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Reg Zone



MiFID and MAD round two - an overview

London and Edinburgh


CMS Cameron McKenna

CMS Cameron McKenna is an international commercial law firm advising businesses, financial institutions, governments and public sector bodies.

We are a founding member of CMS - the alliance of independent European law firms. CMS law firms provide clients with access to integrated pan-European legal services, managed by a single point of contact and with common high calibre service standards. The organisation has over 58 offices and associated offices worldwide.

In Europe, CMS Cameron McKenna is a top-ten law firm in its own right with over 130 partners and c 700 legal and tax advisers (including partners). We have the resources and experience to advise clients on a wide range of transactions and projects both in the UK and internationally. We have offices and associated offices in various key business centres worldwide including the UK, Central Europe, Russia, Asia and North America.

Our lawyers have strong specialist expertise in areas such as finance and financial services;

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human resources and pensions; arbitration and litigation.

We have a strong track record in the financial services sector across Europe and are therefore very familiar with the key issues affecting clients at the moment.

We are committed to providing the highest quality professional advice and building enduring relationships with our clients. We place great emphasis on the training and development of our partners and staff in both current legal and business issues. Our investment in know- how and information systems allows us to share our knowledge and experience throughout the firm, helping to ensure that all our lawyers add value to the services they provide. We work with our clients to identify their business needs and provide them with comprehensive, cost-effective commercial guidance, we offer a clear business lead - not just legal opinion.

CMS Cameron McKenna is a member of Scottish Financial Enterprise.


New EU developments – MiFID II & MAD II The bird’s eye view

Simon Morris

December 2011



1. MiFID II – MiFID: the sequel

2. MAD II – even madder than MAD?


MiFID – the sequel

1. The policy drivers

2. The reasoning for the Regulation 3. The “news headlines”

1) Extension of scope & withdrawal of exclusions 2) Enhancing investor protection

3) Upgrading market structure & organisation 4) Controls over derivatives

5) Transparency

6) Strengthening corporate governance 7) The 3 rd country regime



1. The policy drivers

– EU committed to minimise discretions available to MS in FS – MiFID => more competition between venues in the trading of

financial instruments and more choice for investors.

– But benefits from increased competition have not flowed equally to all market participants and have not always been passed onto end investors. Market fragmentation resulting from competition has made the trading environment more complex.

– Market and technological developments have outpaced MiFID, undermining the level playing field.

– The financial crisis has challenged previous assumptions that

minimal transparency, oversight and investor protection are

conducive to market efficiency no longer hold.


2. The reasoning for the Regulation

– Regulation necessary to grant product intervention and trade

transparency powers to ESMA because deviation at national level would lead to market distortion and regulatory arbitrage.

– Central aim of proposal is to ensure that all organised trading is conducted on a regulated trading venue

• Regulated market, MTF or OTF with

• Identical (but appropriately calibrated) pre- and post-trade transparency requirements

• Almost identical market organisation and surveillance requirements.


2. The “News Headlines”

1) Extension of scope & withdrawal of exclusions 2) Enhancing investor protection

3) Upgrading market structure & organisation 4) Transparency

5) Controls over derivatives

6) Strengthening corporate governance 7) The 3 rd country regime



1) Extension of scope & withdrawal of exclusions

MiFID regime extended to

• 3 rd country firms

• Credit institutions

• Selling/advising on deposits with non-interest rate returns

• Firm issuing own investments on primary market or advised distribution

Exclusion for dealing as principal withdrawn if

• Any other investment service or activity provided not ancillary to main unregulated business, not member/participant regulated market/MTF or execute client orders

• Execute client orders

• Do more for group undertakings than deal on own account


2) Enhancing investor protection

– Investment advisory firm must state

• Independent & based broad or narrow market review. And if independent – Must assess sufficiently large number of FI

– May not take 3


party fees (but non-monetary benefits like training OK)

• Whether provides ongoing assessment of suitability of FI recommended

• How advice meets client’s characteristics

– Portfolio manager may not take 3 rd party fees

– Price packages separately and explain if available separately – No suitability for execution/RTO for liquid/non-complex FIs only

– All execution venues must publish quality & firms their top 5 venues – Eligible counterparties – must treat HF&P and communicate CF&NM – No retail collateral transfer

– Breach reporting within firms to be encouraged


3) Upgrading market structure & organisation - the vocabulary

1. Regulated market

• Multilateral system + market operator + multiple 3 rd parties + non discretionary rules => contract in listed FI. Transparent access rules.

2. Multilateral trading facility

• Like an RM but can be operated by a firm & no requirement for listing

3. Organised trading facility

• System or facility (not RM or MTF) + firm or market operator + multiple 3 rd parties + contract to deal. May determine & restrict access.

4. Systemic internaliser

• Firm dealing on own account organised, systemic & frequently executing client orders outside RM, MTF or OTF (but not occasional, ad hoc,

irregular, off venue)


Upgrading market structure & organisation - the upgrades

– Regulated market must ensure resilient trading systems

• Ensure algorithmic trading cannot create disorderly market

• Ensure participant only provides DEA if authorised and responsible for trades

– MTFs and OTFs must ensure transparent & orderly trading

– OTF may not execute client orders against operator proprietary capital, may not connect with each other and operator cannot be SI on own OTF.

– Risk controls for algorithmic trading

• Automatic determination of trading parameters

• Must operate continuously & post competitive quotes at all times

– Firm providing DEA must vet user suitability

• Ensure observe thresholds and monitor for disorderly trading

– Data consolidators to require authorisation


4) Transparency (the Regulation)

– RMs, MTFs & OTFs shall

• Continuously during normal trading hours publish current bid/offer prices & depth of trading interest in equity instruments

• Publish real time price, volume & time of equity instrument transactions

• And in non-equity instruments – bonds, structured finance, products, emission allowances & derivatives

– SI shall publish firm quote for liquid instrument traded on RM, MTF or OTF

• Shares, depository receipts, ETFs, certificates & similar FIs

• Must publish quotes & execute at quoted prices

– Firms must report (or through venue) execution to regulator &

publish trade data – volume, price, time


5) Controls over derivatives

– Financial transactions in specified derivatives may only be concluded on RM, MTF, OTF or approved 3 rd country venue

• Anti-avoidance provisions

• Operator of RM to ensure all transactions are cleared by CCP which is obliged to clear for all venues

– Market, MTF or OTF trading commodity derivatives must apply position limits

– And provide weekly aggregate report

– Regulator can (Regulation gives ESMA power)

• Demand information on anyone’s derivative positions – size & purpose

• Require to reduce exposure

• Limit ability to enter into commodity derivatives


6) Strengthening corporate governance


– Members of management body must have repute, skills, knowledge, experience and time

– Adequate collective knowledge to understand business & main risks – Have independence of mind to assess & challenge senior

management decisions

– Oversee senior management & ensure firm soundly managed Personally

– Limit ED+NED+NED or NED+NED+NED+NED (Group (N)EDs = 1) – Must be inducted & trained

– Firm must take diversity into account


7) 3 rd country regime

Must harmonise fragmented framework => uniform treatment

3 rd country firm must be authorised before providing branch services – Mandatory for retail business

– Commission to certify 3 rd country equivalent & reciprocal – Plus cooperation & OECD agreements

– Subjected to initial capital, COBS and SYSC May then passport

Existing branches have four years grace before need authorisation EC not need branch if ESMA registers

• 3 rd country supervision, co-operation & reciprocity

EU person may receive unsolicited 3 rd country services


8) Anything else?

– ESMA power of product intervention

• Temporarily prevent or restrict

• Marketing distribution or sale

• FI, activity or practice

• Where threat to investors, market integrity or financial stability

• Where current requirements and action inadequate


MAD II – madder than MAD?

1. The new structure

2. Criminalisation – the policy and the proposals 3. The policy behind the Regulation

4. The main changes in the Regulation

5. The practical implication of the Regulation


1. The new structure

The Directive

• Criminal sanctions

– Insider dealing

– Market manipulation

The Regulations

• Directly applicable

• All the current material

• Plus some


2. Criminalisation – the policy

– A well-functioning legislative framework on market abuse requires effective enforcement [but] not all national competent authorities had a full set of powers ... and level of sanctions varied widely

– Establishing criminal offences for the most serious forms of market abuse sets clear boundaries in law ... There is no Union- wide understanding on what is a serious breach ...

– Inciting as well as aiding and abetting should be punishable

– Liability (including criminal) should be extended to legal persons

– Member states may have more stringent criminal laws


Criminalisation – the proposals

Insider dealing

– Intentionally using inside information to deal in a financial instrument – Unlawfully disclosing* inside information to another

Market manipulation

– Intentionally giving false/misleading signals of supply/demand/price of an financial instrument

– Intentionally securing price of financial instrument at abnormal/artificial level – Intentionally trading using a fictitious device/deception/connivance

– Intentionally disseminating* information giving false/misleading signal And ancillary offences – inciting, aiding, abetting, attempting (not*)

And firm where “leading person” commits for its benefit or fails to supervise


Criminalisation – so what?

– Similar to current FSA stance on insider dealing prosecutions – But far wider scope

• All financial instruments

• Includes cancelling or amending prior order

• Includes disclosure

• Includes market manipulation suite of offences

• And ancillary offences

• And legal persons

– Requires criminal trial

• Judge

• Jury

• Beyond reasonable doubt


3. The policy behind the Regulation

1. The Commission has … identified problems which have negative impacts in terms of market integrity and investor protection, lead to an unlevel playing field and result in compliance costs and

disincentives for issuers.

2. Regulatory, market and technological developments cause gaps in the regulation of new markets, platforms and OTC instruments.

3. Numerous options and discretions in MAD, as well as a lack of clarity on certain key concepts, undermines the effectiveness of the Directive.

4. Divergence of national laws creates obstacles to trade and significant distortions of competition. A uniform framework is

needed to preserve market integrity, avoid regulatory arbitrage and

provide more legal certainty and less legal complexity.


4. The main key changes

– The Regulations should extend to financial instruments traded on MTFs and on other types of organised trading facilities such as

broker crossing systems or only traded OTC (such as credit default swaps).

– Inside information can be abused before an issuer is under an

obligation to disclose it because it is insufficiently precise ... contract

negotiations, the possibility of placement, conditions of marketing a

financial instrument may be relevant information for investors and

should qualify as inside information.


What is it?

OLD WORLD Market abuse

Behaviour by one or more persons – No intent needed

Relating to qualifying investments on a prescribed market

Occurring in the UK or UK listed


Insider dealing & market manipulation

Any behaviour or transaction – No intent needed

Relating to financial instrument on a

regulated market or MTF or OTF

Occurring anywhere


Market abuse – insider dealing


1. Did you act – deal/require/tip off?

2. Did you have inside information?

a) Precise =

i. Exists or reasonably expected + ii. Can conclude price effect

b) Not generally available

c) Reasonable investor likely to use 3. Did you deal on the basis of it?

a) Or it was a contributory element


1. Did you possess II?

2. Did you use? – same + cancel, amend

& attempt

3. Was it inside information re issuer?

a) Precise = unchanged;

b) Not made public & if made public likely significant price effect;

c) Or other information

i not precise & not announceable ii not generally available

iii which reasonable investor likely

regard as relevant (including

likely significant price effect)


Market manipulation


– Trade for illegitimate reason – Giving false or misleading

impression or

– Secures prices at abnormal level – Defend – your legitimate rationale


a) Deal, trade or behaviour

i. Gives false or misleading signals supply/demand/price or

ii. Secures prices at abnormal level iii. Or likely to do so

b) Deal, trade or behaviour using fiction, deception or contrivance c) Disseminating false/misleading

information => (a)

d) Or attempting to do so

Examples given in Annex


Not market abuse if…

– You don’t do it

• Based on own decision X not now

• Observe Chinese wall X not now

– It is market abuse but …

• Reasonably believe not market abuse or X not now

• Take all reasonable precautions and due diligence to avoid X not now


5. So what?

– Broader definitions, absent defences

• Wider categories

• Connected investments

• Wider markets

– Arrangers & executors must have systems to detect & prevent – Once finalised refresh procedures & training

• Can you show not possess or, if did, did not use?

– Penalties up – fine up to twice profit; €5m for individual; 10% firm t/o


Markets in Financial Instruments Directive (“MiFID”) – reform proposals for the EU investment sector

New EU measurers announced in four areas

On 20 October 2011, the European Commission (EC) published its proposed reforms to MiFID. These include a large number of new measures mainly in four areas:

- Extending MiFID regulation of investment firms and credit institutions.

- Tougher conduct of business and prudential requirements.

- Extending EU regulation of markets and trading venues.

- Increasing the powers of ESMA and national supervisors.

Background and timetable

The MiFID regime (which came into effect on 1 November 2007) harmonised EU1 rules for investment business; it applies to investment firms, banks, other credit institutions as well as to exchanges and trading platforms.

The EC consulted2 on amendments to MiFID and drafts of the new legislation have been circulating for some time. On 20 October 2011, the EC finally published the official level one proposals which comprise a directive (to amend the level one directive i.e. the framework legislation known as MiFID I) and a new EU Regulation (which will have direct effect without national implementing measures being required).

It is anticipated that there will be new level two measures and the complete reform package will take at least a couple of years to implement, given the raft of further measures and technical details which have to be produced by the EC and European Securities and Markets Authority (“ESMA”).

The proposals will make a large number of changes to the current MiFID regime. We summarise some of these changes below and briefly consider the likely impact on firms and other market participants.

Extending the scope of MiFID regulation of investment firms and credit institutions

A radical new EU authorisation regime for third country firms – a new services passport for firms from countries that pass the ‘equivalence’ test.

The issue:

Third country investment firms i.e. those incorporated outside the EU/EEA do not currently enjoy a MiFID passport. They must apply for separate authorisation in each member state (for services/ cross border business or to operate a local branch). The regulatory ‘perimeter’ varies from one member state to another and different authorisation requirements apply. In relation to UK business, many third country firms without a UK branch, rely upon the ‘overseas persons’

exemption’ in Article 72 of the Regulated Activities Order to avoid authorisation.

The change:

Third country firms will not be able to obtain authorisation to provide any MiFID services to retail clients unless they have established a branch within the EEA.

1 MiFID legislation refers to the EU but the regime is extended geographically and applies across the 30 countries of the EEA.

2 See the 2010 consultation paper here.



The EC will consider whether a third country passes equivalence and reciprocity tests -

- Equivalence test: does the third country have an equivalent3 regulatory regime to the EU/MiFID/CAD (including equivalent regulation in a broad range of prudential areas including market abuse, capital and organisational requirements and supervision)?

- Reciprocity test: does the country give equivalent reciprocal recognition to the EU prudential framework?

A firm from a third country that has passed both tests will be able to establish a branch in any member state by applying for authorisation from the authority in the relevant state. There will be a harmonised process (including harmonised

requirements as to cooperation agreements with the third country regulator) and a harmonised set of MiFID rules (conduct of business, prudential and other MiFID requirements) will apply to the third country firm branch.

Once authorised, the third country firm branch will be free to provide services in/to other member states without the need to establish a local branch or branches. It will have the benefit of an EEA wide services passport (i.e. it will able to conduct services business in other member states and only need complete a simple notification process to the member state authority which has granted its EEA authorisation, similar to the current passport regime for EEA firms).

Third country firms providing services to eligible counterparties would not have to establish a branch, but will need to register with ESMA.

The impact:

All third country firms will need to review their EEA entity operating structure across all relevant states. They will need to assess the impact of the changes on their current operations and consider the optimum structure for their business under the different models which will be available. Much will depend on whether their home country passes the equivalence and reciprocity tests.

Third country firms from countries that pass the equivalence and reciprocity tests will be in a much improved position. They will be able use a single EEA branch authorisation to provide services from that branch to clients across the EEA, and they will have a harmonised set of MiFID rules to follow. Third country firm groups may even switch from a local EEA subsidiary (perhaps originally established to take advantage of the MiFID passport and avoid current difficulties for third country firms) back to a branch of the third country firm.

Third country firms from other non-equivalent/reciprocal countries cannot set up a branch and will have to incorporate an EEA subsidiary and obtain authorisation as an EEA firm. They will be precluded from dealing with retail clients other than via an authorised subsidiary. It is not clear whether or not the UK’s overseas person exemption will be permitted to remain to allow a third country firm to provide services on a remote basis to professional clients and eligible counterparties.

Regulating structured deposits and ‘own issue’ financial instruments

The issue:

(a) MiFID conduct of business rules may not currently apply to transactions where the firm is not giving advice and the investment is by way of primary transaction involving the firm itself issuing a new financial instrument to the client, and (b) the regime does currently apply to structured deposits.

The change:

(a) In future, the issue of financial instruments will generally be treated as the ‘execution of a client order’ by a firm and will therefore be MiFID regulated, and (b) certain MiFID rules will in future apply to banks/credit institutions and other firms when they are selling or advising on certain structured deposits (i.e. those falling within the definition of ‘packaged retail

investment products’ under the EC’s PRIPs proposals).

The impact:

(a) Firms subject to MiFID which issue their own financial instruments (such as bonds) will need to comply with MiFID conduct of business rules and conflicts of interests rules when carrying out these activities and, (b) structured deposits will now be subject to more coherent harmonised rules across retail products that the proposals on PRIPs. The main debate is over the definition of those ‘structured deposits’ caught by the change; if this is drawn to broadly it will cause confusion and difficulty.

3 The concept of regulatory ‘equivalence’ is also used (but in a more limited way) in Solvency II.



Bringing more own account dealers into regulation

The issue:

Certain firms fall outside MiFID regulation as a result of (a) an exemption for own account dealers in commodities and commodity derivatives or (b) other exemptions for own account dealing.

The change:

(a) The commodity dealers exemption is to be removed, and (b) another own account dealer exemption is being changed and the definition of the MiFID activity of ‘executing client orders’ is also being amended.

The impact:

Some firms which currently fall outside of MiFID will in future be caught; they may need to become authorised and/or comply with additional requirements. This is a particular issue in the commodities sector where firm may have been protected by the exemption which is being removed

Algorithmic trading and market protection

The issue:

There are concerns, within the EU and beyond, about algorithmic trading, particularly about the dangers of high frequency automated trading.

The change:

There will be new requirements on regulated markets regarding systems resilience, circuit breakers and electronic trading;

these include a prohibition on giving direct electronic access to any firm that is not authorised under MiFID.

Extensive new requirements will apply to firms engaged in algorithmic trading including the obligation to report to its supervisor on its trading strategy and parameters as well as its related and risk/compliance controls. Additional requirements apply to firms with direct electronic access to trading venues and general clearing members.

The impact:

There are significant impacts for regulated markets and for firms involved in these forms of trading. There is particular alarm at the implications of needing to report details of highly sophisticated and confidential algorithmic trading strategies.

Bringing physical emission allowance trading into regulation

The issue:

Whilst emission allowances derivatives are currently caught by MiFID, dealings in the physical market are not.

The change:

Emission allowances are to be added to the MiFID definition of financial instruments.

The impact:

Firms involved with physical emission allowance business that are not currently authorised for financial business, will need to consider their position carefully and may need to apply for authorisation and/or restructure their carbon market operations to take advantage of those exemptions which will continue under MiFID II. Those that are authorised will need to extend their compliance regime.

Tougher conduct of business and prudential requirements

Enhanced governance The issue:

There has been much discussion about the failures of corporate governance as a cause of excessive risk taking by financial institutions.


4 The change:

There are enhanced governance provisions with new and some rather specific obligations; these will all apply to investment firms and some to banks, other credit institutions and regulated market operators. For the first time, the legislation places a clear responsibility on each member of the board – both executive and non-executive – to assess and challenge the decisions of senior management. They are also obliged to commit sufficient time with hard limits on executive and non- executive directorships – a maximum of one executive with two non-executive or four non-executive (with no executive roles).

Collectively the board must have the knowledge, skills and experience to understand the business and the main risk involved. Larger and more complex businesses must have a nomination committee responsible for assessing compliance with these obligations. Firms must use diversity as a selection criteria for the board and must have a policy (taking account of the size of the board) to promote gender, age, educational, professional and geographic diversity. Firms will have to report to the regulator presumably on its policy and the ‘diversity’ achieved.

There are further broad obligations on the board relating to effective management of the firm and effective oversight of senior management. This includes broad governance obligations to define, approve and oversee and to monitor and periodically review the firm’s strategic objectives, organisation, systems, personnel, resources and policies on risk tolerance, stress testing and client profile/products/services.

The impact:

Immediate concerns may focus on the limits on directorships, which seem to run counter to FSA’s emphasis on the value of attracting non-executives with broad and continuing business experience, although it does reflect concerns on the level of attention paid by non-executive directors to each of their roles.

The specific obligations on board responsibilities will add to the existing governance processes in many firms including more formalised board level policies, monitoring and review.

There will be many issues for directors to consider individually in relation to their personal position and exposure.

Commission ban and other obligations for independent advisors and portfolio mangers

The issue:

Firms that provide investment advice are not required (under MiFID at least) to explain the basis on which they provide advice and the scope of their service. Although the inducements rules apply, advisers and portfolio managers may still receive commission for a product for which they give advice/effect discretionary transactions.

The change:

When investment advice is provided, the client must receive information that specifies if the advice is provided on an independent basis, whether it is based on a broad or more restricted analysis of the market, and if the adviser will provide an on-going assessment of suitability of his recommendations.

If advice is notified as being provided on an independent basis the adviser is required to assess a sufficiently large number of financial instruments available on the market, and is not permitted to receive fees, commissions or any monetary benefits from third parties.

Portfolio managers are also not permitted to receive third party fees, commissions or monetary benefits.

The impact:

The FSA has already legislated for many changes under the RDR in relation to advisers in the UK, which are to some extent similar to the MiFID proposals, and will take effect by the end of 2012. However, to the extent that the FSA’s rules go further than the proposals (for example by banning commission payments to restricted advisers as well as independent advisers), this raises the question as to whether the UK will be ‘gold-plating’ the directive which would require a justification to be made to the Commission

Other measures

MiFID confirms the recent UK move to ban title transfer financial collateral arrangements for retail clients, strengthening the protection for retail client money. Firms will now have to summarise and make public on annual basis, for each class of financial instruments, the top five execution venues where they executed client orders in the preceding year. The definition of non-complex instruments (for which execution-only services can be provided without assessing appropriateness) is narrowed and now excludes structured UCITS.



Extending the scope of regulation of markets and other trading venues

Extending market regulation – organised trading facilities.

The issue:

MiFID I introduced a three tier classification for the regulation of trading venues. Regulated markets (RMs), such as the main stock exchanges, are subject to the highest standards – for example in relation to the listing of investments; only dedicated market operators can run a RM. One of the policies behind MiFID I was to increase competition for the RMs. MiFID I therefore introduced a new category of ‘multilateral trading facilities’ (MTFs). These can be primary trading venues – for example AIM , which is a primary market for junior stocks not listed on the main market/RM; this is operated by the LSE (i.e.

an RM operator) and is an example of an ‘exchange regulated market’ (ERM). Some MTFs such as Chi-X are secondary or alternative trading venues (which might be operated by an investment firm) that offer a competitor platform for instruments traded on an RM. The third category was a ‘systematic internaliser’ – for example a bank offering an off-market dealing facility where the bank buys and sells as principal.

There are concerns that trading venues have evolved which are not caught by the current categories.

The change:

There will be a new category of ‘organised trading facilities’ (OTF) which will require specific authorisation and which will be subject to trading venue rules (e.g. relating to organisation and transparency). As with MTFs, OTFs can be operated by a market operator or an investment firm. OTFs are prohibited from executing orders using the operator’s proprietary capital and must justify why they cannot operate as an MTF or SI (or RM).

The impact:

Various trading arrangements may be conducted by authorised firms but without MTF or SI status, thereby escaping trading venue rules (e.g. broker crossing networks). This reform will drive these into regulation and subject them to greater transparency requirements. In some cases they may adjust e.g. to operate as an MTF, as the regulatory arbitrage opportunity to avoid trading venue regulation falls away.

Moving OTC derivatives transactions onto exchanges

The issue:

There is a global push towards how derivatives are traded, and this was the subject of G20 commitments in 2009. In Europe, delivery of these commitments has been split between two regulations: the requirement to trade through a CCP is found under the European Market Infrastructure Regulation (“EMIR”), while the new MiFID regulation requires firms to use certain trading venues. Up until now, standardised derivatives were being traded outside of MiFID’s perimeter, which meant that regulators had no oversight of them.

The change:

Standardised derivatives will now have to be traded on a regulated market, OTF or MTF.

The impact:

The push of OTC trading on to regulated markets, OTFs or MTFs, should be viewed in tandem with firms’ requirements under EMIR (see a previous RegZone article on EMIR here) and the proposals on reforms to the Market Abuse Directive (see latest RegZone article on MAD II here). Put simply, there will be greater transparency and regulatory oversight of trading of standardised derivatives, and many existing business models and operating structures will need to be overhauled as a result of the changes.

Non-discrimination rules clearing

The issue:

CCPs and trading venues demanded that certain requirements were met before they agreed to trade. This meant that firms would either have to restrict which CCP/trading venue they operated on, or use multiple CCPs/trading venues. Given that all firms are required to use a CCP and operate on certain trading venues, firms should be able to use any CCP/trading venue without having to meet criteria specific to each CCP/trading venue.


6 The change:

CCPs must not discriminate between trading venues when deciding whether to accept financial instruments for clearing.

CCPs can only refuse to clear financial instruments if certain, limited criteria are met. Similar provisions will open up trading venues.

The impact:

CCPs and trading venues will have less scope to refuse to clear financial instruments. This will prevent firms having to avoid complying with multiple sets of admission criteria or having their choice of CCP/trading venue restricted.

Other measures

Extension of pre- and post-trade transparency, broader and more detailed data provisions, arrangements to facilitate central publication of trade data, obligations on SIs and trading venues to publish transparency data and annual data on execution quality, broader transaction reporting requirements for firms, new ‘SME growth market’ category for admission to trading facilities.

More powers for ESMA and national supervisors

Banning financial products The issue:

Authorities wanted increased powers to control financial products, activities and practices.

The change:

ESMA and competent authorities now have the power to ban certain financial products, activities or practices, where there is a threat to investor protection, or to the orderly functioning and integrity of the financial markets, or to the stability of the financial system.

The impact:

The authorities have the power to intervene with the provision and management of financial products, activities and practices. Firms may have to adapt their businesses in line with such potential intervention, ensuring that their businesses are flexible enough to respond to the regulators’ requests. We have already seen the potential impact of this type of practice through recent short selling bans.

Limiting derivative contracts and exposures

The issue:

Authorities wanted more powers to monitor derivative positions to prevent the build up of firm-specific, sectoral or systemic risk.

The change:

Authorities are given powers to request information on a wider range of products (including derivatives). Authorities will also enjoy a wider range of remedies open to them. In respect of commodity derivatives, the markets and trading venues, the EC and national regulators will all have different powers to set position limits to support liquidity, prevent market abuse and support orderly markets, and more detailed position reporting by trading venues will be required.

The impact:

Firms may find that authorities will request more information, and intervene at an earlier stage, to prevent the build up of risk. Firms not only face limits, but could be asked to reduce existing positions.

Swingeing penalties

The issue:

Member states’ enforcement of MiFID rules and the penalties imposed vary from one country to another


7 The change:

For certain listed breaches (e.g. failing to meet MiFID requirements on conflicts of interest), there will be new EU requirements for effective sanctions and remedies to be available to the domestic authorities in each state, including a maximum sanction of at least EUR5 million against individuals and at least a maximum sanction of 10% of group world-wide turnover for companies. The authorities must have the power to apply sanctions to the directors and other individuals involved, in addition to sanctions against the company. Sanctions are generally to be published. Whistle blowing processes are also required.

The impact:

These changes are likely to lead to tougher enforcement with higher penalties, particularly in those states with a weak enforcement record. The reference to 10% of turnover is modelled on EU competition rules where the record fine is over EUR1 billion. This is of a different order to FSA’s current fines which rarely exceed £10 million (although the compensation paid to customers is often much greater).


Regzone materials are intended for clients and professional contacts of CMS Cameron McKenna LLP.

They are intended to simplify and summarise the issues covered and must not be relied upon as giving definitive advice.

Further information, including a list of our offices, can be found at www.cms-cmck.com

© CMS Cameron McKenna LLP 2011. All rights reserved.

Mez Raja

Solicitor, Financial Services T: +44 (0) 20 7367 2445 E: mez.raja@cms-cmck.com Ash Saluja

Partner, Financial Services T: +44 (0) 20 7367 2734 E: ash.saluja@cms-cmck.com


MAD II – Revision to the Market Abuse Directive

Filling in the gaps and introducing tougher sanctions – amendments to the Market Abuse Directive announced

On 20 October 2011, the European Commission (EC) published its proposed revisions to the Market Abuse Directive (MAD) in a draft Regulation. The draft Regulation provides for:

- an extension to the scope of MAD to include additional financial instruments and markets, and covering financial instruments traded solely on multilateral trading facilities (MTFs) and organised trading facilities (OTFs)1;

- a new definition of inside information for commodity derivatives and new powers for regulators to request information on spot commodity markets;

- bringing emission allowances into the scope of the market abuse regime;

- a new offence of attempting market manipulation;

- broadening and clarifying the definition of market manipulation;

- amendments to the disclosure requirements; and

- strengthening of the investigative powers of regulators.

The EC also published on 20 October 2011 a draft Directive on criminal sanctions for insider dealing and market abuse. The draft Directive proposes minimum rules on criminal offences and criminal sanctions for market abuse.

Background and timetable

MAD (which came into effect in 2003) introduced a comprehensive EU-wide framework for dealing with market abuse. MAD prohibited those who possess inside information from trading in related financial instruments and from manipulating the market. Since MAD came into force there have been a number of market and regulatory changes, and as a result there are a number of perceived gaps in the MAD regime. The draft Regulation seeks to plug the gaps identified by the EC, while the draft Directive seeks to introduce tougher sanctions for market abuse.

The draft Regulation and Directive on criminal sanctions will now be passed to the European Parliament and the Council of the European Union. The aim is to reach political agreement on the amendments to MAD by the end of 2011. Once adopted, the Regulation will apply two years after its entry into force (on which date MAD I would be repealed), and so member states will have two years to transpose the Directive into national law.

Extending the scope of MAD to include additional financial instruments and markets and to ensure MTFs and OTFs are covered

The issue:

MAD currently uses the definition of financial instruments from the Investments Services Directive (ISD), even though the ISD was replaced by the Markets in Financial Instruments Directive (MiFID) on 1 November 2007. MiFID contained a broader definition of financial instruments and introduced a new investment service of operating an MTF. MAD currently

1These are a new category of trading venue under MiFID II, proposals for which were also published on 20 October 2011.

OTFs are defined by MiFID II as “any system or facility which is not a regulated market or MTF, operated by an investment firm or market operator, in which multiple third-parties buying and selling interests in financial instruments are able to interact in the system in a way that results in a contract.” This should capture trading venues, such as broker crossing networks, which are not currently classified as regulated markets, MTFs or systematic internalisers.



only prohibits insider dealing or market manipulation in financial instruments which are admitted to trading on a regulated market. However, financial instruments have increasingly been traded on MTFs, on other types of OTFs or only traded over the counter (OTC).

The change:

The draft Regulation brings the definition of financial instruments in MAD in line with the definition used in MIFID. MAD will apply to any financial instrument:

- admitted to trading on an MTF or OTF, irrespective of whether or not the behaviour or transaction actually takes place on that market; or

- whose value depends on the financial instruments traded on a regulated market, MTF or OTF (e.g. OTC derivatives referenced to such financial instruments).

As a result, financial instruments which are currently outside the scope of MAD such as credit default swaps will therefore now be caught.

To ensure that there is a level playing field, operators of regulated markets, MTFs and OTFs will be required to ensure that they have mechanisms in place for preventing and detecting market manipulation and insider dealing.

The impact:

Extending the market abuse regime (and consequently obligations on transaction reporting) to include instruments traded on any MTF or any OTF will substantially increase the burden on firms across the EU that will have to comply with the market abuse regime.

With such a large number of markets and financial instruments potentially caught by the new market abuse regime, it will be interesting to see the extent to which regulators (outside the major EU financial jurisdictions at least) seek to monitor such markets and take action in respect of any abusive behaviour identified.

A new definition of inside information for commodity derivatives and new powers for regulators to request information on spot commodity markets

The issue:

MAD contains a specific definition of inside information for commodity derivatives (supplemented by the MAD implementing directive which defines the information which market users would expect to receive). The current definition was however considered unclear.

In addition, a person can benefit from inside information in relation to the spot markets by trading on a financial market, although the current definition of inside information includes information that relates to the derivative but not information that relates to the spot commodity contract. This can lead to information asymmetries in connection with related spot markets.

MAD also gives regulators the power to demand information from any person to investigate suspicions of market abuse.

However, this information may not be sufficient if there is no authority supervising the sector as is the case with spot commodity markets (although this will change with the introduction of the new Regulation on Energy Market Integrity and Transparency known as “REMIT”).

The change:

The draft Regulation amends the definition of inside information for commodity derivatives so that it is more general, and covers all information which is likely to have a significant effect on price of, and is relevant to, either the related spot commodity contract or to the derivative itself.

The draft Regulation also gives regulators access to continuous data on spot commodity markets, delivered to them in a specified format to assist them in identifying insider dealing and market manipulation in commodity derivatives.

The impact:

The new definition of inside information for commodity derivatives is intended to provide clarity for the market and for regulators, but whether this is arguably now too broad and how this dovetails with REMIT remains to be seen.

Regulators will have the tools they have asked for to monitor spot commodity markets on a real-time basis and to identify and take action against market abuse, but this will potentially increase the reporting burden on firms.



Bringing emission allowances into the scope of the market abuse regime

The issue:

The majority of emissions allowances are traded in the form of derivatives (futures, forwards and options), which are included in the MiFID definition of financial instruments. However, transactions for immediate delivery of allowances ("spot"

transactions) are currently not included in the MiFID definition of financial instruments. The proposals for MiFID II expand the definition of financial instruments to include emissions allowance spot transactions.

The change:

As a result of the reclassification of emission allowances as financial instruments under the MiFID II proposals, emission allowances will fall into the scope of the market abuse regime. The draft Regulation introduces a specific definition of inside information for emission allowances.

The obligations to disclose inside information, create and update insider lists and report transactions will fall on participants in the emission allowances market rather than issuers (as participants rather than issuers will possess the relevant information).

Smaller participants whose activities on an individual basis may have no material impact on the price of emission

allowances or the risks of insider trading will not be required to comply with these obligations. The thresholds have yet to be set (expressed in terms of emissions or thermal input or a combination of both), below which participants will be classed as smaller.

The impact:

Bringing emissions allowances into the scope of the market abuse regime will have a huge impact on participants in these markets who will now be required to put in place mechanisms to comply with MAD.

A new offence of attempting market manipulation

The issue:

MAD currently prohibits insider dealing and attempts to engage in insider dealing. While market manipulation is also prohibited, MAD does not prohibit attempts to engage in market manipulation. In some markets, such as the commodity markets, there may be many reasons for changes in prices. Regulators have therefore found it difficult to take action for market manipulation under MAD. The draft Regulation therefore seeks to address this issue by introducing a new offence of attempting market manipulation.

The change:

Attempted market manipulation will be prohibited. It is defined in the draft Regulation as “trying to enter into a transaction, trying to place an order to trade or trying to engage in any other behaviour [that constitutes market manipulation].”

The impact:

The prohibition of attempts to engage in market manipulation will enable regulators to take action in respect of market manipulation even if it cannot be proven that behaviour intended to manipulate the market had that effect (i.e. it does not have to prove a causal link between the behaviour and any price movements). This will make it easier for regulators to take action in relation to markets such as commodity markets where there may be many reasons for changes in price.

Broadening and clarifying the definition of market manipulation

The issue:

The definition of market manipulation in section 118 of FSMA is already broader than the MAD definition. The definition of market manipulation, however, needs to be sufficiently broad to capture new forms of trading or new strategies that emerge that may be abusive.

The change:

The definition of market manipulation will be extended to capture “entering into a transaction, placing an order to trade or any other behaviour:

- which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument or a related spot contract; or



- which secures, or is likely to secure, by a person, or by persons acting in collaboration, the price of one or several financial instruments or related spot commodity contracts at an abnormal or artificial level.”

The draft Regulation also includes a number of examples of market manipulation. Trading of financial instruments is increasingly automated so the examples refer to abusive activities which may be carried out by algorithmic trading such as high frequency trading.

The impact:

The draft Regulation will bring some additional clarity to the definition of market manipulation and the examples of market manipulation provided will highlight the range of ways in which the market may be manipulated particularly through new automated trading technology.

Amendments to the disclosure requirements

The issue:

Issuers are required to inform the public as soon as possible of inside information. They may however delay public disclosure under specific conditions. Regulators are not currently notified where a decision to delay disclosure has been made.

The change:

Issuers will be required to inform regulators of their decision to delay the disclosure of inside information immediately after a disclosure is made. Responsibility for deciding whether to delay disclosure or not will remain with issuers.

If inside information is of systemic importance and it is in the public interest to delay disclosure, the regulators will have the power to permit a delay for a limited period in the wider public interest of maintaining the stability of the financial system and avoiding losses which could result from the failure of a systemically important issuer.

To ensure the disclosure requirements are proportionate and issuers whose financial instruments are admitted to trading on SME growth markets are not deterred from raising capital, these issuers will be subject to modified and simplified disclosure requirements. Inside information may be published by SME growth markets on behalf of issuers. The content and format of these disclosures will be standardised. These issuers will also be exempt from the obligation to keep and constantly update insider lists and a different threshold for the reporting of transactions by persons occupying a managerial role within issuers (“managers”) will be applied.

The draft Regulation also clarifies the scope of reporting obligations in relation to managers’ transaction. It states that any transaction made by a person exercising discretion on behalf of a manager or whereby the manager lends or pledges his shares must be disclosed to the regulators and the public. The draft Regulation also introduces a threshold of EUR 20,000 which triggers the obligation to report a manager’s transactions.

The impact:

Regulators will be able to investigate whether in fact the specific conditions for delaying disclosure were met. They will also have the power to sanction delays in the interests of financial stability and to protect investors from losses which may result for the failure of a systemically important issuer.

Manager transaction reporting obligations are aimed at deterring managers from insider dealing. Further clarity around when transactions should be reported may reinforce this deterrent effect.

Strengthening of investigative powers of regulators

The issue:

Not all member states have provisions which allow regulators to enter private premises and seize documents and demand telephone and data traffic records from investment firms and telecommunications companies, which often assists regulators in proving that inside information has been transferred from an insider to someone trading with this inside information.

The change:

The draft Regulation provides for measures to strengthen investigations including;

- the power to enter private premises and to seize documents after having obtained prior authorisation from the court of the relevant member state; and

- the power to request existing telephone and existing data traffic records held by investment firms or

telecommunication operators where a reasonable suspicion exists that such records may prove insider dealing or market manipulation.



Member states will also be required to put in place adequate measures to encourage whistleblowers to report suspected market abuse and protect them from any adverse consequences. The draft Regulation also provides for financial incentives for whistleblowers that provide regulators with salient information that leads to a monetary sanction.

The European Securities and Markets Authority (“ESMA”) will have a strong coordination role and regulators will be required to cooperate and exchange information.

The impact:

The provisions of the draft Regulation which allow regulators to enter private premises and seize documents and demand telephone and data traffic records from investment firms and telecommunications companies will have little impact in the UK as the FSA already has such powers. Under section 176 of FSMA, the FSA already has the power to apply for a warrant to enter premises where documents or information is held. The FSA also currently has the power request telephone and data traffic records from telecommunications companies under the Regulation of Investigatory Powers Act 2000.

While the FSA has in place long-established procedures for dealing with whistleblowers, it does not currently offer financial incentives to whistleblowers.

Minimum rules on criminal offences and criminal sanctions for market abuse

The issue:

EU financial markets are increasingly integrated. However, Member states adopt different sanctioning regimes which can lead to regulatory arbitrage.

The change:

The draft Directive introduces minimum rules for administrative measures, sanctions and fines. It provides for the disgorgement of any profits where identified, including interest, and in order to ensure an appropriate deterrent effect, it introduces fines which must exceed any profit gained or loss avoided as a result of a violation of the Regulation. Fines for corporates will be based on a proportion of annual turnover, which is similar to the approach taken to sanctions in EU competition law.

Member States will be required to put in place “effective, proportionate and dissuasive” criminal sanctions for the most serious insider dealing and market manipulation cases.

The impact:

The FSA has already increased the number of criminal prosecutions it pursues and has sought to introduce harsher sanctions in pursuit of “credible deterrence”, but fines are likely to increase even further. The minimum rules will also ensure a more uniform approach across the EU.


Regzone materials are intended for clients and professional contacts of CMS Cameron McKenna LLP.

They are intended to simplify and summarise the issues covered and must not be relied upon as giving definitive advice.

Further information, including a list of our offices, can be found at www.cms-cmck.com

© CMS Cameron McKenna LLP 2011. All rights reserved.

Mez Raja

Solicitor, Financial Services T: +44 (0) 20 7367 2445 E: mez.raja@cms-cmck.com Ash Saluja

Partner, Financial Services T: +44 (0) 20 7367 2734 E: ash.saluja@cms-cmck.com


© CMS Cameron McKenna LLP 2010

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