Client Categorisation

Client Categorisation Rules and Guidance under MiFID

In force for certain FSA regulated firms from 1 November 2007. Subject to change prior to that date.

1 Clients: general definition

A person to whom a firm provides, intends to provide or has provided:

(a) a service in the course of carrying on a regulated activity; or

(b) in the case of MiFID business or the equivalent business of a third country investment firm, an ancillary service, is a "client" of that firm.

A "client" includes a potential client.

In relation to the financial promotion rules, a person to whom a financial promotion or marketing communication is or is likely to be communicated is a "client" of a firm that communicates or approves it.

A client of an appointed representative or, if applicable, a tied agent is a "client" of the firm for whom that appointed representative, or tied agent acts or intends to act in the course of business for which that firm has accepted responsibility under the Act or MiFID (see sections 39 and 39A of the Act and SUP 12.5.5R).

If a firm provides services to a person that is acting as an agent, the identity of its client will be determined in accordance with the rule on agents as clients (see COBS 2.4.3R).

If a firm provides services to a person that is acting as the trustee of a trust, that person will be the firm's client and the underlying beneficiaries of the trust will not.

2 General notifications: MiFID and equivalent business

In relation to MiFID business or the equivalent business of a third country investment firm, a firm must:

(1) notify a new client of its categorisation as a retail client, professional client, or eligible counterparty in accordance with this chapter; and

(2) prior to the provision of services, inform a client in a durable medium about:

(a) any right that client has to request a different categorisation; and

(b) any limitations to the level of client protection that such a different categorisation would entail.

3 Retail clients

A retail client is a client who is not a professional client or an eligible counterparty.

4 Professional clients

A professional client is a client that is either a per se professional client or an elective professional client.

4.1 Per se professional clients

Each of the following is a per se professional client unless and to the extent it is an eligible counterparty or is given a different categorisation under this chapter:

(1) an entity required to be authorised or regulated to operate in the financial markets. The following list includes all authorised entities carrying out the characteristic activities of the entities mentioned, whether authorised by an EEA State or a third country and whether or not authorised by reference to a directive:

(a) a credit institution;

(b) an investment firm;

(d) an insurance company;

(e) a collective investment scheme or the management company of such a scheme;

(f) a pension fund or the management company of a pension fund;

(g) a commodity or commodity derivatives dealer;

(h) a local;

(i) any other institutional investor.

(2) a large undertaking (i.e. a body corporate or partnership; or an unincorporated association carrying on a trade or business, with or without a view to profit) meeting two of the following size requirements on a company basis:

(a) balance sheet total of ‚ 20,000,000;

(b) net turnover of ‚ 40,000,000;

(3) a national or regional government, a public body that manages public debt, a central bank, an international or supranational institution (such as the World Bank, the IMF, the ECP, the EIB) or another similar international organisation.

(4) another institutional investor whose main activity is to invest in financial instruments (in relation to the firm's MiFID business or the equivalent business of a third country investment firm) or designated investments (in relation to the firm's other business). This includes entities dedicated to the securitisation of assets or other financing transactions.

4.2 Elective professional clients

A firm may treat a client as an elective professional client if it complies with paragraphs (1) and (3) and, where applicable, paragraph (2):

(1) the firm undertakes an adequate assessment of the expertise, experience and knowledge of the client that gives reasonable assurance, in light of the nature of the transactions or services envisaged, that the client is capable of making his own investment decisions and understanding the risks involved (the €œqualitative test€);

(2) in relation to MiFID business or the equivalent business of a third country investment firm, in the course of that assessment, at least two of the following criteria are satisfied:

(a) the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters;

(b) the size of the client€™s financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds ‚ 500,000;

(c) the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged, (the €œquantitative test€); and

(3) the following procedure is followed:

(a) the client must state in writing to the firm that it wishes to be treated as a professional client either generally or in respect of a particular service or transaction or type of transaction or product;

(b) the firm must give the client a clear written warning of the protections and investor compensation rights the client may lose; and

(c) the client must state in writing, in a separate document from the contract, that it is aware of the consequences of losing such protections.

If the client is an entity, the qualitative test should be performed in relation to the person authorised to carry out transactions on its behalf.

The fitness test applied to managers and directors of entities licensed under directives in the financial field is an example of the assessment of expertise and knowledge involved in the qualitative test.

Before deciding to accept a request for re-categorisation as an elective professional client, a firm must take all reasonable steps to ensure that the client requesting to be treated as an elective professional client satisfies the qualitative test and, where applicable, the quantitative test.

An elective professional client should not be presumed to possess market knowledge and experience comparable to a per se professional client.

Professional clients are responsible for keeping the firm informed about any change that could affect their current categorisation.

If a firm becomes aware that a client no longer fulfils the initial conditions that made it eligible for categorisation as an elective professional client, the investment firm must take the appropriate action.

5 Eligible counterparties (ECP)

An eligible counterparty is a client that is either a per se eligible counterparty or an elective eligible counterparty.

In relation to MiFID business or the equivalent business of a third country investment firm, a client can only be an eligible counterparty in relation to eligible counterparty business.

5.1 Eligible counterparty business

Eligible counterparty business is defined as the following services and activities carried on by a firm:

(a) dealing on own account, execution of orders on behalf of

clients or reception and transmission of orders; or

(b) any ancillary service directly related to a service or activity

referred to in (a),

but only to the extent that the service or activity is carried on with or

for an eligible counterparty.

Outside the limited range of ECP business, an undertaking will need to be categorised as a professional or retail client for MiFID business.

5.2 Per se eligible counterparties

Each of the following is a per se eligible counterparty (including an entity that is not from an EEA State that is equivalent to any of the following) unless and to the extent it is given a different categorisation under this chapter:

(1) an investment firm;

(2) a credit institution;

(3) an insurance company;

(4) a collective investment scheme authorised under the UCITS Directive or its management company;

(5) a pension fund or its management company;

(6) another financial institution authorised or regulated under European Community legislation or the national law of an EEA State;

(7) an undertaking exempted from the application of MiFID under either Article 2(1)(k) (certain own account dealers in commodities or commodity derivatives) or Article 2(1)(l) (locals) of that directive;

(8) a national government or its corresponding office, including a public body that deals with the public debt;

(9) a central bank;

(10) a supranational organisation.

5.3 Elective eligible counterparties

A firm may treat a client as an elective eligible counterparty if:

(1) the client is an undertaking (i.e. a body corporate or partnership; or an unincorporated association carrying on a trade or business, with or without a view to profit) and:

(a) is a per se professional client (except for a client that is only a per se professional client because it is an institutional investor under 4.1(4) above); or

(b) requests such categorisation and is an elective professional client, but only in respect of the services or transactions for which it could be treated as a professional client; and

(2) the firm has, in relation to MiFID business or the equivalent business of a third country investment firm, obtained express confirmation from the prospective counterparty that it agrees to be treated as an eligible counterparty.

The categories of elective eligible counterparties include an equivalent undertaking that is not from an EEA State provided the above conditions and requirements are satisfied.

A firm may obtain a prospective counterparty's confirmation that it agrees to be treated as an eligible counterparty either in the form of a general agreement or in respect of each individual transaction.

6 Client and firm located in different jurisdictions

In the case of MiFID business or the equivalent business of a third country investment firm, in the event of a transaction where the prospective counterparties are located in different EEA States, the firm shall defer to the status of the other undertaking as determined by the law or measures of the EEA State in which that undertaking is established.

7 Providing clients with a higher level of protection

A firm must allow a professional client or an eligible counterparty to request re-categorisation as a client that benefits from a higher degree of protection.

It is the responsibility of a professional client or eligible counterparty to ask for a higher level of protection when it deems it is unable to properly assess or manage the risks involved.

A firm may, either on its own initiative or at the request of the client concerned:

(1) treat as a professional client or a retail client a client that might otherwise be categorised as a per se eligible counterparty;

(2) treat as a retail client a client that might otherwise be categorised as a per se professional client, and if it does so, the client will be re-categorised accordingly. Where applicable, this re-categorisation is subject to the requirement for a written agreement in 7.1 below.

If a per se eligible counterparty requests treatment as a client whose business with the firm is subject to conduct of business protections, but does not expressly request treatment as a retail client and the firm agrees to that request, the firm must treat that eligible counterparty as a professional client.

7.1 Written agreement

If, in relation to MiFID business or the equivalent business of a third country investment firm a per se professional client or a per se eligible counterparty requests treatment as a retail client, the client will be classified as a retail client if it enters into a written agreement with the firm to the effect that it will not be treated as a professional client or eligible counterparty for the purposes of the applicable conduct of business regime.

This agreement must specify the scope of the re-categorisation, such as whether it applies to one or more particular services or transactions, to one or more types of product or transaction or to one or more rules.

7.2 Different forms of additional protection

The ways in which a client may be provided with additional protections under this section include re-categorisation on:

(1) a general basis;

(2) a trade by trade basis;

(3) in respect of one or more specified rules;

(4) in respect of one or more particular services or transactions; or

(5) in respect of one or more types of product or transaction.

8 Policies and procedures

A firm must implement appropriate written internal policies and procedures to categorise its clients.

9 Records

A firm must make a record of the form of each notice provided and each agreement entered into under this chapter. This record must be made at the time that standard form is first used and retained for the relevant period after the firm ceases to carry on business with clients who were provided with that form.

A firm must make a record in relation to each client of:

(a) the categorisation established for the client under this chapter, including sufficient information to support that categorisation;

(b) evidence of despatch to the client of any notice required under this chapter and if such notice differs from the relevant standard form, a copy of the actual notice provided; and

This record must be made at the time of categorisation and should be retained for relevant period after the firm ceases to carry on business with or for that client.

(3) The relevant period is five years in relation to MiFID business or the equivalent business of a third country investment firm.

J E Halsey

Sources: FSA Conduct of Business sourcebook (MiFID Transposition) Instrument 2007; FSA Glossary (MiFID) Instrument 2007; FSA Handbook Glossary