European Firms Say Smart Investors Need "Light Touch" of Protection
August 19, 2010
European buy- and sell-side firms are asking the Committee of European Securities Regulators to not change the way they classify their clients, in order to comply with the European Markets in Financial Services Directive.
As part of a potential revamping of MiFID, the Committee of European Securities Regulators last month began seeking industry comment on making changes to the three categories financial firms use to classify their customers under MiFID: retail, professional and eligible counterparty.
The categories are used in the directive to create a fiduciary standard of how much protection brokers and advisers must give to the interests of their customers.
Retail investors are given the most protection. ECPs – typically investment firms, credit institutions, nsurance companies, central banks, and national governments—are considered the most sophisticated investors and are given a “light touch approach.” That means the least protection.
The distinction between ECP and professional appears to be very hazy, except that “locals” are included as professional investors. While MiFID does not define the term:”locals,” CESR said that it meant firms which deal for their own accounts – aka proprietary trading shops.
Respondents to CESR’s request for comments agreed financial firms should be required to evaluate just how knowledgeable and experienced their customers are before they can be classified as professional clients.
“It is the responsibility of each entity to ensure it has a well-qualified and experienced staff, together with appropriate internal processes,” wrote Stefan Gavell, executive vice president and head of regulatory and industry affairs for Boston-headquartered global custodian State Street in its letter to CESR.”
In its request for comments CESR had wanted to know if firms which are considered professional clients or eligible counterparties should be tested to verify that they really understand the products they are buying.
The CESR had proposed eliminating either the ECP status for transactions in “highly complex” products or create a separate category such as “super ECP” for large financial firms wanting to invest in OTC derivatives and asset backed securities. In addition, firms which may know that an investor classified as an ECP might not be able to properly assess the risks of its investment and should be categorized as professional clients.
When it comes to defining the phrase "local authorities," State Street said that they should not be automatically be eliminated from the category of professional clients, as CESR suggested.
Instead, they should be pegged by a certain threshold. “Local authorities below such a threshold would not automatically qualify as professional clients,” wrote State Street’s Gavell. “Local authorities above the threshold would, however, fall into the category of public bodies that manage public debt and therefore qualify as professional clients.”
Even so, larger authorities could still requires non-professional treatment in certain instances and be given a higher level of protection under MiFID.
In the case of "public debt bodies," just how the term is defined meant the difference between being classified as a professional firm or an eligible counterparty. “In some member states local authorities are classified as professional clients while in most they are not,” said CESR in its request for comments.
