Regulator urged to drop MiFID II portfolio threshold
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Photo: © European Parliament – Audiovisual Unit
Proposals which could make it impossible for half of local authorities to be classified as professional investors should be dropped, according to local government finance representatives.
Last week, the Financial Conduct Authority (FCA) closed its consultation on new rules implementing the European Union’s Markets in Financial Instruments Directive II (MiFID II).
The proposals would automatically categorise local authorities as retail investors, unless they meet a set of criteria including a financial instrument portfolio of more than £15m.
In its response to the consultation, the Local Government Association said: “The consultation states that the typical portfolio size for a smaller local authority is £10m, yet the analysis carried out by the FCA itself in the consultation concludes that the £15m cut off would exclude about half of all UK local authorities.”
It complained that no evidence-based reason has been given by the FCA for the £15m cap, when the original EU directive was based on a figure of €500,000.
“As is acknowledged in the consultation, a portfolio size of €500,000 would not be a significant bar to UK local authorities,” the LGA said.
The “unnecessary” reclassification of local authorities as retail investors could also hit service provision, the LGA claimed.
“UK local authorities rely on the income they generate from their investments as part of their annual budgeting process,” it said.
“If this income is decreased through lack of access to investment opportunities, shortfalls will have to be met by reductions elsewhere in council budgets — and this is at a time when council budgets are already under severe pressure from major reductions in core funding.”
Michael Quicke, chief executive of investment manager CCLA, said: “We believe that MiFID II was mistaken to categorise all local authorities as retail clients by default.
“This is because we do not believe that local authorities are any less able to manage their affairs than any other similar sized institution.
“As a result, we believe that the FCA should exercise its discretion to, as far as possible, give local authorities the same freedoms and protections as any other similar sized institution. As a consequence, we think that the requirements proposed are unduly restrictive.”
Sean Nolan, director of local government at the Chartered Institute of Public Finance and Accountancy, said the £15m limit may not be a reliable measure of professional conduct” and called for a “principles based approach” that would be “in keeping with the prudential approach taken in both the statutory framework and the CIPFA codes of practice.”
Risk
The FCA threshold proposals could also result in councils becoming exposed to greater financial risk, according to David Green, client advisor at treasury adviser Arlingclose.
He said: “The protections afforded will not extend to exemption from bail-in, governed by the Bank Recovery and Resolution Directive, or to protection under the Financial Services Compensation Scheme, governed by the Deposit Guarantee Schemes Directive.
“It is odd that these three directives are not harmonised with each other. As it stands, the EU is saying that there are local authorities that are too small and too inexperienced to access professional financial markets at the same time as being too large and too knowledgeable to deserve protection from bank failures.”
Quicke also voiced concerns over another hurdle — that professional status would only be granted if a local authority has carried out significant transactions at a frequency of 10 per quarter over the previous four quarters.
“The minimum number of transactions suggested is much higher than appropriate, given that local authorities generally hold the relevant assets to maturity or for the long-term, rather than to trade,” he said.
In its response to the consultation, AFME, which represents Europe’s wholesale financial markets, called on the FCA to park the proposals, saying: “AFME members operate their businesses as far as possible on an internationally consistent basis and therefore would prefer local authorities to be treated consistently across Europe, so we would in the first instance suggest that FCA refrains from exercising the power MiFID grants it to make UK-specific rules.”
Sense
Green said there may be some limited benefits of being a retail client, including a requirement on firms to ensure that the financial products they offer are suitable for a local authority, and that they fully understand their implications.
“This should limit some of the practices criticised by MPs, and indeed which are the EU’s main reason for making the changes to MiFID.”
However, implementing the new rules would result in more paperwork for local authorities and the firms servicing their finance needs, he said.
Green called on the FCA to “see sense” and allow as many local authorities as possible the choice of opting-up to be professional clients.
Last week, The Pensions and Lifetime Savings Association (PLSA) claimed in its response that the proposed rules threaten local authority pension funds’ ability to invest in infrastructure.
It said the majority of infrastructure investment firms are structured to explicitly exclude retail investors.
Graham Vidler, director of external affairs at the PLSA, said: “With LGPS funds investing billions in infrastructure right now, and at a time when the government is calling for greater infrastructure investment by pension funds, these proposals are counterintuitive.”
The consultation closed on 4 January, with the FCA expected to publish a policy statement by the second quarter of the year.
MiFID II is set to come into effect on 3 January 2018.
