MiFID II Technical Standards: Safeguarding of client financial instruments and funds
The new MiFID II and MiFIR regulatory framework seeks to provide an updated harmonised legal framework to govern requirements relating to investment firms, regulated markets, data reporting service providers, and third country firms providing investment services or activities in the European Union (EU). A recently released delegated directive sets out rules governing the safeguarding of financial instruments (FIs) and funds belonging to clients (Chapter II), product governance requirements (Chapter III), and also rules relating to inducements (Chapter IV), i.e. the provision or reception of fees, commissions, or any other monetary or non-monetary benefits.
With regards to the safeguarding of FIs and funds, investment firms are required to keep records and accounts that enable them to distinguish assets held for one client from assets held for other clients or their own assets, at any time and without delay. These records must be sufficiently accurate to enable them to be used as an audit trail, and investment firms must conduct reconciliations between internal accounts and records and those of any third party asset holders on a regular basis. Investment firms are also required to ensure that any client FIs deposited with a third party are separately identifiable, and also that any client funds deposited with a third party institution (i.e. central bank, credit institution, bank authorised in a third country, or qualifying money market fund) are held in separately identifiable accounts.
MiFID II Technical Standards
Investment firms are also required to exercise all due skill, care and diligence in the selection, appointment, and periodic review of third party institutions in which they deposit client FIs or funds. Whilst investment firms are prohibited from using title transfer collateral arrangements (TTCAs) with retail clients, investment firms are not prohibited from concluding TTCAs with non-retail clients. Consequently, investment firms are required to demonstrate the appropriateness of TTCA for non-retail clients, they must document the use of TTCA, and they must disclose the risks involved and the effect of TTCA on the client’s assets.
Investment firms that are ‘manufacturing’ FIs must comply, in a way that is appropriate and proportionate, with a broad range of requirements, taking into account the nature of the FI, the investment service, and the product’s target market. By way of example of a few of these new requirements, the manufacturing of FIs must comply with requirements relating to the proper management of conflicts of interest (including remuneration); it must not adversely affect end clients; and it must not lead to problems with market integrity (i.e., by enabling firms to mitigate and/or dispose of firm risks, or by exposure to the product’s underlying assets, where the investment firm already holds the underlying assets on own account). There are also new rules on inducements, inducements relating to investment advice on an independent basis or portfolio management services, and inducements in relation to the provision of research.
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 Directive (2014/65/EU).
 Regulation (EU) No 600/2014.
 Commission Delegated Directive (EU) of 7.4.2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any other monetary or non-monetary benefits.
 This obligation requires investment firms to ensure that separate identification is facilitated by differently titled accounts on the books of the third party, or other equivalent measures achieving the same level of protection.
 Directive 2014/65/EU, Article 16(10).
 The manufacturing of FIs incorporates the creation, development, issuance, and/or design of FIs.
 Fees, commissions, or non-monetary benefits are considered to be designed to enhance the quality of a relevant service to a client if a number of conditions are met. Fees, commissions, or non-monetary benefits are not considered acceptable if the provision of relevant services to a client is biased or distorted as a result of the fee, commission, or non-monetary benefit.
 Investment firms providing investment advice on an independent basis or portfolio management, must return to clients any fees, commissions, or any monetary benefits paid or provided by any third party (or a person acting on behalf of a third party) in relation to the services provided to that client, as soon as reasonably possible after receipt. All fees, commission, or monetary benefits received from third parties in relation to the provision of independent investment advice and portfolio management must be transferred in full to the client.
 Where third party firms provide research to investment firms providing portfolio management or other investment or ancillary services to clients, such research will not be regarded as an inducement if it is received in return for specified reasons, e.g., direct payments made by the investment firm out of its own resources.