The Adoption of MiFID in Cyprus

Contributed by Patrikios Pavlou & Associates LLC [www.pavlaw.com]
Published by Law Business Research, 2011

MiFID – General Overview

The Markets in Financial Instruments Directive (MiFID) 2004/39/EC forms part of the E. U. Financial Services Action Plan (FSAP), which was developed in furtherance of the E. U. single market vision and the abolition of market barriers. The aim of the FSAP was to extinguish the gaps that restrained the development of a single E.U. market. One of the most significant tools used for the advancement of this vision is MiFID. MiFID, has constituted a progressive step towards the abolition of internal Market gaps and the development of a single level playing field across the EU. The concept of a single market initially kicked off with the Investment Services Directive in 1993, which established the conditions upon which authorised investment firms and banks could provide specified services in other EU member states on the basis of home state authorisation and supervision. However the ever-changing investment demands pushed for reform and on 7th November 2007 the Markets in Financial Instruments Directive entered into force. The enactment of MiFID proved to be a significant tool in the harmonisation / facilitation of a single EU market. Unlike ISD, MiFID encompasses a greater scope of investment activities and services that can be passported and it provides measures for the strengthening and improvement of the way Investment Firms function. Additionally its scope offers greater security to investors as it sets out rules for investor protection. This undoubtedly raises investor confidence whilst minimizing risks. MiFID, in effect, represents a sweeping reform towards the establishment of a common regulatory framework for Europe’s securities market.

MiFID was implemented through the Lamfalussy process, which is an accelerated decision-making procedure created by the Committee of Wise Men. This process, differentiates between Levels of implementation, and aims to facilitate the passing of legislation. Level 1 of the Lamfalussy procedure refers to the adoption of directives and regulations using the codecision procedure at the EU level, Level 2 is the implementation of the law by “filling in the details.”, Level 3 refers to greater cooperation among national supervisors to “ensure consistent implementation and enforcement.” and Level 4 refers to more effective enforcement of EU laws. This process in effect facilitates the steady integration and enforcement of the MiFID provisions, ensuring a smooth transition.

The provisions of MiFID essentially allow regulated markets, multilateral trading facilities and investment firms to operate throughout the EU on the basis of authorisation from the home Member State.

Adoption of the MiFID Directive in Cyprus

The MiFID Directive was adopted in Cyprus in 2007 with the harmonisation of the local legislative framework in accordance with the provisions of the EU Directive. On 26 November 2007 the provisions of MiFID were codified with the passing of the Investment Services and Activities and Regulated Markets Law of 2007 (Law 144(I)/2007), replacing the previous Investment Firms Law of 2002. The integration of MiFID in the Cypriot investment industry has opened a significant gateway to EU Investors who are particularly attracted by the favourable tax regime currently retained in Cyprus.

CySEC – The regulating authority of Cyprus

The Cyprus Securities and Exchange Commission (CySEC) is the primary regulating body in Cyprus, playing a significant role in the supervision, authorization and monitoring of Cyprus Investment Firms. In order for a company to qualify as an Investment Firm it must mandatorily be granted authorization by the competent authority.
The Cyprus Securities and Exchange Commission has been appointed as the competent authority under the recent Cyprus Securities and Exchange Commission Law 2009 [73(I)/2009]. Under the Investment Services and Activities and Regulated Markets Law of 2007 144(1)/2007, the Commission is accorded express power to act as the authorizing body for Cyprus Investment Firms.

Directive 2004/39/EC, expressly states that an investment firm is “a person that operates under an authorization granted by the competent authority”. Respectively under Law 144/(I)/2007 which adopts the provisions of the European Directive, a "Cypriot Investment Firm" or "CIF" means the company that is established in the Republic and authorised by the Commission to provide one or more investment services to third parties or/and perform one or more investment activities.

Authorization Process

The authorization process is regulated by Directive 2004/39/EC, Law 144(I)/2007 and Directive D144-2007-03.

In order for a Cypriot company to be permitted to provide one or more investment services to third parties or/and perform one or more investment activities, it must be granted authorization to register as a Cyprus Investment Firm (CIF) by CySEC. Once registered as a CIF, the company may provide investment services on a professional basis. Beyond the bounds of national benefits, a CIF registration opens a significant gateway to the EU market. Section 6(5) of 144(1)/2007 provides that once a company registers as a CIF, it becomes valid in all member states and is consequently allowed to provide services and perform activities in all the Member States. As the law provides, this can be established by the following two methods. Either through:

• The establishment of a branch and/or
• The free provision of services or the performance of activities.

Law 144/(I)/2007 sets some conditions that must be complied with in order for a company to be licensed to act as a CIF

Legal Requirements for Authorisation

Due to the tightly regulated nature of Investment Firms, the law imposes an extensive number of prerequisites for the granting of a CIF authorization.

One of the first requirements under Law 144/(I)/2007 is that the company seeking a CIF authorization, must be an established company in the Republic in which it is seeking authorization, and its head office must be situated in the Republic.

Secondly, a notably important requirement that must be complied with not only whilst authorization is granted but at all times, is the requirement to retain the initial capital above the permitted level. The initial capital is strictly regulated and it must reflect the requirements provided under section 10 of the Law 144/(I)/2007. Section 10 specifies the minimum issued and fully paid share capital required, depending on the nature of the CIF’s core activities.

It specifically provides as follows:

1. when a CIF holds client’s money and/or client’s financial instruments and provides the following activities:
   
   a. the reception and transmission of orders in relation to financial instruments,
   b. the execution of orders on behalf of clients
   c. portfolio management; or
   d. provision of investment advice
   
   it must have an initial capital of at least €200.000
   
2. When a CIF provides investment services as above however it does not hold client’s money and/or client’s financial instruments, it may have an initial capital of at least €80.000
   
3. (3) If a CIF provides one or more of the following:
   
   a. Dealing on own account
   b. Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis;
   c. Placing of financial instruments without a firm commitment basis;
   d. Operation of Multilateral Trading Facility;
   
   It must have an initial capital of at least 1.000.000

Furthermore, the persons who direct the company’s business must have a sufficiently good repute and must be sufficiently experienced. If the CIF applicant fails to convince CySec of this, CySec may reject the CIF application. This requirement is crucial as it ensures the sound and prudent management of Investment Firms. It constitutes a method of internal regulation which establishes a level of protection for investors. Article 9 of the European Directive provides that Member states shall require the investment firm to notify the competent authority of any changes to its management and provide information so as to assess whether the new staff appointed are of sufficiently good repute. Furthermore, an obligation exists under section 12(3) of Law 144(I)/2007 to have a minimum of at least two persons undertaking the management of the CIF.

In addition to the above requirement, the CIF applicant must inform the commission of the identities of the shareholders and additionally satisfactorily show that they are suitable shareholders. Section 13 of Law 144(I)/2007 gives the Commission the authority to reject the application if it is not satisfied as to the suitability of the shareholders.

The requirement of good repute extends to the employees of the CIF applicant. Specifically section 15 provides that they must be of sufficiently good repute and have the necessary skills, knowledge and expertise for performing their assigned responsibilities.

And lastly according to section 18 the CIF must comply with the following organizational requirements:

(a) it must establish adequate policies and procedures sufficient to ensure its compliance with the law, directives, and relevant rules. The policies and provisions will not only apply to its managers, but also to the employees, and other relevant persons.

(b) it must maintain and operate effective organizational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest

(c) take reasonable steps to ensure continuity and regularity in the performance of investment and ancillary services and activities

(d) ensure, when relying on a third party for the performance of investment services or activities, to take reasonable steps to avoid undue additional operational risk.

(e) have robust governance arrangements which include a clear organizational structure

(f) have sound administrative and accounting procedures, internal control mechanisms, and effective procedures for assessing the risks the CIF undertakes or may undertake

(g) arrange for records to be kept of all services provided and transactions undertaken, to enable CySec to monitor its compliance with the relevant legislation and directives

(h) apply appropriate client identification procedures, record maintenance and internal reporting

(i) make adequate arrangements to safeguard client’s ownership rights.

The above provisions demonstrate a high level of supervision and control that is effected over a CIF’s structure and performance as an investment firm. This control is vital for the effective implementation of the passporting vision since the harmonization of all the EU member states in one single market is a colossal task that mandates tight regulation. Additionally, the strict control works towards eliminating any unfair market abuse.

Procedure for Authorization

The actual CIF authorization process is made via the submission of the relevant application. The application must be accompanied by the applicant’s confirmation that it possesses or will possess the required initial capital, including an undertaking to block it in a bank account held by a credit institution. The application must be submitted along with a questionnaire which is completed by the persons who effectively direct the business and the shareholders with direct or indirect qualifying holding in share capital. The responsibility to provide all the correct documents required and to duly complete the application rests on the members of the board of directors. On submission it is the members of the board of directors who sign the application and confirm that they have exercised due diligence in ensuring the information included is complete and truthful. During the assessment of the application CySec may request additional information which will aid in the assessment of the application. Additionally at the final stage of assessment Cysec will demand from the applicant, to submit a confirmation by one or more member states’ credit institutions, in which it shall be stated that the entire initial capital required is blocked in a bank account by that institution and will remain blocked until the CIF is granted.

Once the application has been submitted CySec must within 6 months reach a decision and inform the applicants of either their approval or rejection.

Post Granting requirements

If the CIF license is granted, the authorization will state the name of the CIF, the number and the date of issue of the authorization, the investment and ancillary services it is allowed to provide, the investment activities it is allowed to perform, and any other necessary details. Upon authorization the CIF may only provide and perform the investment and ancillary services defined in the authorization. Additionally, a CIF must proceed with amending its memorandum of association to include the fact that the company is now operating as a CIF and it must specify the ancillary services and investment activities it will be undertaking therein.

Furthermore, the Commission is under a duty to establish and maintain a public register in which all CIF companies must be registered.

Following the authorization and the granting of a CIF License, a CIF continues to be regulated and has an ongoing obligation to ensure it complies at all times with the conditions under which the authorization was granted. It must at reasonable intervals, carry out a regular internal review of its organizational requirements.

It is extremely important that the CIF makes use of its authorization within 12 months from the date of issue, otherwise the authorization will lapse.

What investment activities can they enter into?

MiFID, provides a broader range of investment services and activities in comparison to the DIS. This inevitably means there are more extensive regulation requirements under the MiFID umbrella.

The investment services and activities covered are listed in appendix 3 part 1 of Law 144(I)/2007 and are as follows:

• The Reception and transmission of orders in relation to one or more financial instrument
• Execution of orders on behalf of clients
• Dealing on own account
• Portfolio management
• Investment advice
• Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis
• Placing of financial instruments without a firm commitment basis
• Operation of Multilateral Trading Facility

The CIF applicant must provide in the application, the investment services and ancillary services which the CIF intents to perform. Once authorization is granted the CIF will not be able to deviate from the prescribed scope of services for which it is authorized. Therefore it is extremely vital they are included since section 8 of Law 144(I)/2007 explicitly states that a CIF may only provide the investment and ancillary services or/and only perform the investment activities that are stated in its authorization. Additionally with regards to ancillary services and activities, it is provided in section 7 that authorization shall in no case be granted solely for the provision of ancillary services.

The establishment of a Branch

Once authorization is granted a branch may be established either in Cyprus, in another Member State or in a Third Country. An outline of the procedure that must be followed for the creation of a branch, as provided in part IX of Law 144(I) 2007 is set out below.

Establishment of a CIF branch in Cyprus

Firstly, according to Section 75 of Law 144(I)2007, a written notification of the intention to form a branch is communicated to the Commission. The notification must include the address, the persons responsible for its management and organizational structure and the programme of operations setting out the investment and ancillary services it intends to provide and the investment activities it intends to perform.

Upon receiving the notification the commission will examine the information provided and will announce its decision within three months.

Establishment of a branch in a Member State or Third Country

Where a CIF intends to establish a branch in a Member State or a Thirds country, it must notify the Commission in writing its intention to do so and it must include information as to which Member State or third country it wishes to branch out to. Additionally it must include the address of the branch, the names of those responsible for the management and the programme of operations setting out the investment and ancillary services that it intends to provide. The Commission must communicate its decision within three months. If the decision is positive then it must announce the approval of the branch to the host Member State. Once a communication form the competent authority of the host member state is received the CIF branch may commence its business in that Member State. If the competent authority of the host member state fails to communicate a receipt within at least two months, it may commence its business after the lapse of such time.

Establishment of a branch by an Investment Firm in Cyprus

A branch can be respectively created in Cyprus by an Investment Firm of another Member State. The procedure is fairly identical to the establishment of a CIF branch in another Member State. The Investment Firm must be authorized and supervised by the competent authority of that Member State to provide the investment and ancillary services. The competent authority of that Member State must provide the Commission with information regarding the address of the branch, the names of those responsible for the management of the branch and its organizational structure and the programme of operations setting out the investment and ancillary services that it intends to provide and the investment activities it intends to perform.

The free provision of services and performance of investment activities

This is regulated by Section 79 of the Law 144(I)2007. A CIF may freely provide investment and ancillary services and perform investment activities within the territory of another member state if it communicates its intention to the Commission along with the following information:

• The member state or third country where it intends to provide and perform those services
• The programme of operations
• Whether it intends to use tied agents in the host member state.

Within one month of receiving the above information, the Commission will forward it to the competent authority of the host member state. Once the relevant notification has been given the CIF may start to provide and perform its services and activities.

If a foreign investment firm wishes to provide services in Cyprus under the free provision of services, the competent authority of its home state must communicate the relevant notification to the Commission. Once this has been effected, it may begin to provide or perform its services and activities

Investors’ Protection

One of MiFID’s significant aspects is the transparency provisions contained therein. It provides for both pre-trade and post trade transparency provisions, which guarantee a more secure market. As published in the 2009 CESR annual report the aim of Securities Regulators is to secure the orderly functioning of the financial markets by ensuring the markets operate in a fair, efficient and transparent manner. This furthers the aim of the EU to ensure equivalent market conditions across the EU borders. It effectively works towards the implementation of the European Pillar of a Single EU Market. This level of protection provides intensified market clarity and as a result increases investor confidence, pushing the number of investors up. However this improvement, inevitably comes with a downside. As a result of the extensive control measures, the cost implications have dramatically increased. The strict regulation requirements have in effect resulted in the elimination of the small-sized market participants who cannot afford the compliance costs, forcing them eventually out of the game. The process of implementing MiFID proved to be a colossal and complex task, with excessive cost implications. Nevertheless, in the long run, it promises greater potential gains, and increased opportunities.

Some of the key investor protection provisions introduced are:

• Best Execution
• Order Handling
• Transaction Reporting

Best Execution

The provisions of MiFID impose a duty on investment firms to take all reasonable steps to deliver the best results to their clients. It’s one of the core principles of MiFID and it is fundamental for the protection of investors. It develops a fiduciary duty owed from the Investment Firm towards the client. The importance of this core provision resulted in its adoption in the Cypriot legislation 144(I)/2007. Section C specifically outlines key provisions which ensure investor protection. Section 38 expressly deals with the best execution obligation. It provides that A CIF must take all reasonable steps to obtain, when executing orders, the best possible result for its clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. In furtherance of the above obligation a CIF must establish and implement an order execution policy to allow the CIF to obtain the best possible result for its clients. The order execution policy shall include, in respect of each class of instruments, details on the different venues where the CIF executes its client orders and the factors affecting the choice of execution venue. It must additionally provide appropriate information to its clients on its order execution policy and obtain the prior consent of its clients to the said execution policy and monitor its effectiveness.

A healthy outcome of this provision is the stimulation of competition between the trading venues. This additionally contributes to the stimulation of innovative growth which derives from the CIF;s obligation to monitor the effectiveness of their order execution arrangements and execution policy and to identify and correct any deficiencies. In particular, section 38(6) provides that it must assess, on a regular basis, whether the execution venues included in the order execution policy provide the best possible result for the client or whether it needs to make changes to its execution arrangements.

Order Handling

Section 39 of Law 144(I)/2007 regulates the handling of investment orders, aiming to prevent the misuse of information. Specifically it states that a CIF authorized to execute orders on behalf of clients must implement procedures and arrangements which provide for the prompt, fair and expeditious execution of its client orders, relative to other client orders or its trading interests. It gives the power to the Commission to define through the implementation of directives, the conditions and nature of the procedures and arrangements for the prompt, fair and expeditious execution of client orders and the situations where a CIF may reasonably deviate from the requirements of prompt execution so as to obtain more favorable terms for its clients.

Obligation to record Transactions

In order to ensure the market integrity, transparency provisions have been incorporated in the Legislation. According to section 43 A CIF must maintain records that contain the relevant details relating to all transactions in financial instruments carried out by the CIF, the respective rights and obligations of the CIF and its clients as set out in an agreement to provide services or the terms on which the CIF provides services to the clients. The Commission may define the form, type and content of the records via a directive.

Section 44 specifies that a CIF must maintain the records for a period of at least five years, and they are to be available for review by the Commission, at any given time. The records must be retained for at least the duration of the CIF's relationship with the client.

Obligation to Report Transactions

Section 45 additionally provides that a CIF, a credit institution authorised in the Republic and the branch which execute transactions in any financial instruments admitted to trading on a regulated market, must report details of such transactions to the Commission as quickly as possible, and no later than the close of the following working day. This obligation shall apply whether or not such transactions were carried out on a regulated market.

The reports must in particular, include details of the names and numbers of the instruments bought or sold, the quantity, the dates and times of execution and the transaction prices and means of identifying the CIF or credit institution or branch concerned.

Clients’ Classification

A notably important requirement introduced by MiFID and adopted by the Investment Services and Activities and Regulated Markets Law of 2007 is the requirement of client classification either as a Retail Client, Professional Client or an Eligible Counterparty. The criteria used for the classification of the clients takes into consideration their size and level of professional knowledge and expertise in the financial market. Classification in effect, enables the appropriate level of protection to be awarded to the client based on their vulnerability. The legislation is tailored appropriately to cater for the needs of each client category. This subjective characteristic introduced by MiFID, is highly important, as it aids in the smooth operation of the market and a high level of protection for the clients.

A Retail Client is defined as a client who does not fall within the “professional client” definition. Normally Retail Clients are smaller sized customers and have less expertise. As a result, Retail Clients are awarded a higher level of protection. Professional Clients on the other hand are clients who possess the experience, knowledge and expertise to make their own investment decisions and properly assess the risks that they incur. In order to be considered as Professional Clients, they must comply with certain criteria set out by Law 144(I)/2007. Professional clients can range from Credit Institutions, Investment Firms, Insurance Undertakings and other Institutional investors and they must meet at least two of the following requirements:

They must have:

• a balance sheet total of at least 20.000.000 Euro
• a net turnover of at least 40.000.000 Euro
• own funds of at least 20.000.000 Euro

Eligible Counterparties are the investors and market participants who are highly experienced in the market industry. They include amongst others, Investment Firms, Credit Institutions, Insurance Undertakings that fall outside the Professional Client category and National Governments, Public Bodies that deal with public debt and Central Banks. The level of protection for Eligible Counterparties is significantly less since they are considered to be the most sophisticated category and they therefore have the advanced expertise and knowledge to take informed decisions.

MiFID has indeed opened a vital gateway within the EU Market, increasing opportunities, competition and quality amongst investors. It is consequently exceptionally important for Cyprus, as one of the newest additions to the European family, establish and retain a high level credibility as a financial centre. Cyprus has a very favorable advantage, triggering investor interest. The tax regime adopted in Cyprus is if not the most favorable, one of the most favorable in Europe. A CIF will be charged at 10% Corporation Tax, a rate which no other European Country offers. The combination of low tax rates, innovative prospects and attractive location, has resulted in the gradual and steady increase in investor interest, allowing Cyprus to be an active participant in the European Market industry.

Read More Contributed Articles