Stephen Hanks, the man who co-ordinates the Financial Conduct Authority's ‘policy work’ on the European Union's second Markets in Financial Instruments Directive, spoke at Clearview Publishing's compliance conference in London yesterday and imparted some words of comfort for firms that were struggling to meet the deadline.

Hanks discussed the state of play regarding FCA policy and the conduct-related provisions of the directive. He told a hall full of compliance officers, CEOs and others in the wealth management business that the FCA would be lenient on firms that had problems meeting MiFID II’s implementation deadline of 3^rd January 2018, as long as they were making genuine efforts to comply. The rest of this article is in the form of a transcript of his speech.

Policy in the making

We are building up to a crescendo, with our second policy statement to be issued at the end of June. In its present form it runs to about 130 pages. As with most of the regulator's previous policy documents on the subject, it is by and large a technical exercise in which the FCA copies out legislation into its rulebook. Although the FCA receives plenty of technical comments during its consultative exercises, most of it is not inherently exciting.

Issues on which the FCA might change its mind slightly

There were four or five issues where we got a significant amount of comments about our policy choices where we were exercising some degree of discretion and where we have been reviewing what we did to work out whether we should simply press ahead or do some things slightly differently.

The key areas that we are looking at (we have a board meeting later today that will run through the issues) are client categorisation in relation to local authorities, the scope of application of the MiFID II best execution standards we have proposed, applying them to collective portfolio managers, research and inducements (again, there is partly an issue about the application to collective portfolio managers). There are also various questions that will be raised about the practical detail of the way those provisions [might] work. Finally, we were proposing to extend taping rules to cover all corporate finance activity and to remove the existing partial exemption in our rules for discretionary investment managers.

You shouldn't read into what I've just said that we are necessarily going to change in those areas but, as I say, we've got a lot of comments on those in response to CP16/29 and therefore necessarily we have looked again at those issues.

ESMA [the European Securities and Markets Authority, an organ of the EU] is continuing with its work on policy. There's a meeting going on today. That should result in two outputs: firstly the guidelines on product governance, which they consulted on earlier, should be finalised and should be published, I presume, earlier next week. There is also more Q&A on investor-protection issues; in particular there's going to be a set of questions on custom charges, mainly looking at the interaction between the custom charges disclosures in MiFID and PRIIPS, and there will also be some more questions on best execution, in particular looking at the disclosures required under RTS [regulated technical standards, issued by the European authorities] 27 and 28.

We expect ESMA to continue to provide interpretive material through the course of this year. Existing ESMA guidelines on suitability are being revised in the light of the changes between MiFID and MiFID II.

There is a 2007 Q&A on best execution. I think there are about 20 questions in it, and again ESMA is now looking at that to see what updating it needs. I would expect more Q&A on a variety of topics that industry raised questions [about] and individual national regulators become conscious of [involving] particular issues in their jurisdiction which they think have general applicability.

Variation of permission

Domestically also, as I said, we are doing various things in terms of the practical implementation of the legislation. We have sent out a series of messages about people needing to have applications in where they need to vary their permission in order to be ready for 3rd January 2018. That continues to be an issue that concerns us.

I think a lot of the change is essentially on the market side, [involving] issues around organised trading facility, commodity derivatives firms [and] proprietary traders, but there are some issues which may more broadly affect the market, where people are providing services in relation to structured deposits. People can make notifications where they need to have an appropriate permission in relation to that before 3rd January 2018. Thereafter, they would have to make a variation of permission and there are changes to the scope of foreign exchange derivatives included in the scope of the legislation and also the inclusion of binary bets, so if anyone is affected by those, we again urge you to make your applications for variations of permission as soon as possible.

As the deadline approaches, the FCA will be forbearing

When it comes to our approach to the implementation of the legislation I think there are two main things I want to say. One is about the deadline of 3rd January 2018 and the second is more generally about our approach to implementation.

We expect firms to take all reasonable steps to meet that deadline. We recognise that there is a very significant degree of regulatory change that MiFID II brings and I think inevitably in some cases firms will simply be putting in place some tactical solutions to get them to 3rd January, which will then evolve subsequently over time.

We also recognise that there are issues of dependency, both on policy and information that's coming out through our policy statement through ESMA. We think that where firms are needing to make decisions in terms of the way in which their systems operate and they do not think they quite at the moment have the appropriate clarity, it is all right for them to make assumptions to set those down those assumptions. We will not be punishing firms for doing that.

Our main concern is around firms who are not making adequate efforts to try and comply by 3rd January rather than around people who are making honest efforts, even if subsequently ESMA or ourselves say something that causes them to think that an assumption they thought was reasonable is not actually what the legislation requires.

Supervisory work

I think it's also important that people do not see MiFID II as being separate and distinct from what we are generally about as a regulator. Our business plan and our mission statement set out issues that concern us as a regulator about the way in which firms go about their business. The way we think about MiFID II is in that context. It's not separate and distinct and in a box over here. Therefore, if you look at what we say in the business plan, in the mission, that will help you to understand what we will be expecting when we do supervisory [pronounced, rather amusingly, ‘supervizzory’] work in the course of next year, looking at the way in which people have implemented it.

Governance, culture, software and the presentation of information

In that respect, I think that there are four things I would emphasise. When it comes to conduct, firstly, we have emphasised the importance to us of (i) governance and (ii) culture. Governance – having the right way of running your firm so that it is clear who is accountable for what. This obviously ties in also to the implementation more broadly of the Senior Management and Certification Regime. Culture – are firms putting the customer first? Is that understood from the top to the bottom of the organisation? Are the senior management setting the right example? Are they then engaging staff so that staff more broadly understand what their expectations are?

I would also emphasise the issue of smarter communications. There are lots of areas in which MiFID II requires you to make new disclosures, whether it's costing charges, best execution or inducements.

Obviously, firms are expending a lot of effort getting the right information to make those disclosures but the right compliance is about having more than just the right information to meet the technical requirements of the legislation. It's then about how you communicate that information to clients to help them understand and to help them make choices and decisions about products and services and decisions between different sorts of firms. Please think about it in those terms!

If you've complied in terms of having the right information but, frankly, your presentation of that information doesn't help people to understand the disclosure that you are making, then as I say, that will not be a good way to comply with the legislation.

Finally, technology. We are keen to encourage the innovative use of technology, whether that is about helping you to...as part of your compliance efforts, as part of your monitoring efforts, or whether it's about the way in which you deliver your services. If there are issues that arise as a result of the use of innovative technology, where you have issues about how it actually fits in with the legislation, then obviously we're happy to have a discussion about that to try to understand it and to try to ensure that we are facilitating the use of technology.

The use of technology obviously brings risks. The two in particular that we have highlighted through a series of documents are, first, the general heading of cyber-risk, the need to have adequate security and the like, and the second is that we recognise often when you're using technology you will be outsourcing and that outsourcing has to be managed properly, both in terms of your relationship with whomever you are directly outsourcing to, but also where there is in effect a chain of outsourcers and they are using whichever company you are directly contracting with...they are using other suppliers that you have an understanding of that and how that then affects your relationship with the firm to whom you are directly outsourcing.

As I say, [with] technology, we are keen to be facilitators in people adopting innovative solutions and that's both in terms of compliance and also the way in which they deliver services.

Policy issues: inducements and research

Now I want to move on to some of the policy issues in MiFID II, starting with inducements and research. Firms have a lot to do in terms of implementing that. Again, there is a dependency here. [The] buy side needs to make changes, [the] sell side needs to make changes and there is a dependency here for both sides [i.e. each side depends] on what the other is doing.

We will, in the policy statement, say a little bit more about some specific issues of detailed implementation of the regime but we are also trying to exercise a degree of flexibility. We are deliberately not...providing detailed guidance on the way in which the pricing of research should work. We think that this should, at least in the first instance, be left to the industry to work out rather than us jumping in and attempting to micromanage what is going on there.

The twofold aim of the FCA

People need to remember the aim of what we are trying to achieve through this policy, which is twofold. One is to ensure that the buy-side has proper control over its spending of clients' money on research, and secondly that there is a separation of decisions around the purchase of research from decisions around the execution of transactions. People need to bear that in mind when they are looking at the details of the implementation. They need to ensure that that is what they are delivering on when they are implementing these provisions.

Best execution

Fundamentally, I don't think there is a huge difference between the ‘best execution’ standard in MiFID II and that in MiFID. Yes, you can talk about – and ESMA has done – the difference between 'all reasonable steps' and 'sufficient steps' but fundamentally it's about achieving the best possible outcome for clients when executing transactions.

In that context, the sorts of concerns that we will have and the sorts of issues that we will be interested in when we look at the way in which firms have implemented [MiFID II] are the sorts of issues that we raised in our thematic review back in 2014. If people have implemented [perhaps he meant ‘paid attention to’ or ‘taken stock of’] that review properly then they should be well placed to deal with MiFID II in terms of the basic sets of standards of best execution.

Two key issues

I think there were two key issues that we highlighted in that thematic review. The first is around the monitoring of transactions, the monitoring of the execution quality you obtain. There is going to be more information available to you as a result of MiFID II to potentially take account of but still, fundamentally, it is a question of sitting down and thinking "what is the best way I can monitor the execution quality I am achieving?" It's about asking you the selves both sets of questions in order to be able to ensure that you are complying with the rules.

The second thing, and again this ties back to what I said earlier about governance, having an appropriate governance around best execution and being clear who is responsible in the firm for your best execution arrangements and how the decision-making process works in your firm once you've done the monitoring, once you've collected the information, how do you then ensure that that is followed through on, to deliver changes in your arrangements and in your policies?

Product governance

What the product governance requirements in MiFID II do I think are twofold. One is to have a set of requirements that expand across a wider range of activities and secondly there is a greater formalisation of certain aspects of the way that the product governance process is supposed to work.

Per se, the product governance arrangements in MiFID are not there to stop people from selling products. They are there simply to require some thought about the products that are being sold and to whom those products are being sold. It's ensuring that we try to achieve good consumer outcomes, that we avoid mis-selling. Again, those are the sorts of high-level outcomes that people need to focus on when thinking about product governance.

I suspect that when we come to look at product governance...historically, our focus has been on structured products, packaged products. That will probably remain the main focus of our supervisory efforts, although MiFID II applies across a wider set of instruments. That is because that is where we think there is likely to be the most risk of harm from the way in which firms go about their business.

It's also, I think, a case of, as we have tried to emphasise by putting the proportionality provisions in the product governance rules in MiFID II up front in the product governance rules in our handbook, the rules have to apply proportionately and they will apply more heavily the more complex the product and also where the firm is undertaking something other than simply offering products on an execution-only basis.

Inducements and suitability

Again, I think what MiFID II is doing here chimes in with what we have been doing historically as a regulator. We have had concerns about receipts of inducements; obviously the Retail Distribution Review is one aspect of that. We have published the results of our review of inducements. We have finalised our guidance in FG14/1. [This was to do with the ways in which the payments that product providers (who manufacture retail investment products) make to advisory firms under service or distribution agreements can go against the FCA’s Principle 8 (on conflicts of interest) and its conduct-of-business sourcebook (COBS) inducement rules, thereby undermining the objectives of the Retail Distribution Review.] Looking at what we have said in those sorts of documents is, I think, important again for understanding how we will look at the way in which firms are implementing the requirements of MiFID II.

In terms of suitability, again our business plan emphasises the fact that we continue to have concerns in some instances about the quality of suitability assessments. We have set out in the past what we think are the sorts of failings that tend to undermine suitability assessments: inadequate references to the cost of particular products; inadequate understanding of the products which are being recommended; and also mis-profiling of the attitude to risk of clients.

Again, those are the sorts of areas I expect us to focus on. There are elements in the MiFID II rules that speak to aspects of that. As I say, it's not going to be a huge disjunction in terms of what we look at and the concerns that we have between the implementation of the...between what we have been doing recently and what happens in terms of the implementation of MiFID II.

A significant challenge

We recognise that you face a significant challenge. We are trying to help you with the implementation through communication, through various bits of work that we are doing, but if there continue to be issues that you're struggling with, please come and talk to us about them and we will try to proffer assistance.