The MiFID II Review - HMT Consultation on MiFID II

Introduction

HM Treasury ("HMT") has published a consultation paper on the UK's approach to the transposition of the MiFID II Directive (2014/65/EU) into national law. The consultation follows hotly on the heels of the first discussion paper issued by the FCA (and which we examined in our briefing here). At just under 50 pages the HMT paper is, in MiFID II terms, a deceptively short and concise document (excluding the legal drafting). HMT has set out questions and (possible) answers to policy questions that run the full spectrum of MiFID II activities (and even on one MiFID I point, binary options). It asks for comment in relation to these issues and, in particular, the legal drafting set out in the annexes. The specific areas discussed in the HMT consultation are set out below and we examine each of these in turn in more detail:

• Third country regime;
• Data reporting services;
• Position limits for commodity derivatives and reporting;
• Unauthorised persons;
• Structured deposits;
• Power to remove board members; and
• OTFs.

These areas are discussed separately below as each throws up distinct issues.

1. MIFID II TRANSPOSITION APPROACH

In terms of underlying philosophy, the UK's approach will follow the pattern and process established during the MiFID I transposition. Broadly (and with some notable exceptions) this is based on the following principles:

• Continuity: changes to the current UK legislative regime required by MiFID II will be enacted by amendments to FSMA, the RAO and related statutory instruments. What this means is that MiFID II will not be transposed into a standalone act or piece of legislation.
• Copy out: transposition should mirror as closely as possible the original wording of a directive and go no further than the requirements of MiFID II, except where there is a clear justification and authority to do otherwise. As noted below, the UK has found a number of areas that give rise to such a justification (such as structured deposits and powers to remove board members).
• Transparency: the consultation states that "the UK is providing draft secondary legislation as early as possible to provide stakeholders with the opportunity to review and comment."

2. THIRD COUNTRIES

The headline here is that UK has decided not to 'optin' to the Article 39 MiFID II Third Country regime (the "Article 39 Regime"). To understand this position fully, we have to take a few steps back.

The position in relation to third country firms' access to EU markets, under MiFID I, is largely left to Member States' national law. This has given rise to a rather idiosyncratic system, whose frustrating quirks will be all too familiar to third country firms who have sought to do business in the different European Member States. Currently, as is set out in the consultation, there are three ways a firm can conduct investment business in the UK:

• through the establishment of a UK subsidiary that is authorised by the FCA (or the PRA);
• a UK branch (where such a firm has a permanent place of business in the UK); or
• on a cross-border basis through relying on the various exclusions set out in UK legislation (principally, the Overseas Persons Exemption at article 72 RAO)

The list given by HMT above, assumes that the activity occurs in the UK. The question of when an activity takes place in the UK is an altogether more complex one and appears outside of the consultations area of concern. MiFID II changes the above position by creating a bifurcated regime based on client classification. Title VIII MiFIR sets out a pan-European position in relation to third country services provided to eligible counterparties and professional clients. In theory this regime significantly liberalises access to European markets and will be good for business. In practice much depends on the detail. In particular, how flexible the European Commission will be in providing "equivalence decisions" under Article 47 MiFIR.

Separately, MiFID II sets out the third country regime in relation to retail and elective professionals (see Article 39). Here (given the nature of the clients) the regime is less liberal requiring physical presence. The question at the heart of the HMT conclusion is whether the UK wishes to opt into this third country regime (as Member States have this discretion to do so).

Article 39 states that Member States:

“may require that a third country firm intending to provide investment services or perform investment activities with or without any ancillary services to retail clients or to professional clients within the meaning of Section II of Annex 2 in its territory establish a branch in that Member State”.

The key elements to the Article 39 Regime are:

• it applies to retail and elective professional clients;
• if opted into it would require the UK to adopt the branch requirements set out at article 39(2) MiFID II (some of which are potentially problematic to administer, such as the requirement to actively ensure tax treaties are effective);
• there is also a read across to MiFIR which states that where a branch has been established under Article 39, that firm (from an equivalent jurisdiction) has the right to passport services in relation to eligible counterparties and professional clients (although not retail) across Europe.

The above MiFID II third country regime is the result of hard fought negotiating and compromise amongst the Member States. The Commission's position was significantly revised by the Council's General Approach that was then modified in trilogue discussions. The outcome set out above is the result. The Commission retained power over wholesale investment activities via its equivalence decision (set out in MiFIR) while Member States retained control of the process for permitting third country access to retail/elective professional clients - albeit within the context of harmonised European requirements (for those that enjoy following the history of negotiations the Danish President Progress Report, n122 and Council General Approach, n28 Arts 51- 45 are worth reading).

In light of this why, then, has a decision been made by the UK to opt out of the article 39 MiFID II regime?

A number of explanations could reasonably be given. One conclusion that might be drawn is that the political climate is such that "opting in" to a European harmonized branching regime (even one that contains little substantive role for ESMA or the Commission) is unattractive to the Government from a public relations point of view. Putting political guess-work aside, there are some substantive and technical reasons given for not opting into the Article 39 regime, which are set out in the consultation:

• the current regime appropriately balances flexibility and openness with investor protection concerns. Put differently, the position is "if it isn't broke, don't fix it". There appears to be something to be said for this, in the sense that the UK regime has much to recommend it when compared to its continental counterparts (at least from the perspective of conducting cross-border business). The overseas person exemption is one such example. The question remains though, how much would opting into the Article 39 regime actually damage this flexibility? Ultimately this is an economic question and those with data should not be shy about sending it to HMT.
• From a legal perspective, one point that stands out above others is how the Article 39 regime would narrow the current system of access. In particular, the “overseas persons” exclusion permits third country firms to solicit UK clients where this is the result of a "legitimate approach". Broadly, the meaning of "legitimate approach" is similar to those exemptions found in the FSMA Financial Promotions Order 2005 (“FPO”) and permit third country firms to carry out business with, for example, certified high net worth individuals and previously overseas customers – both of which might be categorised as retail clients under the UK conduct rules transposing MiFID. On one view, therefore, article 39 does not permit such solicitations to be made to retail/elective professional clients without the establishment of a branch. Whether this is necessary (in terms of increasing investor protections) when balanced against the cost appears to be in HMT's mind.

Third Country Regime: Alternative Options

One point not discussed in the consultation (understandably perhaps given the UK is currently minded not to opt in) is how Article 39 MiFID II could be interpreted in a more flexible way than simply "opt-in" / "opt-out". It is possible for example, to read it as permitting Member States to apply the Article 39 criteria on a selective basis. For example, the UK could retain its current system as the norm, but designate certain territories for which the Article 39 regime applies. If this were possible it would permit certain business (from specified jurisdictions) to continue but also provide the flexibly to apply the branch conditions to other jurisdictions. Alternatively, it could retain the current system and the Article 39 regime simultaneously, but making the latter a voluntary 'opt-in' for firm where they wish to do so (they might wish to do so, for example, to take advantage of the MiFIR passport). It is possible that lobbying to take this more flexible approach will occur, but it will only succeed if the political will is also present (see above).

3. DATA REPORTING SERVICES

The consultation sets out a draft statutory framework governing the new Data Reporting Services ("DRS") that, under MiFID II, are set out at Annex 1, Section D and are the following:

• Approved publication arrangement ("APA");
• Approved reporting mechanism ("ARM"); and
• Consolidated tape provider ("CTP").

The Background to Data

The Commission in its MiFID I review (2011) set in motion a reform agenda that aimed to improve the quality and reduce the cost of execution/transparency data. One particular concern was how the removal of the “concentration rule” and the fragmentation of liquidity through the establishment of competing trading venues, had led to a situation where there is insufficient data consolidation. In response, MiFID II has introduced a panoply of measures designed to target this perceived market failure, one of which is the requirement that Data Reporting Service Providers ("DRSP") be authorised by Member States (subject to certain derogations) (see Article 59 MiFID II). How to transpose this requirement is not as straightforward as it appears.

Broadly, HMT have decided that rather than embed the obligation at Article 59 MiFID II through the Regulated Activities Order 2011, the Government will create a separate regulation (the Data Reporting Regulation, "DRR") that applies to entities which offer these services. The primary rationale for this appears to be twofold:

• trying to embed these new services within the RAO would be a complex legal task given the inter-relationships with FSMA; and relatedly
• these services are both in nature and concept separate from the other regulated activities that are set out in MiFID (at Annex 1, Section A).

The upshot of (a) and (b) is therefore the DRR, a separate regulation that sets out the obligations of DRSPs and the powers of the FCA in relation to such entities.

This regulation is in the main copy out of the MiFID II text (that of Title V MiFID II) and imposes the specified organisational and managerial obligations set out in MiFID II on the DRSPs. As this forms part of the level 1 text, market participants (whether they consider such provisions useful or otherwise) may find it relatively uncontroversial in terms of policy substance. However, there are at least two problematic areas (to which HMT is looking for comment in relation to), these are:

• the nature of the CTP regime; and
• the FCA powers in relation to these new data reporting services providers (DRSPs)

CTP Regime

The CTP (like many aspects of MiFID II) is the outcome of Member State compromise. At the time of the Commission's review, discussions were had over the most effective way to achieve consolidated data. The options included a public non-profit making monopoly provider (that drew its inspiration, if not its detail, from the US model), or a commercial monopoly and what might be termed (for want of a better expression) a market model. The outcome of negotiations was the victory of the market model, and a regulatory framework was inscribed in MiFID II that (perhaps optimistically) envisages such entities competing against one another in the supply of consolidated data to the market.

The CTP MiFID II regime is for post-trade data and will initially be applied to the equity and equity-like instruments (questions regarding how it will apply to the non-equity market are for another day). However, one of the most significant consequences of being a CTP is that the service has to be provided on a “reasonable commercial basis” (this being perhaps one of the first examples of contemporary price regulation in the securities markets). Notwithstanding this CTPs are required to make data available free of charge after 15 minutes.

The problem in transposition terms is what the term CTP actually captures. As HMT itself notes it is important that there is certainty as to what entities fall within the DRRs, not least because such entities will be subject to certain obligations and sanctions. In this respect, most of HMT's transposition headaches turn on the definition of CTP provided by the level 1 text, or rather lack of it.

CTP Definition

“a person authorised under this Directive to provide the service of collecting trade reports for financial instruments listed in Articles 6, 7, 10, 12 and 13, 20 and 21 of Regulation (EU) No 600/2014 from regulated markets, MTFs, OTFs and APAs and consolidating them into a continuous electronic live data stream providing price and volume data per financial instrument.”

The CTP definition throws up the following transposition issues:

• circularity: who is to be authorised as a CTP? The answer appears to be a person who is authorised as a CTP;
• what does consolidation mean? Does it mean that in respect of relevant data an entity has to consolidate 100% of the market? Or would, for example, 95% be adequate?
• is the regime elective or mandatory?

In terms of the above questions there is both advantage and disadvantage in being the 'first mover'. One assumes that there is no settled understanding across Europe, otherwise why would the Government consult on the issue? Most of the answers to these questions, however, will be pan-European in nature and therefore it is likely that discussions are happening on these topics in private with the Commission as well as in public through the consultation.

Turning to the first issue, that of circularity, the Government has proposed a simple copy out. It is far from clear, however, whether this achieves the certainty that they aim for. One will look at Regulation 9 of the DRRs that requires a CTP to be authorised and then turn to the relevant definition and be forgiven for wondering whether or not they are caught.

It may be better from a legal certainty perspective to depart from a copy out approach and borrow the definitional methodology used elsewhere in MiFID II i.e. define a CTP in the same way an investment firm is defined:

“any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis”.

Where a person meets this criteria and is not otherwise exempt it will require authorisation as an investment firm, authorisation is therefore a consequence rather than a part of the definition. If it is the UK's view that the regime is mandatory then modifying the definition in this manner would appear to have merit from a legal certainty perspective. This is suggested as an alternative in the consultation paper and it will be interesting to see respondents' comments on the topic.

The remaining two questions are perhaps more controversial. On one view the European Commission has bound the hands of Member States by stating that consolidation means 100%. Whether the consequences of this were fully understood is unclear. It is, for example, a regulatory consequence that those who provide data on 99% of the market fall outside of the regulatory obligations that would otherwise be imposed if they added an additional 1%. Although this appears rather arbitrary, it is certainly no more arbitrary than many other elements of the MiFID II text (the 4 and 8% double volume cap limits spring to mind). Further, the underlying public policy rationale for requiring a CTP to provide 100% data coverage is for market competition to take place on the basis of quality of service to clients “rather than breadth of data covered” (recital 117 MiFID II). A reasonable policy position perhaps, whether it amounts to little more than optimism and good intentions remains to be seen.

On the third and final issue of whether the regime is mandatory, the consultation states that: “The government recognises that views have been expressed that the definitions (set out in MiFID II) have been structured in this way to provide that the requirement to be authorised is formally elective for DRSPs.” To this the Government gives a rather empathic answer: “the government does not agree with this view and considers that it is clear that a person must be authorised in order to provide a DRS (see in particular Article 59 MiFID II).” This resolute statement is however weakened slightly by its invitation for comments “on this point and on its interpretation of Title V of MiFID II,” which suggests that there might at least be some internal doubt (whether this is inside HMT or between HMT and other relevant bodies, such as the FCA or parts of industry we can only speculate). Ultimately, the point is that MiFID II level I provides only the barest of bones in answering the question whether the CTP regime is elective or mandatory.

Whatever the outcome of the mandatory/elective debate, it might turn out to be no more than academic. Will any market participant want to increase its coverage to 100% so as to be a CTP? Whether a CTP emerges depends on how much credence the market places on a) the label and b) the ability to passport such services under article 60 MiFID II. The passport is likely to give rise to another set of legal and policy issues, such as what happens if a Member State takes a different approach to the UK in terms of what consolidation means – will that CTP be allowed to passport into the UK?

A harmonised approach clearly needs to be worked out and presumably there are discussions currently taking place between Member States and the Commission on the point. However, more generally HMT appears to envisage that applications for CTP status will be a trickle rather than a deluge, as it specifically flags the ability of ESMA to review the situation by 2019: “if it is found that the CTP system has failed to provide the necessary information, the Commission has the ability to request that ESMA operate a tender process leading to a single pan-EU CTP provision being implemented by the Commission.”

DRSPs and FCA Powers

One of the reasons for separating DRSPs from the RAO is to reduce complexity and ensure that some of the read across provisions of FSMA do not apply to such services. Nevertheless, a regime that creates obligations requires administration and enforcement powers and the Government has applied a number of the FCA's investigatory powers to this end. In particular, the ability of the FCA to require information and carry out investigations is required under Article 69 MiFID II. These necessary powers and enforcement provisions are specified at Part 6 of the DRRs and include, inter alia, the following being applied to DRSPs:

• section 165 FSMA (the power to require information);
• section 166 FSMA (reports by skilled persons);
• section 166A FSMA (appointment of skilled person to collect and update information);
• section 167 FSMA (appointment of persons to carry out general investigations); and
• section 168 FSMA (appointment of persons to carry out investigations in particular cases).

It appears to be the Government's position that these powers are required by MiFID II, particularly under Article 69. However, it also suggests applying provisions – similar in nature – to section 89 (Misleading statements) and section 90 Financial Services Act 2012 (Misleading impressions) to DRSPs. The concern seems to be that because investment firms/credit institutions can operate a DRSP there might be an incentive for such entities to create misleading impressions, through the manipulation/distortion of post-trade data reporting (the revelations concerning LIBOR may underpin such policy suggestions). However, one gets the sense that this is perhaps a point that the Government is not overly concerned with as it suggests that such rules would be duplicative (given the conflict of interest obligation of a DRSP should prevent such behaviour).

4. POSITION LIMITS, MANAGEMENT AND REPORTING

The Government has provided a standalone regulation that largely copies out the MiFID II requirements in relation to position limits, management and reporting (section 57 and 59 MiFID II). The draft regulation is expected to receive particular attention from those who are concerned with this area and will give rise to a number of issues. This will not come as a surprise to the HMT or the UK regulators who, one gets the impression, do not hold the position limit regime in particularly high regard. This being the case the Government has diligently copied out the provisions to achieve compliance with its European transposition obligations. Despite the copy out approach there are a few points of interest, especially given this is the first time the UK Government has pronounced on the regime since its inscription into level 1.

The first point of note is what HMT has to say regarding the issue of territoriality. The position limit regime is full of Gordian knots and the precise perimeter of its application, in terms of territoriality, is one of the most thickly tied (the vexed issue of territoriality in other contexts, such as EMIR, will no doubt be in readers' minds). The consultation sets out a framework for thinking about the issue. In particular, it is stated that in considering the scope of the position limit regime there are two levels to consider.

The first relates to the nature of the "contract".

• For limits set by the FCA this will include commodity derivatives traded:
  • Only on UK trading venues and economically equivalent OTC contracts; and
  • On contracts traded on UK trading venues and the same contracts traded on trading venues in other EEA countries that are the same as contracts traded on UK trading 22 venues and economically equivalent OTC contracts where the UK is the most liquid market for those contacts.
• Second, the persons with positions to whom the limits might apply. In respect of the limits which the FCA will be required to set, the limits apply to any person regardless where they are situated, provided there is a link to a contract traded on a UK market. This means that where two persons in a third country with no link to the UK trade economically equivalent OTC contracts the limits do not apply.

The words highlighted above, will (in due course) need to be clarified. Many in the market will be left wondering what constitutes such a 'link'? Such questions, on one view, are better left to guidance or, at least, rules rather than legislation. It is also reasonable to query quite how enforcement will be effective between those in third countries. Although this will in some cases be straightforward, in others it does not overly stretch the imagination to think that there might be complications. Much depends on what is meant by "link" to the UK market. This is important as the FCA's powers here are substantial, permitting it to take action against anyone within its supervisory scope for these purposes, so as to “restrict the size of position that a person may hold in a commodity derivative including by requiring any person to reduce the size of a position held” by issuing a supervisory notice.

A second aspect of the regime that is noteworthy is how it applies to “unauthorised persons". On the face of it the current regime would capture a large swathe of persons involved in non-investment based activity (this is perhaps the unavoidable intention of the level 1 text). Of course, where a position is held by a nonfinancial entity that is objectively measurable as reducing risks relating to commercial activity, then this will sit outside of the regime. Whether this is sufficient comfort to those involved in the commercial production and distribution of commodities is an open question.

5. UNAUTHORISED PERSONS

The narrowing of the MiFID II exemptions set out at Article 2 has been more publicised than the extensions to unauthorised persons set out at Article 1. However, it is the case that (certain) MiFID II provisions apply (in certain circumstances) whether or not you are authorised. A straightforward example is in relation to the position limits regime, but other less straightforward cases exist and have to be transposed by the UK. The sensitivity here is how to apply enforcement powers to these kinds of unauthorised persons; there is a balancing act to be achieved between appropriate transposition of MiFID II requirements while also keeping in mind the public law protections afforded to such persons. The following are the primary classes of unauthorised persons to which HMT have transposed obligations in relation to:

• a person in the UK engaging in algorithmic trading who is not required to be authorised under Part 4A FSMA in order to perform investment services and activities, who is a member or participant of a regulated market or multilateral trading facility, and to whom Article 2(1) a, e, i or j MiFID II applies. This section places a number of obligations arising from Article 17 MiFID II on such firms, including to have systems and controls that are of sufficient quality, do not contribute to disorderly trading and are fully tested. Although it is hard to see (as a matter of practice) who this would catch those who rely on the dealing on own account exemption (Article 2(1)(j)) might conceivably (in some cases) be brought within its scope;
• a person in the UK providing the service of direct electronic access to a regulated market or MTF who is not required to be authorised under Part 4A FSMA (and is a member or participant of a regulated market or multilateral trading facility, and to whom Article 2(1) a, e, i or j MiFID II applies); and
• a person in the UK providing the service of acting as a general clearing member who is not required to be authorised under Part 4A FSMA (and is a member or participant of a regulated market or multilateral trading facility, and to whom Article 2(1) a, e, i or j MiFID II applies).

6. BENCHMARKS

The consultation paper raises an issue regarding whether the FCA's current enforcement powers in relation to benchmarks are sufficient to capture (certain) unauthorised entities. The point is made that the UK regime does not capture all persons with a proprietary right to a benchmark (as set out at Article 37 MiFIR) and to extent that there are persons who are not otherwise caught under the RAO, the FCA will not have sufficient powers to request information or enforce the obligations set out at Article 37 MiFIR. Although, on first analysis, it appears that there is a point here it must be a 'wait and see point'; there is little use in trying to second guess/front run the European-wide Benchmark Regulation (and it is for this reason that the Government presumably have raised it as a question rather than providing drafting).

7. STRUCTURED DEPOSITS

MiFID II brings "Structured Deposits" within the ambit of instruments regulated by it in a rather half-hearted manner. Article 1(4) MiFID II applies specified provisions of MiFID II to investment firms and credit institutions when these firms "sell" or "advise" client in relation to structured deposits. Notably, the Article 5 (Requirement for Authorisation) is absent from this list. However, it is the government's view that in order for the FCA and the PRA to be able to effectively supervise the obligations specified by Article 1(4) MiFID II, certain activities in relation to structured deposits must be brought within the UK regulatory perimeter. The exercise which follows is one of interpreting the words "selling" and "advising" and applying them to UK regulated activities. Reading through the list of what is captured it is clear that a relatively expansive interpretation has been adopted, guided perhaps by the recitals that point to the substitutability of structured deposits with other MiFID II financial instruments. The following activities are proposed to extend to structured deposits:

• Article 21 RAO (”Dealing in investments as agent”)
• Article 25(1) RAO ("Arranging deals in investments”)
• Article 25(2) RAO ("Making arrangements with a view to transactions in investments")
• Article 37 RAO ("Managing investments")
• Article 53 RAO ("Advising on investments")

The consultation document provides reasoning in relation why the words "selling" and "advising" refer back to each of these activities. It is possible, however, to take a different view, at least in relation to some of these activities than the one adopted. In particular, it could be argued that "selling" and "advising" should be construed narrowly and in any event go no further than the terms meaning set out in MiFID II. A literal and narrowly constructed approach would give rise to a list that would not include Article 25(2) that is not a MiFID II activity, cast doubt on the inclusion of Article 37 (given managing is a separate activity to selling) and at least for the purposes of Article 53 RAO limit the activity (insofar as structured deposits is concerned) to where a personal recommendation has been made (the UK activity is wider than the MiFID advisory service in this respect). However, it is clear from some of the reasoning that these points have been considered. Therefore firms that wish to challenge the outcome might therefore consider submitting detailed legal reasons why an alternative outcome is preferable.

8. POWERS TO REMOVE A BOARD MEMBER

It will be of no surprise that MiFID II augments the regulatory powers already available to competent authorities. A specific power is, however, likely to receive more attention than others and has already been the subject area of a separate body of legislation and rules (the Senior Managers and Certification Regime from the 7 March 2016). The provision in question is Article 69(2)(u) MiFID II, which requires that a competent authority has at least the power to “require the removal of a natural person from the management board of an investment firm or market operator”. In this area, various public law caveats and principles will apply and transposition will need to be particularly sensitive to what are termed a person's "fundamental rights" (Recitals 137 and 138 MiFID II).

Broadly there are two options that the Government is considering:

• rely on the existing FSMA powers (“Option A”); or
• create a new standalone power in Part V FSMA to allow the PRA or the FCA to require an institution to remove members of its board, where specific conditions are met (“Option B”)

Although the UK appears to be edging towards a new standalone power, there is a good case for those who think no further action is required. Under FSMA the FCA has the power to modify or remove a relevant person's approval (see section 55L, 55M and also 56 and 63 FSMA). The basic reason the Government does not consider these sections sufficient is that they all involve some element of delay in bringing about the removal or cessation of activities. It is for this reason, that Option B is suggested and is modelled on section 63ZB FSMA that allows the FCA to "pull the plug" (subject to the restrictions set out at 63ZC). The point is taken and the policy rationale that sits behind it is clear; the regulators wish to be able to wield a sharpened sword decisively when they feel the need to. In practice this would mean that a member of a board could be removed with immediate effect subject to a supervisory notice and the ability to challenge at a tribunal. Putting aside possible public law consequences of such actions, the question remains does MiFID actually require this? The words of the relevant section are "require the removal of a natural person" not "require the immediate removal of a natural person". It is suspected that the Government considers it good policy, but not strictly required by MiFID II and therefore a departure from its general approach (i.e. copy out).

9. ORGANISED TRADING FACILITY

The consultation document provides drafting legal text transposing the new OTF trading venue activity (a new section 25DA RAO). There are few surprised here. Helpfully, however, the Amendment Order 2016 allows applications under Part 4A of FSMA for OTF status to be submitted ahead of the application of MiFID on 3 January 2017. Apart from good-planning, this suggests that the FCA is expecting its letterbox to be relatively busy around this time.

This line of pragmatism is extended further by the proposal that certain elements of the regime be left to FCA rules rather than hardwired into the authorisation process (a case in point is how exactly an OTF will notify the FCA that it has secured client consent to engage in matched principal trading in certain instruments).

10. BINARY OPTIONS

The section of the consultation paper on binary options is separate from the UK's obligations to transpose MiFID II. It is a result of a change of position in relation to the classification of binary options (a contract that pays a fixed sum if the option is exercised or expires in the money, or nothing at all if exercised/expires out of the money). At the time of MiFID I it was considered that these options were more akin to gambling than investments and therefore considered to sit outside of the RAO framework and were supervised by the Gambling Commission. This rather neat explanation is somewhat muddied by the counter-intuitive current position where the FCA formally regulates sports spread betting. Whether Manchester United win next weekend is something that you would not expect the average financial regulator to be overly concerned with. Following this observation through there is the hint of concern that in bringing binary options into the regulatory perimeter the FCA will be burdened with yet more seemingly non-financial instruments to regulate.

To see this one has to look carefully at the questions asked by the consultation paper. The basic proposed position is that binary options where they relate to specific underlying's will be considered MiFID financial instruments. This seems understandable and amendments have been made to Article 85 RAO to ensure this happens, by applying this article to instruments covered by paragraphs 4 to 7 and 10 of Section C of Annex 1 to MiFID (or where Article 38 of the Community Regulation 1287/2006/EC applies). Again the logic behind this seems sound, but the problems presumably start arising in relation to instruments relating to 10 Section C of Annex 1 MiFID, which includes climatic variables. This would leave the FCA not only concerned with the sporting section of the newspaper but also the weather. Anyone want to place a bet (sorry, we mean an investment) on whether the summer of 2015 will be a long one?