2.1.3 Ancillary services in MiFID

97. Performing any of the investment services or activities mentioned in Section A of Annex I of MiFID, and discussed above in Section 2.1.2, results in the firm having to apply for an authorisation under MiFID. However, these investment services or activities are not the only services an investment firm is allowed to perform. MiFID II also identifies several “ancillary services”1 which an investment firm is allowed to perform, but supervisory authorities are not allowed to grant an authorisation solely for the provision of ancillary services without providing any investment services or activities.2 Conversely, firms providing only ancillary services without providing any investment services or activities are not subject to the provisions of MiFID and are not required to obtain a MiFID licence. In certain cases, however, particularly those listed in (1), (2), (4), (6) and (7) of Section B of Annex I of MiFID, it is inconceivable that these services are provided other than in conjunction with the provision of investment services. The ancillary services included in Section B of Annex I of MiFID are:

98. To assess the prudential risk profile of an investment firm, ancillary services 1 (safekeeping of financial instruments)3 and 2 (grating credit)4 are those that could result into operational or financial risks on their own. The other ancillary services will usually be provided by an investment firm only in conjunction with an investment service or activity56 As these ancillary services are performed in conjunction with an investment service or activity, the primary risk for a client or for the investment firm itself when performing these ancillary services, will occur in the provision of that investment service or activity and not in the ancillary service. These ancillary services 3 through 7 can therefore be seen as a part of the activities performed under the related investment services or activities.7 As such, these ancillary services will not result into a financial or operational risk that require a supervisory response on their own as these should be included within the financial and operational risks of the various investment services and activities. The risks associated with these ancillary services are comprised in the discussion under the investment service most closely related to these ancillary services.

99. The standalone financial risks for an investment firm providing ancillary services 3 to 7 are therefore limited, as they will be part of the financial risk of the related investment service or activity. However, these ancillary services can result in the same liability risk through operational errors or incorrect or inappropriate actions by the investment firm as is the case for investment services. The main difference between the investment services and these ancillary services is that the latter are not directly related to financial instruments, whereas all investment services and activities are related to trades in financial instruments. Because these ancillary services are not directly related the trades in financial instruments, the need for regulation from a prudential perspective decreases. The purpose of supervising investment services is to protect customers who wish to enter financial markets. Any activity that is not directly related to a financial market or instrument traded in financial markets therefore falls outside of the need for financial market supervision.

100. Safekeeping of financial instruments and cash/collateral management is a very important aspect, however, when analysing an investment firm’s (prudential) risks. If the investment firm is allowed to perform a safekeeping function, it is actually holding the financial instrument or cash for its clients. This increases the risk for the clients, since the firm performing the investment services is the same as that is safeguarding and administering the financial instrument or cash. Depending on the contract between the investment firm and its clients, the investment firm may or may not have the economic or legal ownership of the financial instruments or cash. The specific risks associated with the various methods of asset segregation applied in Europe will be discussed in Chapter 4. However, generally speaking, if the investment firm itself is offering some form of asset segregation (using trusts, segregation on the balance sheet or separate related legal entities), then the risk profile of the investment firm increases significantly, especially when compared to an investment firm performing exactly the same investment services and activities but using a bank or other specialized and non-related entity as a separate depositary for its asset segregation.

101. The second ancillary service that exposes the investment firm to additional risks is the granting of credit. Granting credit or loans to an investor, to allow the investor to carry out a transaction in a financial instrument, inherently exposes the investment firm to additional (prudential) risks.8 By granting credit to an investor, the investment firm is exposed to the risk that the investor may be unable to repay its loans. The investment firm is thus exposed to its client’s credit risk. If the investment firm requires a financial instrument to be used as collateral for the loan itself, either the instrument purchased using the received loan or the existing portfolio of the client, the investment firm changes its risk profile once again. Using collateral reduces the credit risk, i.e. the risk of the client being unable to repay its loan, by the value of the underlying financial instrument used as collateral. However, the investment firm then exposes itself to the market risk of that underlying financial instrument. If the financial instrument decreases in value either through movements in the price of that financial instrument or through movements in the general market, the value of the collateral also decreases. The operational risk of the investment firm also increases. Firstly, it needs to have in place adequate processes to assess which client is eligible to receive a loan and for which amount.9 Secondly, when using collateral, the investment firm needs to determine how much collateral is required for a given loan. But it also needs to monitor the value of the collateral over time to ensure that any changes in the value of the collateral do not result in the investment firm being under collateralized. Granting credit can therefore significantly alter the risk profile of the investment firm and should be included in the activities covered by prudential regulation.