markets, indeed

75 may undermine them. This is exacerbated by the Commission's suggestion that consultation, evidence and analysis would be by-passed "in extraordinary circumstances": we would hope and expect that, if the powers were introduced, bans would be very unusual indeed.

The case for introducing an additional consumer protection ground of intervention is not articulated in the consultation and this proposal therefore represents a significant step beyond the grounds of market confidence and financial stability on which ESMA’s powers are, in general, based.

 The proposed powers of intervention to be given to national regulators appear to complement ESMA’s emergency co-ordination powers set out in Article 18(3). But this is not stated in the consultation document; equally the proposed powers could be considered additional to ESMA powers – in which case they could well conflict.

 Similarly, the proposed powers of intervention where competent authorities fail to act do not appear to be limited to the circumstances where ESMA can intervene under Article 18. This is a major development, but expressed with extreme vagueness – merely a reference to the creation of a "relevant mechanism at Union level".

Does this mean giving an additional power to ESMA? Or a possibly conflicting power to the Commission? If the latter, what is ESMA’s role? And, finally, what is the relationship between this proposal and the wider banning powers proposed at the beginning of section 9 of the consultation?

9.1 Ban on specific activities, products or services

(142) What is your opinion on the possibility to ban products, practices or operations that raise significant investor protection concerns, generate market disorder or create serious systemic risk? Please explain the reasons for your views.

For the reasons set out above, the Committee strongly objects to the proposal to allow for the banning of products, practices or operations in the manner put forward by the Commission unless appropriately tangible and detailed safeguards can be articulated, so as to give certainty and confidence for market participants as to the circumstances in which those powers may and, critically, may not, be exercised.

(143) For example, could trading in OTC derivatives which competent authorities determine should be cleared on systemic risk grounds, but which no

76 CCP offers to clear, be banned pending a CCP offering clearing in the instrument? Please explain the reasons for your views.

We think it is more important from a systemic risk perspective that CCPs should not be placed under undue pressure to clear particular classes of derivatives where they are not comfortable doing so.

An OTC derivative product which has reached the stage of raising systemic risk concerns is likely to be popular and a useful tool: it seems to be quite perverse to prohibit it rather than to use other prudential rules and supervisory measures. Banning the product would likely simply move the market in that product outside to EU or could damage the market such as to make it much more difficult for the derivative to be reintroduced as a cleared and exchange-traded product.

(144) Are there other specific products which could face greater regulatory scrutiny? Please explain the reasons for your views.

Rather than scrutinising products with a view to banning them, in our view the Commission, ESAs and national regulators should focus more on (a) firms making appropriate disclosures and complying with suitability/appropriateness obligations, (b) firms complying with organisational requirements appropriate to the products and services they offer, (c) exercising the supervisory powers they already have, and (d) ensuring that firms' activities and practices comply with their regulatory obligations.

9.2 Stronger oversight of positions in derivatives, including commodity derivatives

(145) If regulators are given harmonised and effective powers to intervene during the life of any derivative contract in the MiFID framework directive do you consider that they could be given the powers to adopt hard position limits for some or all types of derivative contracts whether they are traded on exchange or OTC? Please explain the reasons for your views.

This is another area where regulators' use of existing supervisory, investigatory and prosecution powers (and additional powers resulting from the review of the MAD and measures of the kind referred to in question 134) should suffice, especially given the powers of most exchanges to intervene to manage dominant/potentially abusive positions. Such position management is in general best left to exchanges which are familiar with the particular market and, typically, with each market's larger participants.

The joint paper (Reforming OTC Derivatives Markets) published in December

77 2009 by the UK Government's Treasury Department and the FSA (available at http://www.fsa.gov.uk/pubs/other/reform_otc_derivatives.pdf) concluded that "a broad and dynamic approach to position management is an effective tool in deterring market manipulation; and … the evidence does not support the idea that position limits could be used to control commodity prices or price volatility." Accordingly, we consider that the Commission should conduct an impact assessment and cost-benefit analysis before proposing legislative provisions to give powers to regulators (national regulators or ESMA) in this area.

(146) What is your opinion of using position limits as an efficient tool for some or all types of derivative contracts in view of any or all of the following objectives: (i) to combat market manipulation; (ii) to reduce systemic risk; (iii) to prevent disorderly markets and developments detrimental to investors; (iv) to safeguard the stability and delivery and settlement arrangements of physical commodity markets. Please explain the reasons for your views.

Please see our response to question 145 above.

(147) Are there some types of derivatives or market conditions which are more prone to market manipulation and/or disorderly markets? If yes, please justify and provide evidence to support your argument.

Please see our response to question 145 above.

(148) How could the above position limits be applied by regulators: (a) To certain categories of market participants (e.g. some or all types of financial participants or investment vehicles)? (b) To some types of activities (e.g. hedging versus non-hedging)? (c) To the aggregate open interest/notional amount of a market?

Please see our response to question 145 above. We consider that the types of distinction proposed may be difficult to define and apply in practice, and potentially lead to distortion because of arbitrary distinctions between different types of market participant or user and different types of use. The hedging/non- hedging distinction itself is frequently unclear as has been emphasised by other respondents, such as in the Market Submissions referred to in our response to question 8 above, in addressing other questions which raise hedging issues.

78 We would be delighted to discuss any of the above observations and suggestions with you. You may contact me on +44 (0)20 7295 3233 or by email at [email protected].

Yours sincerely

Margaret Chamberlain Chair, CLLS Regulatory Law Committee

© CITY OF LONDON LAW SOCIETY 2011.

79 All rights reserved. This paper has been prepared as part of a consultation process. Its contents should not be taken as legal advice in relation to a particular situation or transaction.

80 THE CITY OF LONDON LAW SOCIETY REGULATORY LAW COMMITTEE

Individuals and firms represented on this Committee are as follows:

Margaret Chamberlain (Travers Smith LLP) (Chair) Chris Bates (Clifford Chance LLP) David Berman (Macfarlanes LLP) Peter Bevan (Linklaters LLP) Patrick Buckingham (Herbert Smith LLP) John Crosthwait (Independent) Richard Everett (Lawrence Graham LLP) Robert Finney (Dewey & LeBoeuf LLP) Jonathan Herbst (Norton Rose LLP) Mark Kalderon (Freshfields Bruckhaus Deringer LLP) Ben Kingsley (Slaughter and May) Nicholas Kynoch (Mayer Brown International LLP) Tamasin Little (S J Berwin LLP) Simon Morris (CMS Cameron McKenna LLP) Rob Moulton (Ashurst LLP) Bob Penn (Allen & Overy LLP) James Perry (Ashurst LLP)

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