Miffed by MiFID 2 David Green dgreen@arlingclose.com

Last week the Financial Conduct Authority published its rules on which local authorities will be allowed to remain professional clients when the second Markets in Financial Instruments Directive takes effect in January.

MiFID II is the pinnacle of Europe’s two-faced approach to the regulation of local authority treasury management. On the one hand, councils are assumed to be large enough and sophisticated enough for their bank deposits to be excluded from the Financial Services Compensation Scheme and to be first in line for bail-in. In other words, if they have £1 million in the bank then they are treated like other millionaires.

But on the other hand, Europe’s MiFID II directive says that local authorities might not be sophisticated enough to use safer investments like money market funds, repo, covered bonds or treasury bills, and they must jump through several hoops to prove they don’t need their hands holding. In other words, the financial services industry should treat them the same as individuals. What are your incomings and outgoings? What is your risk appetite? The value of your investment can go down as well as up. Etc.

Now, MiFID II gave the UK’s Financial Conduct Authority free reign in deciding exactly what those hoops should be. A low hurdle would have been to keep the same rules as currently apply – a local authority can be classed as professional if it would be a large company (i.e. not an SME). But the FCA seem to have opted for the steeplechase option and applied a £10m investment balance threshold and a choice of three other criteria. So, local authorities with £8m in the bank can’t be trusted to select a money market fund without filling in a raft of paperwork first; but having £12m will be a sign of sophistication and give you the right to make your own investment decisions. Other people might think that a small authority with £12m invested might just be one that has borrowed too much, but not the FCA.

There is also the rule in MiFID II about making an average of ten similar transactions a quarter over the previous four quarters. That’s a typically complicated European way of saying 40 transactions a year. Again, the FCA has opted to keep this rule in as, in their eyes, trading in and out of the same property fund every week at high cost signifies greater knowledge and experience than just buying and holding. At least you’ll be able to demonstrate your expertise in other ways instead of this one.

But local authorities unable or unwilling to meet the opt-up criteria will be classed as retail clients by the financial services industry, which is likely to mean reduced access, or higher fees for access to, low risk investments like money market funds, treasury bills, gilts, covered bonds and repo. It will be no surprise if the 42 local authorities identified by the FCA decide to stick to unregulated bank deposits in future. The FCA must be ready to bear its share of the responsibility if some of them lose a large sum when their regulatory colleagues bail-in the first UK bank.