These conduct based rules apply to staff who engage directly (eg. sales, front of house) or indirectly (eg. managers of the sales force, financial analysts whose work is provided to clients) with clients in the provision of investment services.
The rules could potentially be transposed nationally in late October 2013, subject to ESMA's 'comply or explain' mechanism for national regulators not being held-up.
Which firms do the rules apply to?
These rules apply to investment firms and credit institutions that provide MiFID investment services (eg. portfolio management, investment advice, taking and placing orders in relation to one or more financial instruments) or MiFID ancillary services (eg. safekeeping and administration of financial instruments in a client account).
The rules will also apply to UCITS management companies and Alternative Investment Fund Managers (AIFM's) that provide individual portfolio management, investment advice, undertake the safe-keeping and administration of shares or units in collective investment schemes and take and place orders for financial instruments on behalf of clients.
Tied agents and entities which have had the provision of investment services outsourced to them are also in scope. Firms will need to ensure that these outsourced entities and tied agents have remuneration policies and practices that are also MiFID compliant.
In relation to MiFID services and activities provided through a branch of an investment firm based in another EU member state, the supervisory responsibility will be split between the home member State (where the MiFID entity is authorised) and the member state the branch is established in.
The MiFID 2 Directive, which is expected to be implemented in 2015/16, contains proposals which would require any non-EU firm wanting to provide investment services and activities to EU retail clients, to establish an EU branch authorised as a MiFID entity subject to the provisions, including remuneration.
Which employees do the rules apply to?
The rules apply to the remuneration of individuals who have a material impact on the service provided or corporate behaviour of the firm ("Relevant Persons"). The staff categories, identified in addition to sales, include:
- Client facing, front of house
- Line managers of the sales force
- Financial analysts
- Complaints handling
- Claims processing
- Client retention
- Product design and development
- Tied agents
ESMA is clear that the MiFID guidelines are intended to be supplementary to those remuneration guidelines already in place eg. CRD IV.
What are the new rules?
The guidelines provide a broad, principles based outline and are not prescriptive in nature. They do however prohibit remuneration directly linked to sales (eg. "all or nothing" targets, large bonuses linked to a specific products' sales or even having a sales quota threshold for receiving a bonus). The aim is to lessen the risk of mis-selling via the use of inappropriate sales target and performance based incentives for sales staff that are not deemed to take into account the clients best interests.
The guidelines also state that:
- The design and implementation of remuneration policies and practices should be approved by senior management or the supervisory function with input from the control function.
- The control functions must be independent with the individuals remuneration not based on the performance of the business units it oversees.
- The role performed by the Relevant Person, the type of products offered, the methods of distribution (eg. face to face, advised or non-advised) should be taken into account when designing remuneration policies and practices.
- The firm has discretion as to the 'appropriate balance' between fixed and variable remuneration but the interests of the client must be taken into account (there is no variable pay cap as seen under CRD IV proposals).
- Performance criteria must be developed which encourages the Relevant Person to act in the best interests of the client.
- Appropriate governance controls should be put in place to prevent actions detrimental to the client from occurring as a result of the firms' remuneration policies and practices eg. have regular reviews of client documentation, monitor telephone sales and sampling client advice.
- As good practice, the payment of variable remuneration should be aligned with the investment term or timeframe of the product to avoid excessive risk taking by the Relevant Person.
- Variable remuneration cannot be assessed purely on quantitative criteria (eg. sales volumes, value of instruments sold and new client targets). Qualitative criteria such as client satisfaction through low number of complaints over a prolonged time period should also be considered. Examples of poor practice given in this respect include:
- Additional remuneration for encouraging a client to apply for new fund products the firm has a particular interest in 'pushing' (eg. launch of new product, "product of the month" etc)
- Having different remuneration policies and practices for individual product sales, where the Relevant Person's remuneration is dependent on the type of product they sell.
- Having a reduction made to a bonus already earned due to a secondary sales target not being met e.g. sales for optional "add-on" product features.
- Bonus schemes with in-built accelerators increasing the proportion of bonus earned as different sales thresholds are met.
Next steps for firms
The MiFID remuneration rules are due to come into force 60 days after the EU regulators have confirmed to ESMA whether they intend to comply with these guidelines. Given regulators have two months following the translation of the guidelines into all the official EU languages to respond, the requirements might come into force as early as October 2013. We understand from a UK perspective that until the Financial Conduct Authority (FCA) Handbook rules have been amended to incorporate these guidelines or include a reference to them, the FCA will not have the power to enforce them in the UK.
Firms should as part of their compliance strategy, start reviewing their population to assess who will be a Relevant Person under these rules, cross referencing with their current Identified Staff list under CRD or AIFMD (or provisionally under UCITS 5).
Once an initial list of roles has been identified, firms can review the relevant remuneration structures and processes against the guidelines to identify any compliance gaps.
For those firms looking to vary their MIFID permission by applying for an AIFM licence during the transitional AIFMD period (up to 21 July 2014), which do not intend to perform MIFID services following AIFM authorisation, you will still need to be compliant with the MIFID remuneration rules once they take effect during this transitional period.
Given the number of EU remuneration guidelines taking effect in the immediate future it is vital that firms keep on top of each set of domestic regulations applicable in each jurisdiction in which their business operates.
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