2.1.5 Exemption to the scope of MiFID

114. It is important to note that not all firms providing investment services or performing investment activities, and thus meeting the definition of investment firm under MiFID, are subject to the provisions of MiFID. MiFID contains several exemptions1 to the scope of firms’ subject to MiFID. These exemptions result in firms which do perform an investment service or investment activity being excluded from the application of MiFID. They meet the definition of investment firm but are placed outside the application of MiFID by the European legislator and therefore do not have to comply with the provisions of MiFID. This study will not describe the exemptions in full detail but will give an elaboration on the most relevant exemptions for determining the prudential risk profile of the investment firm sector and the changes to these exemptions made in MiFID II.

115. Article 2 of MiFID contains 14 exemptions to the scope of MiFID and thus 14 types of firms which do meet the definition of investment firm, but to which the European legislator has, for various reasons, decided to not apply the provisions of MiFID. The non-application of the MiFID II provisions to these exempted firms means that, the prudential requirements2 applicable to all non-exempted investment firms do not apply as well. Generally speaking, Article 2 of MiFID exempts, amongst others, those firms which perform investment services or activities on an incidental basis,3 which do so exclusively for their parent undertaking or other undertakings within the same group,4 or which perform investment services or activities solely in relation to commodity derivatives.5 MiFID also exempts those firms which only perform the own-account dealing investment activity, unless, for instance, these firms also qualify as market makers or deal on own account outside a regulated market or MTF, or if they are involved in high-frequency trading.6

116. These firms are exposed to the prudential risk associated with the respective provision of investment services and activities as discussed in Section 2.1.2 above. However, the application of the provisions of MiFID, which itself primarily contains rules governing market conduct, were not considered necessary for firms providing investment services and activities in these circumstances. The non-application of the market conduct provisions of MiFID means that, the prudential requirements are similarly not applicable, as the cross-references to the prudential requirements are included in Article 12 of MiFID and as such fall within the provisions which are not applicable to firms covered by one of the exemptions of Article 2 of MiFID. The linkages between the application of prudential requirements and the application of MiFID will be further discussed in Chapter 7.

117. One may question whether a firm dealing on own account, either in an incidental manner or for other group entities, should be exempted from prudential supervision, as the financial risks of that firm’s trading book do justify some form of prudential supervision, given the risks associated with that activity such as the market risks for the financial instruments traded by that firm and the operational risks associated with that trading activity, as discussed in Section 2.1.2 on dealing on own account. The scoping of MiFID II appears to be too narrow as the requirements included in MiFID II are intended to increase the protection for clients of investment firms. Not applying the MiFID II requirements to entities providing the investment services only to group entities seems reasonable when looking at this from the perspective of clients as defined in MiFID II. However, as discussed in Section 2.1.2 in the paragraphs concerning dealing on own account, for prudential regulation, a broader scope of clients then those defined in MiFID II seems more logical. The counterparty ‘clients’ of investment firms can also be affected by the misconduct or financial difficulties of an investment firm. As such, the requirements that are intended to mitigate the financial and operational risks of an investment firm should also be useful for these counterparty ‘clients’.

118. Every entity that provides investment services or perform investment activities is exposed to the operational and financial risks as discussed in Section 2.1.2. As such, a prudential regulatory response should be justified for all entities providing investment services or activities. Currently however, the prudential regulatory response in the European Union is limited to those entities that are not exempted from the scoping of MiFID II and thus those that are authorised under MiFID II as investment firms.

119. MiFID II changes the exemptions to the scope on several points. Most notably, after MiFID II came into force, two groups of firms were subjected to the provisions of MiFID II, whereas these firms were exempted under MiFID I. Firstly, the exemption for firms dealing on own account has become stricter under MiFID II and thus resulted in more firms that deal on own account having to apply for a licence under MiFID II. Secondly, the exemption for firms solely providing investment services and activities related to commodity derivatives has been changed significantly.7 These “commodity derivative dealers” will be subject to the provisions of MiFID II unless they fulfil one of the following criteria:8

120. The first criterion has been further elaborated upon by the European legislator.9 The special position occupied by commodity derivative dealers within the European framework will be discussed in the following Section.

121. The result of these two changes to this exemption, amongst others, is that a larger number of firms should apply for a licence under MiFID II and therefore become subject to prudential requirements.