19 December 2012

ESMA publishes supervisory briefings in the area of MiFID

Determining situations where the Suitability assessment is required

11. According to Article 19(4) of MiFID, when providing investment advice or discretionary portfolio management services, firms must ensure that the specific transaction to be recommended, or entered into in the course of providing a discretionary portfolio management services service, is suita-ble for the client in question.

12. On the one hand, it is crucial for the firm to put in place arrangements and procedures to detect any situation where the interaction between itself and the client or potential client will require an as-sessment of suitability. In this context, since the suitability requirement can affect the firm’s ability to sell certain types of (complex and/or risky) financial instruments to most retail clients, it is im-portant to bear in mind the risk of improper classification of the service as ‘non-advised’ although a personal recommendation is given.

13. On the other hand, given the wide scope of the definition of ‘investment advice’, firms that do not intend to give advice should put in place either specific and sound internal systems and controls or focused staff training in order to appropriately and consistently reflect the nature of the ‘non-advised’ service they are providing.

14. Firms that provide both investment advice and non-advised services must take care to avoid situa-tions where it is not clear on which basis the transaction has been performed.4 For example, if the firm advises the client that a transaction is unsuitable, it should consider carefully if it is in the best interests of the client to allow the transaction to proceed on an execution-only basis. Firms should also consider what procedures they should have in place to demonstrate that this is the case.

15. Firms should inform clients, clearly and simply, that the reason for assessing suitability is to enable the firm to act in the client’s best interest. At no stage should investment firms create any ambiguity or confusion about their own responsibilities in the process.

Supervisory briefing on Suitability

Appropriateness

8. The current MiFID appropriateness requirements are set out in Articles 19(5) and (6) of MiFID (2004/39/EC) and in Articles 36-38 of the MiFID Implementing Directive (2006/73/EC). Article 19(6) of MiFID and Article 38 of the MiFID Implementing Directive cover the ‘execution-only’ ele-ment of the appropriateness regime. The aim of the requirements is to increase investor protection in respect of ‘non-advised’ services.

9. The way in which the requirements apply depends on the type of service in question, the type of MiFID financial instrument involved (in particular, whether the product is ‘complex’ or ‘non-complex’), and the type of client.

10. They apply to firms which provide MiFID investment services other than investment advice or portfolio management (in those cases, the obligation is to assess suitability). Therefore, they apply to firms when performing ‘non-advised services’ such as receiving or transmitting orders, executing orders on behalf of clients, dealing on own account, underwriting, and placing.

11. The requirements do not apply to eligible counterparties. In addition, firms may assume that a professional client has the necessary knowledge and experience to understand the risks involved re-lating to the specific product or service for which they are classified as ‘professional’.

12. Where the appropriateness test applies, it requires an investment firm to seek information from a client or potential client about his knowledge and experience (i.e. ability) to understand the risks about a specific type of product or service. This is to enable the firm to determine whether that product or service is appropriate for the client. (Unlike the requirements for suitability, there are no specific requirements to assess the client’s financial situation or investment objectives).

Execution-only business

13. In MiFID Article 19(6) (together with Article 38 of the MiFID Implementing Directive), there is an exemption from the appropriateness test for certain types of ‘execution-only’ business. However, this is currently only available if all of the following conditions are met:

a. the service consists only of the execution and/or the reception and transmission of orders involving shares admitted to trading on a regulated market or in an equivalent third coun-try market, money market instruments, bonds or other forms of securitised debt (exclud-ing those bonds or other securitised debt that embed a derivative), UCITS and other non-complex financial instruments; and

b. the service is provided ‘at the initiative of the client or potential client’; and

c. the client or potential client has been clearly informed that in the provision of this service the investment firm is not required to assess the suitability of the financial instrument or service provided or offered, and that therefore the client does not benefit from the corre-sponding protection of the relevant conduct of business rules; and

d. the investment firm complies with its obligations under Article 18 of MiFID (conflicts of interest).

14. Recital 30 of MiFID states that a service should be considered to be provided at the initiative of a client unless the client demands it in response to a personalised communication from or on behalf of the firm to that particular client, which contains an invitation or is intended to influence the cli-ent in respect of a specific financial instrument or specific transaction. A service can be considered to be provided at the initiative of the client notwithstanding that the client demands it on the basis of any communication containing a promotion or offer of financial instruments made by any means that by its very nature is general and addressed to the public or a larger group or category of clients or potential clients.

15. Communications that are ‘by their very nature general’ will lead to services that are ‘at the initiative of the client’. If the other conditions for providing ‘execution only’ business described above are met, those services will not trigger an appropriateness test. General communications could include, for example, material in newspapers and magazines or on TV, radio or billboards. Other communica-tion methods (such as websites and internet search results) might also fall into this category, but on-ly if they are ‘by their very nature general’, which may depend on the individual circumstances.

16. Therefore, firms are likely to need processes (i) to distinguish between ‘complex’ and ‘non-complex’ products (which may already have been done at the product design stage); (ii) to identify whether contact with the client is at the initiative of the firm; and (iii) to ensure that necessary warnings have been provided.

© ESMA