MiFID II and its Eventual Impacts on Turkey

The financial crisis of 2007–2008, which is considered by many economists to have been the worst since the Great Depression of the 1930s, has exposed weaknesses in the transparency of the financial markets. In order to restore investor confidence, strengthen transparency, and improve the functioning of the internal market for financial instruments, the European Union (“EU”) has started to draft a new regulatory framework for financial markets following the financial crisis. After seven years in the making, the Markets in Financial Instruments Directive II 2014/65/EU, and Markets in Financial Instruments Regulation 600/2014 (hereinafter together referred to as the “MiFID II”) entered into force on January 3, 2018.

As outlined, above, the new legislation includes both a directive and a regulation. While the regulation has a direct effect within the EU, the directive is to be applied by the member states in national law where there may be national discretion. This article aims to focus on the key aspects of the MiFID II and its eventual impact on third country firms i.e. on Turkey.

Scope of Application

MiFID II affects stock, bond, commodity and derivative markets, and
everyone who works, trades or invests in those markets, i.e. banks, exchanges,
trading venues, hedge funds, brokers, pension funds, retail investors, and fund
managers across the EU. Moreover, some aspects of the MiFID II are
extra-territorial.

For instance, the equivalence rule allows third country investment
firms to operate in member states on similar terms like an EU investment firm.
The following criteria should be met for the equivalence rule to apply: (i) third country investment firms must
be authorized and be subject to effective supervision in their home country in
respect of the provision of the relevant service; (ii) cooperation arrangements must have been entered into between
the European Securities and the Markets Authority (“ESMA”) and the third
country supervisory authority which, in particular, relate to coordination of
supervisory activities and exchange of information; and (iii) the European Commission must have adopted an ‘equivalence
decision’ upon the ESMA recommendation stating that the legal and supervisory
arrangements of the third country ensure that its investment firms comply with
legally binding prudential and business conduct requirements of equivalent
effect to MiFID II. Member states may, however, require a branch to be
established in their respective jurisdictions where firms are dealing with
retail customers.

In addition, these firms may be indirectly impacted in their
dealings with business partners that are obliged to comply with the MiFID II.

Investor Protection

Independent Investment Advice and Ban of Inducements

MiFID II draws distinction between the provision of investment
advice on an independent basis, and the provision of investment advice on a
non-independent basis. Where an investment firm informs the client that
investment advice is provided on an independent basis, that investment firm
shall assess a sufficient range of financial instruments available on the
market that must be sufficiently diverse with regard to their type and issuers
or product providers to ensure that the client’s investment objectives can be
suitably met, and must not be limited to financial instruments issued or
provided by: (i) the investment firm,
itself, or by entities having close links with the investment firm; or (ii) other entities with which the
investment firm has close legal or economic relationships, such as contractual
relationships, so as to pose the a risk of impairing the independent basis of
the advice provided, and not to accept and retain fees, commissions, or any
monetary or non-monetary benefits paid or provided by any third party or a
person acting on behalf of a third party in relation to the provision of the
service to clients. Minor non-monetary benefits that are capable of enhancing
the quality of service provided to a client, and are of a scale and nature such
that they could not be judged to impair compliance with the investment firm’s
duty to act in the best interest of the client must be clearly disclosed and
are excluded from that point onward.

Research Unbundling

According to this rule, research provided by any third party to an
investment firm within the EU shall be regarded as an inducement and subject to
the above-mentioned ban, unless the research is either directly paid from the
EU investment firm’s own funds, or paid from a separate research payment
account funded by a research charge to individual clients. In this context,
firms should not accept research for free.

Consequently, the business partners within the EU may roll out new
policies regarding
the provision or receipt of research and other services due
to the unbundling rule that the MiFID II brings.

Best Execution Requirements

MiFID II imposes best execution requirements on the markets wherein
the transactions are executed at and on the firms that execute orders on behalf
of their investors. When executing orders, investment firms should take all
sufficient steps to obtain the best possible result for their clients taking
into account price, costs, speed, likelihood of execution and settlement, size,
nature, or any other consideration relevant to the execution of the order. The
firms must publicly disclose best execution data related to their pricing
structures and disclose prescribed information on commissions, execution costs,
and research-related expenses to their clients. Even third country firms are
not directly subject to the best execution requirement, and non-compliance with
this requirement provides a competitive disadvantage. Revised policies
complying with the best execution rule should also be expected from the business
partners within the EU.

Strict Disclosure Requirements

In order to give all relevant information to investors, investment
firms providing investment advice should disclose the cost of the advice, they
must clarify the basis and reasons of the advice they provide, in particular,
the range of products they consider in providing personal recommendations to
clients, and whether they provide investment advice on an independent basis,
and whether they provide the clients with a periodic assessment of the
suitability of the financial instruments recommended to them. The disclosure
requirement is to be fulfilled at least once in a year, not just at the
investment point.

Market Structures

Organized Trading Facilities (“OTF”)

MiFID II has introduced a new trading venue category of organized
trading facility (“OTF”) for bonds, structured finance products, emissions
allowances and derivatives to ensure that the off-exchange markets are
appropriately regulated. The OTF is broadly defined and complements existing
types of trading venues.

Restrictive Regime for Algorithmic Trading and Direct Electronic
Access (“DEA”)

MiFID II aims to regulate risks arising from algorithmic trading
where a computer algorithm automatically determines aspects of an order with
minimal or no human intervention. Third country firms engaging in algorithmic
trading are subject to different regulations in each member state, and in some
cases, they are required to be locally licensed to access an exchange in some
member states. The competent authority of the member state may also require the
investment firm to provide, on a regular or ad-hoc basis, a description of the
nature of its algorithmic trading strategies, details of the trading
parameters, or limits to which the system is subject, the key compliance and
risk controls that it has in place, and details of the testing of its systems.

On the other hand, DEA means an arrangement where a member or
participant or client of a trading venue permits a person to use its trading
code so the person can electronically transmit orders relating to a financial
instrument directly to the trading venue, and includes arrangements that
involve the use by a person of the infrastructure of the member or participant
or client, or any connecting system provided by the member or participant or
client, to transmit the orders (direct market access) and arrangements where
such an infrastructure is not used by a person (sponsored access).

Following an applicable equivalence decision, third-country firms
can offer DEA services to access trading venues within the EU by complying with
the laws of the respective member state. But MiFID II mandates the investment
firm providing DEA to monitor the client closely, ban the provision of DEA to
markets for their clients where such access is not subject to proper systems
and controls. Irrespective of the form of the DEA provided, firms providing
such access should assess and review the suitability of clients using that
service and ensure that risk controls are imposed on the use of the service,
and that those firms retain responsibility for trading submitted by their
clients through the use of their systems, or using their trading codes.

Market Transparency

Order Record Keeping and Transaction Reporting Requirement

MiFID II broadens the scope of transaction reporting and covers all
financial instruments, such as depositary receipts, exchange traded funds,
certificates, bonds, structured finance products, emission allowances,
derivatives and package orders. Moreover, financial instruments traded on OTFs
are also covered. Plus, transactions do not need to have been executed on an EU
trading venue for the reporting requirement to exist. Financial instruments
where the underlying is a financial instrument that is traded on an EU trading
venue shall have to be reported, as well.

Investment firms should also keep records of all their orders and
all their transactions in financial instruments, and operators of platforms are
required to keep records of all orders submitted to their systems. The ESMA
should coordinate the exchange of information among the competent authorities
to ensure that they have access to all records of transactions and orders,
including those entered on platforms that operate outside their territory, in
financial instruments under their supervision. The records shall be provided to
the client involved upon request and shall be kept for a period of five years
and, where requested by the competent authority, for a period of up to seven
years.

Legal Entity
Identifiers (“LEI”)

The LEI is a twenty character alpha-numeric code used as an
international standard for reporting and identifying underlying counterparties
to transactions. All entities subject to the MiFID II need LEI data on all
their business partners to make required transaction reports to their
regulators. Therefore, the investment firms and listed corporations in Turkey
should obtain this number. Applications for an LEI may be made to an accredited
issuer in the home country or an LEI issuer that offers cross-border services. In Turkey, this service is provided by
Takasbank[1].

Conclusion

Since a large number of corporate investors that invest in Turkey are
established in the EU, there may be changes in commercial behavior. Therefore,
even the investment firms and listed corporations in Turkey are not directly
subject to MiFID II, and those adapting to this new framework shall provide a
competitive advantage.

Regarding the extra-territorial application and third country
assessment of the MiFID, Turkey still needs to meet the equivalence rule. In
this manner, Capital Market Law No. 6362, prepared in accordance with the MiFID
I and ESMA announcement on the equivalency of Turkish share prospectuses[2],
may be taken into consideration.

(First published on the website of Erdem&Erdem Law Office in March 2018: http://www.erdem-erdem.av.tr/publications/newsletter/mifid-ii-and-its-eventual-impacts-on-turkey/) 

[1] https://www.gleif.org/tr/about-lei/get-an-lei-find-lei-issuing-organizations (Access date: 30.03.2018).

[2] https://www.esma.europa.eu/press-news/esma-news/esma-assesses-turkish-laws-and-regulations-prospectuses(Access date: 30.03.2018).