Following the European Securities and Markets Authority’s (“ESMA”) letter of 18 August 2020 to the European Commission (“EC”) anticipating the AIFMD review and suggesting, in particular, a review of the AIFM and UCITS directives’ delegation rules and substance requirements, ESMA published draft technical standards (“draft TS”) on the provision of investment services in the European Union (“EU”) by third-country firms (“TCFs”) under MiFID II (the “draft ITS”) and MiFIR (the “draft RTS”) on 28 September 2020.
These technical standards complete the picture drawn by CSSF Circular 19/716, as amended by CSSF Circular 20/743 (the “CSSF Circular”) on some of the regimes TCFs can use to service Luxembourg clients.
The draft TS mark a shift in the supervision of TCFs providing investment services and activities in the EU. They are expected to be endorsed by the EC by the end of the year and provide for extensive harmonized reporting requirements in accordance with Article 46 of MiFIR both at the registration stage and on a regular basis. Such reporting requirements will be applicable to TCFs providing investment services (e.g. portfolio management or investment advice) to Luxembourg investment fund managers (“IFMs”) or investment companies through a branch (draft ITS), or on a cross-border basis (draft RTS).
While these reporting requirements will bring additional costs for TCFs operating on a cross-border basis or via (an) EU based branch(es) in order to put in place the necessary IT systems, this is compensated by the fact that future registration with ESMA will give access to the EU based on a harmonized regime and harmonized reporting standards for EU-based branches of TCFs.
1) Current state on play on delegation and investment services provided by third-country entities
Since no third country has been declared equivalent by the EC so far, TCFs can only provide services to IFMs and investment companies established in Luxembourg:
· on a cross-border basis to eligible counterparties and professional clients “per se”, under the current national regime foreseen in article 32-1(1)§2 of the Law on the financial sector and clarified in the CSSF Circular
· through a branch established in Luxembourg
· through a subsidiary established in Luxembourg, with a MiFID licence
· through a subsidiary based in another EU member state with a MiFID licence based on free provision of services within the EU
· out of MiFID/MiFIR scope, on a reverse solicitation basis.
On the other hand, IFMs or UCIs delegating portfolio management to a TCF must submit information to the CSSF about such TCF and its authorization to carry on such service in its home-country. A Memorandum of Understanding must also be established between the CSSF and the third-country delegate’s national competent authority.
Where a contract is concluded between a TCF and a Luxembourg chapter XV management company or an investment company in respect of investment advice services payable out of the assets of the UCITS, information must be provided to the CSSF about the TCF as well as certain provisions of the contract and other significant activities.
2) Recent and upcoming changes
a) Investment services provided on a cross-border basis
The Investment Firm Regulation introduced some granular reporting requirements into MiFIR art. 46 which are specified in the draft RTS and would apply to TCFs who register with ESMA, in the event of a future EU equivalence decision.
The reports submitted at point of registration should give ESMA a very detailed view of, inter alia,:
- the investment services and activities TFCs are authorized to provide in their home country and those they provide in the EU, their EU client base, the types of financial instruments concerned, their annual turnover and aggregated value of assets corresponding to the services provided.
- how the TFC’s EU activities contribute to their strategy and why, if relevant, they choose to provide services in the EU on a cross-border basis rather than by establishing branches or subsidiaries
- the composition of the TFC’s management body, the persons conducting the EU activities in the EU and the key function holders
- description of internal governance arrangements
- the EU marketing strategy
- client complaint procedures and other arrangements for ensuring investor protection
- different arrangements of the TCF to comply with MiFID/MiFIR rules of conduct and organizational requirements, where applicable
The annual reports must be submitted by 30 April of each year and cover the previous calendar year. Such regular reporting will enable ESMA to update information received at the point of registration and should also include detailed information on the operations (controls, findings, measures and actions) of the internal control functions, (i.e compliance, internal control and risk management) in relation to services provided to EU counterparties.
As a reminder, ESMA has the power to request additional information, to carry out investigations or on-site inspections and to prohibit or restrict a TCF from providing services in the EU.
The national regime currently available has been clarified by the CSSF Circular. TCFs established in third countries listed in the CSSF Regulation N°20-02, authorized in their home country to provide investment services and authorized by the CSSF to provide these services in Luxembourg, can service UCIs and IFMson a cross-border basis. TCFs are required to submit the application form in Annex II of the CSSF Circular to seek prior approval from the CSSF.
Once an equivalence decision is enacted by the EC for a country deemed equivalent in Luxembourg, third-country firms will be able to continue relying on national third-country regimes for a period of three years after the equivalence decision.
b) Investment service provided through a branch
The draft ITS relating to MiFID II article 41 are aligned to a large extent to the draft RTS but some of the reporting fields are adapted to the provisions of investment services and investment activities by a branch established by the TCF. ESMA also introduced some reporting fields related to services provided by a branch of a TCF to per se professionals and eligible counterparties located in other member states.
3) Reverse solicitation
Where a TCF makes use of the reverse solicitation regime, Part III of the CSSF Circular clarifies that a TCF is responsible to assess whether the investment service it provides to a Luxembourg client is provided at the client’s own exclusive initiative. Such assessment must be conducted on a continuous basis and for every service, taking into account ESMA’s Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics.
The business model selected by TCFs to access the Luxembourg market is driven by the types, number and geographies of the clients they service or intend to service. The national cross-border regime based on national equivalence is only available to TCFs from a list of countries which is subject to changes and is likely to be extended to the United Kingdom in case no satisfactory trade agreement is reached with the EU.
The EU MiFIR cross-border regime may come as an alternative option in the near future but remains subject to EC equivalence decision, which have to be taken.
Third-country business models and access to EU clients