Implementing MiFID II and adaptation to MiFIR

The main focus of the 2^nd FiMaNoG is the implementation of the far-reaching Markets in Financial Instruments Directive II (MiFID II), the successor to MiFID I. The new directive contains a large number of new rules on trading in financial instruments. This includes overarching issues relating to financial market infrastructure, for example the regulation of trading venues, as well as revised regulations for financial market participants regarding the distribution of financial instruments to investors.

MiFID II is complemented by the Markets in Financial Instruments Regulation (MiFIR), which focuses on the market transparency of transactions in financial instruments. While MiFIR is directly applicable, this does not eliminate the need to adjust German law: national regulations which run contrary to MiFIR or contain identical provisions will be repealed. Moreover, national rules on sanctions must be expanded upon so that they correspond to the requirements and prohibitions set out in MiFIR.

Amendments primarily to the WpHG

The most important legal framework for trading in financial instruments in Germany is the Securities Trading Act (Wertpapierhandelsgesetz – WpHG (only available in German)). Therefore, this is where most of the amendments stipulated in the 2^nd FiMaNoG are being made. The legislator has also used the amendment process as an opportunity to restructure the WpHG and make substantial changes to how its sections are numbered. Due to the large number of earlier amendments, the WpHG had grown increasingly unwieldy and in parts it was no longer possible to insert new subsections.

The amendments to the WpHG clearly demonstrate the increasing importance of European law and the receding importance of national regulation – many of the provisions in the WpHG are now merely of a rudimentary nature. By far the larger part of regulatory specifics is now left to European implementing regulations which are directly applicable and which the WpHG makes reference to.

Apart from the WpHG, the 2^nd FiMaNoG also amends other capital market laws for the implementation of MiFID II, in particular the German Stock Exchange Act (Börsengesetz – BörsG (only available in German)) and the German Banking Act (Kreditwesengesetz – KWG - only available in German).

Implementation provisions for other European regulations

Furthermore, the 2^nd FiMaNoG also contains implementation provisions for two other directly applicable European legislative acts, namely the Regulation on Securities Financing Transactions (SFT Regulation) and the Benchmarks Regulation. Among other areas, the 2^nd FiMaNoG codifies the competencies for monitoring adherence to regulations and how the relevant sanctions are applied based on administrative fine provisions.

In addition to the reporting obligations under the European Market Infrastructure Regulation (EMIR), the SFT Regulation of 2015 also introduced notification requirements for the conclusion, modification and termination of securities financing transactions. It also contains expanded transparency requirements for the managers of investment funds and sets out requirements for the continued use of financial instruments received as collateral.

The Benchmarks Regulation, published in the Official Journal of the European Union at the end of June 2016, aims to ensure that the benchmarks created and used in the EU are robust, reliable, representative and suited to their intended purpose. The objective here is to prevent benchmarks from being manipulated in future.

Main objectives of the 2^nd FiMaNoG

With MiFID II and the regulation of financial market infrastructure it entails, the European legislature has responded first and foremost to certain undesirable consequences of MiFID I and to the technological progress which has taken place since its implementation in 2007.

In the area of trading platform regulation, MIFID I lifted the obligation to use a stock exchange with a view to bringing about greater competition and thus reducing costs. This approach, however, has also had its downsides. For example, the benefits of such competition were not always passed onto the end investor. In MiFID II, the rules on transparency and execution ("best execution") were therefore revised and expanded upon.

Furthermore, the markets have become increasingly intricate and abstruse. This means that it was necessary both to readjust the regulations for conventional trading platforms – stock exchanges and multilateral trading facilities – and to improve the monitoring of new types of organised trading facilities and over-the-counter trading, an area which has experienced substantial growth. It is intended to push back against this trend in favour of regulated trading platforms.

Organised trading facilities

Alongside conventional regulated markets and multilateral trading facilities (MTFs), organised trading facilities (OTFs) will also be subject to supervision under the 2^nd FiMaNoG. This means that the legislation now also covers non-transparent trading facilities, such as broker crossing networks, which facilitate electronic trading outside stock exchanges. These avoid being categorised as supervised MTFs because, among other reasons, orders are matched at the discretion of the operator.

In future, operating an OFT will also be considered a financial service subject to an authorisation requirement under the KWG and will entail numerous organisational and conduct of business obligations. The intention is for the operation of OTFs as new trading platforms to be better monitored but not encouraged. The operator will have to demonstrate that the facility cannot be operated as a regulated market or MTF. Furthermore, OTFs cannot be operated for shares and financial instruments similar to shares.

Data reporting services providers

An important matter dealt with in MiFID II, and therefore in the 2^nd FiMaNoG as well, is that of increased transparency by means of easy and cost-effective access to important market data. To this end, a binding regulatory framework for providers of data reporting services is being introduced. Such providers will be subject to an authorisation requirement under the KWG as well as BaFin's ongoing supervision pursuant to the newly inserted Part 10 of the WpHG.

There are three categories of data reporting services providers. The first category is that of consolidated tape providers (CTPs) which publish post-trade transparency data throughout Europe compiled from trading venues and approved publication arrangements. The model of a single European provider, which was initially considered in deliberations on MiFID II, did not come to fruition here. Instead, multiple CTPs will be able to compete in this area. However, they require authorisation from the competent authority of their home country and must fulfil numerous organisational requirements. A particularly important obligation here is that of non-discriminatory pricing. This is intended to prevent the misuse of market power.

Approved publication arrangements (APAs) are also now subject to the supervisory regime. APAs ensure post-trade transparency at investment firms and publish information compiled about their transactions. APAs will also require authorisation and their obligations will be subject to ongoing supervision, for example obligations regarding data quality, pricing and the free provision of data after 15 minutes have passed.
Approved reporting mechanisms (ARMs) are the third category of data reporting services providers. ARMs fulfil notification requirements on behalf of investment firms by reporting the transactions they execute to the competent supervisory authority. This affects notifications pursuant to section 9 of the WpHG (old version), which in future will be governed by section 22 of the WpHG in conjunction with MiFIR.

High-frequency trading

To date, there has been no authorisation requirement for ongoing monitoring of high-frequency traders at the European level, although this was already introduced several years ago in Germany with the High-Frequency Trading Act (Hochfrequenzhandelsgesetz) (see BaFinJournal April 2013 - only available in German).

Since the European regulations could, for the most part, already be predicted at that time and were thus implemented, only minor amendments were needed in the 2^nd FiMaNoG. The requirements and the calculations for order-to-trade ratios and the minimum tick size have been defined more specifically and harmonised with the European requirements.

Commodity derivative positions

The 2^nd FiMaNoG introduces provisions on limiting and monitoring commodity derivative positions for the first time. It thus implements the requirements of MiFID II which are based on decisions reached by the G20. Potential market manipulation and the misuse of dominant market positions in commodity derivatives are to be tackled with better monitoring of market participants. The objective here is to reduce the risk of negative effects on the real economy and the supply of goods to the general population – especially in the raw materials and foodstuffs markets.

Specifically, a position limit is being placed on every commodity derivative traded on trading venues. This applies to all aggregated open positions that are held by natural or legal persons themselves or at group level. The trading venues and investment firms must monitor compliance with the position limit by means of an appropriate internal control system.

Trading venues must also provide the competent authority with a detailed breakdown of the positions in commodity derivatives on a daily basis. The same applies to investment firms conducting over-the-counter trading, both for their own positions and those of their clients and end clients. Furthermore, trading venue operators are required to publish an aggregated weekly report.

Conduct of business and organisational requirements

The 2^nd FiMaNoG also brings about some changes to conduct of business and organisational requirements with a view to improving investor protection. These have been moved from Part 6 to Part 11 of the WpHG and their details have been adjusted.

For instance, the information obligations of companies to their clients have been improved and set out in greater detail. In particular, costs relating to the buying or selling of financial instruments must be detailed more transparently. The effects of such costs on returns from the investment must be stated in a comprehensible manner.

There are also important new developments in the area of investment advice. MiFID II introduced requirements for "investment advice on an independent basis" at the European level. The German legislature had already provided for this type of investment advice in the WpHG with the passing of the Fee-Based Investment Advice Act (Honoraranlageberatungsgesetz (only available in German)) in 2014 (see BaFinJournal July 2014). The 2^nd FiMaNoG thus changes the term "fee-based investment advice" ("Honorar-Anlageberatung") to "independent fee-based investment advice" ("unabhängige Honorar-Anlageberatung"). In the case of independent fee-based investment advice, the investment firm may not receive any non-monetary benefits from third parties. Monetary benefits are only permitted under narrowly defined conditions and must be transferred to the client. In the case of commission-based investment advice and other investment services, benefits are only allowed if they are for the purpose of improving the quality of the service in question.

This requirement has been tightened by MiFID II as it defines when a benefit improves the quality of a service for the client and it provides specific criteria with examples. In Germany, this will be transposed into the Investment Services Rules of Conduct Regulation (Wertpapierdienstleistungs-Verhaltens- und Organisationsverordnung – WpDVerOV (only available in German)). In addition, there are special rules for analyses by third parties to the effect that these do not constitute a benefit if they are provided in return for payment from the company using its own funds or are paid for by the client via a separate research payment account.

The 2^nd FiMaNoG also contains important new provisions on product governance requirements. The starting point for the processes which now must be set up is before the investment service is actually provided, i.e. when a financial instrument is being created. The core component of the product governance requirements is the obligation to conduct an internal product approval procedure and always define a target market in doing so. This is to ensure that the financial instruments are created in such a way that they correspond to the needs of the end clients in the target market. Each product's producer must determine the target market using defined criteria. Such criteria include the client category (retail clients, professional clients or eligible counterparty), the clients' knowledge and experience, their financial situation and risk-bearing capacity, risk tolerance, investment objectives and needs. Because it is often only possible for the producer to take account of these criteria in a very general manner, distributors must provide further details on the target market based on their client structure.

In consideration of developments in other areas of capital market law, the 2^nd FiMaNoG has also toughened up sanctions for violating obligations and prohibitions.

The potential administrative fines are higher than before and can also be calculated based on the turnover of the company concerned. Moreover, BaFin's abilities to make violations and sanctions imposed known to the public have also been expanded.

Outlook

Alongside the 2^nd FiMaNoG, numerous related national regulations will also be newly issued or revised soon, including the WpDVerOV mentioned above and the Investment Services Examination Regulation (Wertpapierdienstleistungs-Prüfungsverordnung – WpDPV (only available in German)). Moreover, both financial market participants and BaFin will be making intensive efforts to integrate this wave of new regulations into their work processes and make the necessary adjustments. Despite their level of detail, the European implementing provisions will also present a great number of questions which BaFin and the European Securities Markets Authority (ESMA) will have to clarify.

With the comprehensive MiFID II/MiFIR package completed, it can now be expected that regulatory efforts will be put on hold for a few years before the topic of "MiFID III" is likely to appear on the horizon.