Significant changes have been made to the client categorisation provisions under MiFID II, including the extension of some conduct of business requirements to eligible counterparty business, a ban on opting up elective professional clients to eligible counterparties and changes to the eligibility criteria for local authorities to be categorised as eligible counterparties. This means that firms will need to carefully review their current customer categorisations to ensure compliance with the new requirements.
Position under MiFID
Eligible counterparties
Firms that have permission to carry on any one or more of the following activities: executing orders on behalf of clients, dealing on own account, or receiving and transmitting orders, are permitted under Article 24(1) of MiFID to bring about, or enter into, transactions with eligible counterparties without having to comply with the conduct of business obligations set out in Article 19, the best execution provisions in Article 21 and the client handling rules in Article 22.
Article 24(2) goes on to specify which types of entity can be categorised as eligible counterparties for these purposes. They are: investment firms, credit institutions, insurance companies, UCITS schemes and their managers, pension funds and their managers, other financial institutions regulated under EU law, MiFID exempt commodities and commodities dealers, and locals, and their third country equivalents. Also included are national governments and their corresponding offices, public bodies that deal with public debt at national level, central banks and supranational organisations.
Any of these entities can request re-categorisation as either a professional client or a retail client benefitting from the investor protection provisions appropriate to each category in articles 19, 21 and 22 either generally or on a trade-by-trade basis. Firms are also permitted to re-categorise eligible counterparties on their own initiative (MiFID Implementing Directive1 Article 28(3)(a) and Article 50(2)).
Categorisation of eligible counterparties is subject to the condition that firms obtain express consent from the client that it agrees to be treated as an eligible counterparty, (Article 24(3)).
A professional client that is both an undertaking and meets the size and eligibility criteria in Section I(2) to (3) of Annex II of MiFID can be re-categorised as an eligible counterparty for the types of business referred to above as set out in Article 24(1). In accordance with Article 50(1) of the MiFID Implementing Directive, professional clients that qualify as such by meeting the qualitative and quantitative tests set out in Annex II, Section II, can also be re-categorised as eligible counterparties, but only for the services for which they could be treated as professional clients. This provision only applies to undertakings, so individuals cannot be categorised as eligible counterparties.
Professional clients
Entities that automatically meet the conditions for categorisation as professional clients are specified in Section I of Annex II of MiFID. They are broadly the same as the entities that can be categorised as eligible counterparties with the addition of other (non UCITS) collective investment schemes, and large undertakings meeting specified size criteria (Section I(2) to (3) of Annex II). Other institutional investors whose main activity is to invest in financial instruments, including entities dedicated to the securitisation of assets or other financing transactions, are also specified within this category (Section I(4) of Annex II).
As with eligible counterparties, professional clients are entitled to request re-categorisation as retail clients to benefit from greater investor protection provisions, or can, either at their own request or on the initiative of the firm, be re-categorised as an eligible counterparty. In the latter case, as mentioned above, the firm can only re-categorise the client as an eligible counterparty to carry on business for which it has been assessed as a professional client (Section II of Annex II, MiFID).
Annex II also sets out the procedure for agreeing categorisation with a professional client, which includes informing the client of its categorisation as a professional, and notifying the client that, subject to agreement with the firm, the client can request categorisation benefitting from additional investor protections.
Retail clients
Any other person or entity that is not a professional client will be a retail client. Retail clients can request re-categorisation as professional clients, subject to meeting the qualitative and quantitative tests described below, and more rarely as described above, as eligible counterparties. Before re-categorising a retail client as a professional client, the firm must first assess the client’s expertise, knowledge and experience as being sufficient for the client to be capable of making his own investment decisions and understanding the risks involved (the ‘qualitative test’). The client must also meet two of the following three size criteria: • the client has carried out transactions in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters • the client’s portfolio exceeds EUR 500 000 • the client is a financial services professional with at least one year’s experience of the services to be provided to him. Retail clients that have been re-categorised as professional clients (‘elective professional clients’) cannot be deemed to possess the same market knowledge and experience as other professional clients (‘per se professional clients’).
Changes under MiFID II
Eligible counterparties
As explained in recital 104 of MiFID II, the financial crisis has shown limits in the ability of non-retail clients to appreciate the risk of their investments and so it is appropriate to extend some information and reporting requirements, such as those relating to the safeguarding of client assets and funds, risk warnings, information about the firm, its services, and costs to eligible counterparties. Recital 103 makes it clear that eligible counterparties should be considered to be acting as clients for the purposes of MiFID II. The list of entities that qualify automatically as eligible counterparties remains largely unchanged and is now set out in Article 30(2) of MiFID II. It no longer refers specifically to commodities and commodities dealers and locals, which were exempt under MiFID, as these firms are now expected to be included as investment firms.
Professional clients
Annex II of MiFID is reproduced in Annex II of MiFID II with the modifications explained below. Public bodies that manage public debt at national or regional level can be automatically categorised as professional clients. Otherwise, such entities should be treated as retail clients. This is in line with the statement in recital 104 that municipalities and local public authorities be excluded from the lists of eligible counterparties and professional clients, although such clients can still request treatment as professional clients provided they meet the qualitative and quantitative tests in Annex II. In addition, a new provision in Annex II, Section I states that Member States may adopt specific criteria for the assessment of the expertise and knowledge of municipalities and local public authorities requesting re-categorisation to professional client, which criteria can be alternative or additional to those listed in the Annex2.
Retail clients
There is little change to the categorisation of retail clients other than the provision in Article 71(1) of the Delegated Regulation3 in which clients re-categorised as professional clients are not included in the list of clients that can be re-categorised as eligible counterparties. Retail client otherwise remains the default category for clients not qualifying for professional or eligible counterparty status.
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