ESMA updates

Several Guidelines to strengthen investor protection

Gabriela Tsekova
Senior Manager, FS Regulations, PwC Switzerland

In recent months, the European Securities and Markets Authority (ESMA) has developed new Guidelines and initiated several reviews of existing Guidelines that are aimed at enhancing clarity and fostering convergence in the application of several aspects of the MiFID II Framework.

As a result of extensive consultations, following Guidelines have been published and/or amended:

Guidelines on certain aspects of the MiFID II appropriateness and execution-only requirements
Guidelines on MiFID II suitability requirements
Guidelines on MiFID II product governance requirements

In a series of blogposts, we would like to inform you about the new regulatory requirements. In the first one, we will focus on the Guidelines governing certain aspects of the MiFID II appropriateness and execution-only requirements (“Guidelines”).

The new Guidelines on the appropriateness and execution-only requirements under MiFID II are applicable as of 12 October 2022.

They cover several important aspects of the appropriateness process, spanning from the information to be provided to clients, the arrangements necessary to understand clients and products, to the matching of clients with appropriate products and the effectiveness of warnings. In addition, other related requirements such as execution-only exemption and record-keeping are clarified.

Background

Under MiFID II, investments firms are required to collect information on the knowledge and experience of their clients when providing non-advised services. The aim is to assess whether the investment service or product envisaged is appropriate. In the event that the service or product is deemed inappropriate, the financial firms should warn the clients accordingly.

The Guidelines are closing a gap identified during the Common Supervisory Action from 2019, which clearly showed that there was a need for further convergence in the understanding and application of appropriateness and execution-only requirements. Following a consultation period of three months (i.e. between 29 January and 29 April 2021), ESMA published the final Guidelines on 3 January 2022. They became applicable six months after the publication on ESMA’s website in all EU official languages.

The Guidelines

The Guidelines aim to promote greater convergence in the application of the MiFID II appropriateness and execution-only requirements by highlighting a number of important issues. By clarifying them, ESMA anticipates a corresponding strengthening of investor protection.

Guideline 1: Information to clients about the purpose of the appropriateness assessment and execution-only requirements
ESMA provides some clarifications about the information to be shared with the clients when providing non-advised services. It makes some special recommendations to firms providing online services.

Guideline 2: Arrangements necessary to understand clients
Firms should have policies and procedures in place to collect all the information necessary to conduct the appropriateness assessment in relation to the specific product types. ESMA makes some concrete recommendations for the firms using questionnaires to collect the relevant information.

Guideline 3: Extent of information to be collected form clients (proportionality)
It specifies that the extent of information to be asked about a client’s knowledge and experience may vary due to the type and characteristics of the investment service or products and the nature of the client. More in-depth information is required for more complex or risky investment products.

Guideline 4: Reliability of client information
ESMA stipulates that firms should take reasonable steps (e.g. implement controls) and have appropriate tools (incl. regular reviews to verify that they are fit for their intended purpose) to ensure that the information provided by the clients is reliable and consistent.

Guideline 5: Relying on up-to-date client information
Firms should establish procedures and policies regarding the frequency of information updates, also considering cases in which more regular reviews are required (e.g. in the case of vulnerable clients).

Guideline 6: Client information for legal entities or groups
ESMA outlines that firms should implement a policy defining on an ex-ante basis how to conduct an appropriateness assessment in situations where the client is i) a legal entity, ii) a group of two or more natural persons or iii) where one or more natural persons are represented by another natural person.

Guideline 7: Arrangements necessary to understand investment products
In order to understand the characteristics, nature and features of investment and how they can behave under different circumstances, firms have to implement policies and procedures that allow them to assess whether a product is appropriate for their clients. These policies and procedures should enable correct product categorisation.

Guideline 8: Arrangements necessary to ensure consistent appropriateness assessments
ESMA underlines that firms should monitor and test the algorithms that determine the appropriateness of investment products. In addition, firms need to establish policies and procedures enabling them to issue a clear and non-misleading warning in case they consider the investment service or product inappropriate for the client.

Guideline 9: Effectiveness of warnings
ESMA provides some hints regarding the definition of warnings. In cases where a client can proceed with the transaction after a warning has been issued, firms should evaluate the effectiveness of the warnings on an ex-post basis.

Guideline 10: Qualification of firm’s staff
Firms are required to regularly train their staff to ensure that they understand the role they play in the appropriateness assessment and have an adequate level of skills, knowledge and expertise, including sufficient knowledge of the relevant regulatory requirements and procedures, in order to discharge their responsibilities.

Guideline 11: Record-keeping
ESMA clarifies that firms should have record-keeping arrangements in place that enable them to track ex-post:

the result of the appropriateness assessment including its rationale
any warning issued by the firm where the investment service or product was assessed as potentially inappropriate for the client, or where the client did not provide sufficient information to enable the firm to undertake an appropriateness assessment (irrespective of whether the client asked to proceed with the transaction or not)
whether the client asked to proceed with the transaction despite the warning and
whether the firm accepted the client's request to proceed with the transaction in accordance with the related procedures adopted.

Guideline 12: Determining situations where the appropriateness assessment is required
The Guidelines emphasize that firms should implement policies, procedures and controls to ensure a clear distinction between “advised” and “non-advised” transactions and to identify which products may be regarded as “complex” and “non-complex”.

Guideline 13: Controls
ESMA highlights the importance of sound control frameworks, which include periodic monitoring of automated systems and controls used in the appropriateness assessment process and written records in case of assessments carried out in face-to-face meetings or by phone. In addition, firms should monitor and analyse the rate of warnings heeded.

Impact on Swiss financial service providers

While the Guidelines have a direct impact on EU/EEA investment firms providing non-advised MiFID services, they also apply to Swiss-based firms performing non-advised MiFID services for clients domiciled in the EU or EEA.