Prudential regulation of investment firms in the European Union (ZIFO nr. 32) 2021/2.1:2.1 Investment firms in European legislation

Prudential regulation of investment firms in the European Union (ZIFO nr. 32) 2021/2.1

2.1 Investment firms in European legislation

Documentgegevens:

mr. drs. B.J. Nieuwenhuijzen, datum 01-02-2021

Datum: 01-02-2021
Auteur: mr. drs. B.J. Nieuwenhuijzen
JCDI: JCDI:ADS262316:1
Vakgebied(en): Financieel recht / Bank- en effectenrecht
Financieel recht / Financieel toezicht (juridisch)

23. Although expressions such as “broker”, “asset manager”, “securities intermediaries”, “market intermediaries” and “investment intermediaries” are used in the media, by international organisations such IOSCO and in academic literature,1 these expressions are not defined in European legislation. European legislation uses the expression “investment firm” to encompass a very broad spectrum of activities, services, business models and types of enterprises. The “[investment services] sector engages in a vast array of activities and services which […] range from the traditional suite of advice, asset management, brokerage, dealing/ market-making, and underwriting activities to trading venue operation, data reporting, and benchmark construction services. It is populated by a multitude of actors ranging from multifunction credit institutions which provide investment services and multi- and single-function investment firms, to commercial firms which engage in investment services incidentally to hedge commercial risks, and to specialist algorithmic dealers”.2 When using the term “bank” or “insurer” one has a clear idea of the type of enterprises or business activities that are meant, which is usually not the case when using the term investment firm.3 The business models of investment firms and banks can vary, and banks can also have activities similar to those of investment firms, certainly if it concerns a bank with a “universal” business model.4

24. The prudential regulation of investment firms in Europe has, therefore, traditionally been closely linked with the prudential regulation of banks.5 One may question whether a prudential framework designed for international banks6 is indeed the best regime to measure and mitigate the specific risks of investment firms. This Chapter will explore which types of activities will lead a firm to be classified as an “investment firm” under European legislation and will then highlight for each activity what types of (financial) risks can be expected when carrying out these activities. The International Organisation of Securities Commissions (IOSCO)7 envisaged that prudential regulation of investment firms should cover both the risk to the firm itself and the risk to financial stability. The (financial) risks identified in the following section will cover both of these aspects. The global aspects of investment firm regulation will be discussed in Chapter 5, where this study will go into further detail on the IOSCO principles.

25. When speaking about investment firms in the European context and without any common usage of this expression by the public or in the media,8 one must first refer to the legal definition of investment firms applied in European legislation. An investment firm is defined in MiFID II as “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”.9 These investment services or activities are subsequently defined as “any of the services and activities listed in Section A of Annex 1”10 of MiFID II and include the following activities11:

1.: Reception and transmission of orders in relation to one or more financial instruments
2.: Execution of orders on behalf of clients
3.: Dealing on own account
4.: Portfolio management
5.: Investment advice
6.: Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis
7.: Placing of financial instruments without a firm commitment basis
8.: Operation of Multilateral Trading Facilities
9.: Operation of an Organised Trading Facility

26. The European legislator incorporated these investment services and activities into MiFID II12 in order to have “the legal framework of the Community […] encompass the full range of investor-oriented activities”.13 With these investment services and activities, the European legislator tried to encompass all the various activities related to investing in financial instruments14 within the European legislative framework. Any firm whose regular occupation or business is performing one of these investment services or activities qualifies15 as an investment firm within the legal definition applied in the European Union.16

2.1.1 How to assess the risks of investment firms?2.1.2 Investment services and activities 2.1.3 Ancillary services in MiFID 2.1.4 Framework for assessing prudential risks of investment services and activities 2.1.5 Exemption to the scope of MiFID 2.1.6 Commodity derivative dealers 2.1.7 AIFMD and UCITS authorised firms performing investment services

Toon alle voetnoten

Voetnoten

Voetnoten

See for instance the works of Niamh Moloney who uses these expressions in her books on EU securities regulation. See Moloney, N., “EU Securities and Financial Markets Regulation: Third Edition’, Oxford University Press, Oxford, 2014 (Moloney (2014).

See Moloney (2014), page 321.

See also See Allen, F., Santomero, A.M., ‘What do financial intermediaries do?’, Journal of Banking & Finance, no. 25, 2001, 271-294.

“Universal banking model” refers to the business model of a bank that offers a wide spectrum of banking services, funded by retail and wholesale deposits and including significant lending business, merchant and investment banking and the provision of securities’ markets intermediary roles.

See for a discussion on the differences between banking regulation and securities regulation Allen, F., Herring, R., ‘Banking regulation versus securities market regulation’, Prepared for the Asian Development Bank Institute/Wharton Financial Institutions Center Conference on Financial Regulation, Securities Markets versus Banks, and Crisis Prevention, July 26-27 2001, Tokyo.

See: (1) Paragraph 7 on page 2 of Basel I, Basel Committee on Banking Supervision, ‘Basle Capital Accord: international convergence of capital measurement and capital standards’, July 1988, updated to April 1998. (2) Paragraph 9 on page 3 of Basel II, Basel Committee on Banking Supervision, ‘International Convergence of Capital Measurement and Capital Standards: A Revised Framework·, November 2005. See also Chapter 5 for a further discussion on the Basel standards.

See Sections 4 and 14 of IOSCO, Objectives and Principles of Securities Regulation, 1998 for the reasons and objectives of prudential supervision for investment firms as defined by IOSCO. In Chapter 5 these will be discussed in more detail.

As discussed, instead of the term “investment firm” other expressions such as “broker”, “dealer”, “broker/dealer” or “asset manager” are commonly used.

Article 4(1)(1) of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173, 12 June 2014, pp. 349–496 (MiFID II).

10.

Article 4(1)(2) of MiFID II.

11.

See Chapter1.2.4 of Busch, D., Lieverse, C.W.M (eds), ‘Handboek Beleggingsondernemingen’, Wolters Kluwer, Deventer, 2019 for a technical description of the various investment services and activities.

12.

One should realize that with every reiteration of the applicable directives on investment services the number of investment services or activities has increased. The Investment Services Directive of 1993 contained five investment services in its Annex, namely “transmission of orders”, “execution of orders”, “dealing on own account”, “portfolio management” and “underwriting”. The first reiteration of the MiFID in 2004 then added “investment advice”, “placing of financial instruments without a firm commitment” and “operating an MTF”, and MiFID II subsequently added a ninth investment activity of “operating an OTF”.

13.

See Recital 2 of Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, OJEU L 145, 30 April 2004, p. 1 (MiFID I).

14.

For investing in Investment Funds (or collective portfolio management), the European legislator established two separate regimes, the AIFMD and UCITS.

15.

Notwithstanding the exemptions in Articles 2 or 3 of MiFID, or Articles 2 and 3 of MiFID II to the application of both directives on firms providing certain investment services or activities.

16.

See Elderfield, M., (Eds.) ‘A practitioner’s guide to MiFID’, first edition, City & Financial Publishing, 2007 for a detailed introduction to the requirements of MiFID.