MiFID II will be implemented into UK law on 3 January 2018 and will replace Directive 2004/39/EC (MiFID I). MiFID II aims to enhance the efficiency and integrity of the financial markets across the European Union and we have prepared a suite of briefings on key areas of change. This briefing examines MiFID II's requirement for firms to have in place a remuneration policy to take care sales staff are not incentivised in a way that has the potential to encourage them to act without the client's best interests in mind. We also consider the impact of this new remuneration requirement for affected firms.
MiFID II is made up of two parts, the MiFID II directive (2014/65/EU) and the MiFIR regulation (2014/600/EU), which together are referred to as MiFID II in this briefing. MiFIR is a regulation and therefore is directly applicable in each member state. MiFID II itself as a directive requires implementation at a national level. The remuneration provisions are set out in both MiFID II (article 24(10)) and MiFIR (article 27) and the FCA has consulted in CP16/19 on the implementation of these requirements.
MiFID firms will of course be familiar with European remuneration codes, having been subject to the CRD III remuneration provisions since 2010 and CRD IV since 2013. The remuneration provisions being introduced as a result of MiFID II overlap to a certain extent with the requirements of CRD IV and AIFMD (for example, the requirement for a remuneration policy to cover conflict of interest provisions) however the MiFID II provisions specifically focus on those persons who have an impact on investments and ancillary services, such as sales staff, rather than those persons who have the potential to pose a material prudential risk to the firm who are the principal targets under current remuneration codes.
FCA's approach to implementation
The FCA intends to introduce a new chapter at SYSC 19F to cover remuneration and performance management of sales staff. The new provisions will take into account the FCA's previous work in this area, including guidance issued in January 2013, a thematic review published in March 2014 and further guidance in July 2015. The new chapter will also take into account the responses to the FCA's discussion paper DP 15/3.
The FCA has stated that it does not intend to introduce a "cross-cutting set of standards on sales staff remuneration" across all firms including non-MiFID businesses, so it is envisaged that the remuneration standards are only going to be applied to common platform firms, firms falling within the Article 3 exemption, and relevant branches of third-country firms.
However, this does not mean that other firms will be unaffected. The reasoning for the FCA's decision against cross-cutting standards lies in the fact that there are incoming European-wide remuneration initiatives, which will lead to more guidelines on a similar theme being published. Such initiatives are more than likely to impact on firms which have not been directly affected at this stage by the MiFID II provisions.
Remuneration and performance management of sales staff
Section 2 of MiFID II, which sets out provisions aimed at investor protection, requires investment firms to ensure they do not remunerate or assess sales staff in a way that conflicts with their duty to act in the best interests of its clients. The provision also highlights that firms must not incentivise staff in way that has the potential to increase the risk of staff acting against the client's best interests.
Additionally, the implementing regulation supplementing MiFID II sets out that firms must have remuneration policies in place so that sales staff who may have an impact on investment and ancillary services, or on the corporate behaviour of the firm, do not favour their own or the firm's interests but instead focus on what is best for the client, and make sure that the clients are always treated fairly.
However, as firms will be aware, there are already lots of rules in place relating to the remuneration of staff and conflicts of interests.
First, as mentioned above the FCA Handbook (at SYSC 19) contains numerous remuneration codes and - more broadly - the third FCA Principle for Business requires firms to take reasonable care to organise and control their affairs responsibly and effectively. Secondly, the MiFID II provisions echo and build on the existing ESMA guidelines on remuneration policies and practices. These guidelines emphasise that staff remuneration policies must always be subject to the best interests of the client – the fundamental point is that firms must safeguard against any potential risk of impairment of the client's interests which could be caused, for example, by staff trying to meet certain targets.
Implications for firms and next steps
These MiFID II remuneration provisions for sales staff will apply to relevant staff in common platform firms, MiFID Article 3 exempt firms and third-country branches.
Essentially, firms and advisers are going to need to check that they have in place sufficient policies and internal procedures to make sure that staff are not tempted to recommend certain products to clients where such recommendation would be to the clients' disadvantage. This could happen in particular where sales staff are promised incentives if they meet a certain target which means they go on to recommend something to a client which is not in the best interests of that client.
In light of the FCA's previous substantial work in this area, many firms will already have policies in place to reduce and control the risk of sales staff behaving in a way that is not in a client's best interests. However, with MiFID II taking effect from 3 January 2018, this is a good time to review any policies in place alongside any arrangements which have the potential to constitute staff incentives or targets.
If you require further information on anything covered in this briefing please contact Grania Baird ([email protected] , 020 3375 7443) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Commercial and Regulatory page on our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, September 2016