MiFID 2 and MiFIR appear to offer inconsistent and sometimes contradictory definitions of third-country firms, creating regulatory uncertainty and forcing firms to ask some difficult questions about their business in Europe.
As the MiFID “D-Day” gets ever closer, certain aspects of the rules and endless RTSs start to come into sharper focus. Among those is the role, and perhaps plight, of what MiFID calls “third-country firms.”
MiFID defines this category as: “a firm that would be a credit institution providing investment services or performing investment activities or an investment firm if its head office or registered office were located within the Union.” So this category encompasses a whole bunch of entities.
The Scope Definitions
So we need to see what both MiFID and MiFIR say about third-country firms. We begin with MiFID 2, Article 1, which says:
“This Directive shall apply to investment firms, market operators, data reporting services providers, and third-country firms providing investment services or performing investment activities through the establishment of a branch in the Union.” (emphasis added)
Because Article 1 singles out third-country firms, and because of the definition in the previous paragraph, we can conclude that this definition of “investment firms” does not apply to firms that have no presence in the EU.
MiFIR has a different approach to third-country firms. Its Article 1(1)(f) applies the regulation to: “provision of investment services or activities by third-country firms following an applicable equivalence decision by the Commission with or without a branch.” (emphasis added)
And Article 1(5) says: “Title VIII of this Regulation applies to third-country firms providing investment services or activities within the Union following an applicable equivalence decision by the Commission with or without a branch.”
So we already have an inconsistency to deal with. MiFID says you only achieve the status via a branch in the EU, and MiFIR says, “Not so fast – you have to have regulatory equivalence, but you don’t need the branch.”
Specific Sections of MiFIR and MiFID
Title VIII of MiFIR is devoted entirely to the regulation of third-country firms. It says:
“A third-country firm may provide investment services or perform investment activities with or without any ancillary services to eligible counterparties and to professional clients … established throughout the Union without the establishment of a branch where it is registered in the register of third-country firms kept by ESMA in accordance with Article 47.”
Thus, MiFIR requires a third-country firm to register with ESMA, and to restrict its dealings in the EU to eligible and professional counterparties.
Article 46 then says, in paragraph 3:
“Where a third-country firm is registered in accordance with this Article, Member States shall not impose any additional requirements on the third-country firm in respect of matters covered by this Regulation or by Directive 2014/65/EU and shall not treat third-country firms more favourably than Union firms.”
In other words, once regulatory equivalence has been established, that firm is subject to its home regulations, not MiFID or MiFIR.
Chapter IV of MiFID 2 also covers the actions of third-country firms, but only under the assumption that the firm has established a branch, and spends most of its time going over how branches are authorized. Here, though, the requirement isn’t hard and fast. For example:
“A Member State may require that a third-country firm intending to provide investment services or perform investment activities with or without any ancillary services to retail clients or to professional clients within the meaning of Section II of Annex II in its territory establish a branch in that Member State.” (emphasis added)
So it appears that an individual member state could drop that requirement. But there is no clarity on how a third-country firm becomes an investment firm under those conditions, except what’s in MiFID.
Interpretations
Given this level of uncertainty, and a few outright contradictions, we should look for some interpretations of the rules. One, from Linklaters, says:
“MiFID II provides that a Member State may require third country firms to establish a branch in that Member State in order to provide services to retail clients and clients treated as professionals upon request, unless at the exclusive initiative of the client. No equivalence decision by the Commission is required, and no passporting regime is provided for … A third country firm without an EU branch may provide services to ECPs and PCs anywhere in the EU if it has registered with ESMA and the Commission has adopted and not withdrawn an equivalence decision. The firm must also be authorized and supervised in its home country, and cooperation arrangements must be in place between its home country regulator and ESMA. Before providing services, firms must inform EU clients that they are only allowed to provide services to ECPs and PCs and that they are not subject to supervision in the EU.” (emphasis added)
According to Norton Rose Fulbright:
“The third country regime that is set out in Articles 46 t0 49 of MiFIR and concerns third country firms providing services to per se professional clients and eligible counterparties without the establishment of a branch (but with direct registration with the European Securities and Markets Authority) is unaffected by the HM Treasury consultation document as MiFIR is a directly applicable EU regulation, and the UK has no discretion as to its implementation.”
Implications
So third-country firms have a choice between two clear and very different paths. If they already have a branch in the EU, or if they establish one there, they can become a full investment firm, with the ability to offer all services to all EU customers. They do, however, become subject to all the MiFID/MiFIR rules, including those that are established by the member states, not just by ESMA.
The other option is to rely on a regulatory equivalence finding by ESMA and operate without a branch. As such, they can deal with any eligible counterparty or professional in any member state and in any instrument without being subject to any of MiFID/MiFIR, just subject to their home regulator(s).
Thus there are a few questions that a potential third-country firm needs to answer:
- How important is our EU business to us? If that business is critical to our success, then decisions have to be made and actions taken. If it is small as a portion of the overall business, then maybe we can sell it or swap it with some other firm’s US business and avoid the headaches.
- What is our natural customer set? Firms that deal primarily with retail customers will gravitate toward the branch path, while those with a primarily institutional clientele will probably opt for the regulatory equivalence.
- What is our home regulator’s relationship with ESMA? If your regulator has had a rocky relationship, depending on regulatory concordance may be too risky. And it is probably worth finding out whether the regulator(s) are going for equivalence, and what they think their chances are.
In any event, we have yet another example of parochial regulation in a very global market. The end result will always be more expenses for liquidity providers, and lower quality service for customers. At this point, the whole market is looking more and more like a third-world country struggling to deal with modern times.
