The requirements under MiFID II relating to conflicts of interest imposed on investment firms remain substantially the same as those imposed under MiFID I. However, while MiFID I emphasised the requirement to identify and manage conflicts of interest, MiFID II puts new emphasis on the obligation to prevent conflicts of interest. MiFID II also provides for more extensive disclosure and oversight requirements.
Under MiFID II, over-reliance on disclosure without taking account of how conflicts can be prevented or managed is discouraged and will be perceived as evidence that the conflicts of interest policy in place is deficient and inadequate. Investment firms must take all “appropriate” steps (rather than “reasonable”) to identify, prevent and manage conflicts of interest. EU regulators have confirmed that this sets a higher bar for compliance and firms must be more active in identifying which changes to their operations may be necessary to prevent or manage conflicts of interest.
Disclosure to clients is a measure of last resort to be used only where the organisational and administrative arrangements established by an investment firm are “not sufficient to ensure, with reasonable confidence, that risks of damage to client interests will be prevented”.
MiFID II introduces more prescriptive requirements when disclosing conflicts of interest which have arisen to clients. Such disclosures, which apply irrespective of the categorisation of the client, should:
1. Member States shall require investment firms to take all appropriate steps to identify and to prevent or manage conflicts of interest between themselves, including their managers, employees and tied agents, or any person directly or indirectly linked to them by control and their clients or between one client and another that arise in the course of providing any investment and ancillary services, or combinations thereof, including those caused by the receipt of inducements from third parties or by the investment firm’s own remuneration and other incentive structures.
2. Where organisational or administrative arrangements made by the investment firm in accordance with Article 16(3) to prevent conflicts of interest from adversely affecting the interest of its client are not sufficient to ensure, with reasonable confidence, that risks of damage to client interests will be prevented, the investment firm shall clearly disclose to the client the general nature and/or sources of conflicts of interest and the steps taken to mitigate those risks before undertaking business on its behalf.
3. The disclosure referred to in paragraph 2 shall:
(a) be made in a durable medium; and
(b) include sufficient detail, considering the nature of the client, to enable that client to take an informed decision with respect to the service in the context of which the conflict of interest arises.
4. The Commission shall be empowered to adopt delegated acts in accordance with Article 89 to:
(a) define the steps that investment firms might reasonably be expected to take to identify, prevent, manage and disclose conflicts of interest when providing various investment and ancillary services and combinations thereof;
(b) establish appropriate criteria for determining the types of conflict of interest whose existence may damage the interests of the clients or potential clients of the investment firm.
The description of the conflict should also consider the nature of the clients to whom the disclosure is made. ESMA has noted in its initial consultation paper that disclosures under the current regime have been very generic and not appropriate for retail clients.
An investment firm’s management body is responsible for ensuring that appropriate governance arrangements, policies and processes are put into place to ensure the prevention of conflicts of interest in a manner that promotes the integrity of the market and interests of its clients. Conflicts addressed should include those arising out of third-party inducements and the firm’s own remuneration policies and incentive structures. In creating its conflicts of interest policy, an investment firm is required to identify conflicts of interest based on the specific services/activities undertaken by the firm. In addition to specific requirements relating to the provision of investment research addressed in MiFID I, the Delegated Regulation provides for additional requirements relating to conflicts of interest in respect of certain activities which may be undertaken by investment firms in the context of underwriting and placings, including (i) the acquisition of the issuance by the placing firm for its clients or its own account, (ii) the pricing of offerings of financial instruments, (iii) distribution of own or group issuances, and (iv) lending to an issuer. The conflicts of interest policy is to be reviewed at least annually and all appropriate measures must be taken by the firm to address any deficiencies. Investment firms must keep and regularly update a record of investment services and activities likely to give rise to conflicts of interest and senior management must receive a written report, at least annually, where conflicts of interest have arisen.
An investment firm should consider whether its approach to conflicts of interest is overly reliant on disclosure as a method of managing its conflicts and whether it has taken adequate steps to prevent such conflicts (this will include considering whether an investment manager’s duty to disclose conflicts of interest under its investment management agreements needs amending). At the same time UK investment firms will need to retain sufficient disclosure to comply with potential fiduciary conflicts arising as a matter of common law. An investment firm should also ensure that it complies with the requirements under ‘Disclosure of conflicts of interest’ above when making conflicts of interest disclosures. Firms which engage in placements and underwriting should also consider whether their conflicts of interest policies and procedures are consistent with the requirements set out in the Delegated Regulation.