Guidelines on certain aspects of MiFID requirements relating to appropriateness

06/11/2018 | ESMA35-43-1163 HR
Guidelines
Guidelines on certain aspects of MiFID requirements relating to appropriateness

Table of Contents
Scope .......................................................................................................... 3
Definitions ............................................................................................... 3
Purpose .................................................................................................... 5
Compliance and reporting obligations ..................................................... 5
Guidelines on certain aspects of MiFID requirements relating to appropriateness ........... 6

Scope
Who?

1. These guidelines apply to:
   a. competent authorities and b. firms.
   What?
2. These guidelines apply in relation to the provision of the following investment services listed in Section A of Annex I to Directive 2014/65/EU1 (MiFID II):
   a. investment advice; b. portfolio management.
3. These guidelines primarily concern situations where services are provided to retail investors. They should also be applied, as appropriate, when services are provided to professional investors, taking into account the provisions of Article 54(3) of Commission Delegated Regulation (EU) 2017/5652 (MiFID II Delegated Regulation) and Annex II to the MiFID II Directive.
   When?
4. These guidelines apply 60 calendar days from the date of the reporting request in paragraph 13.
   Previous ESMA guidelines issued under the MiFID I Directive3 will cease to apply on the same date.

Definitions
5. Unless otherwise stated, terms used in the MiFID II Directive and the MiFID II Delegated Regulation have the same meaning in these guidelines.
6. Furthermore, for the purposes of these guidelines, the following definitions apply:

1 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173, 12.6.2014, p. 349).
2 Commission Delegated Regulation (EU) of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to organisational requirements and operating conditions for investment firms as well as defined terms for the purposes of that Directive (OJ L 87, 31.3.2017, p. 1).
3 ESMA/2012/387 – Guidelines on certain aspects of MiFID requirements relating to appropriateness.

• “investment product” means a financial instrument (within the meaning of Article 4(1)(15) of the MiFID II Directive) or a structured deposit (within the meaning of Article 4(1)(43) of the MiFID II Directive);
• “firms” means firms subject to the requirements set out in paragraph 1 and include investment firms (defined in Article 4(1)(1) of the MiFID II Directive), as well as credit institutions when providing investment services and activities (within the meaning of Article 4(1)(2) of the MiFID II Directive), investment firms and credit institutions (when selling structured deposits to clients or advising clients in relation to structured deposits), UCITS management companies and external AIFMs (as defined in Article 5(1)(a) of the AIFM Directive4) when providing investment services managing individual portfolios or additional services (within the meaning of Article 6(3)(a) and (b) of the UCITS Directive5 and Article 6(4)(a) and (b) of the AIFM Directive);
• “appropriateness assessment” is the entire process of collecting client data and subsequently assessing the appropriateness of a specific investment product for an individual client conducted by a firm, based on a solid understanding which the firm has of products so that it can recommend or invest in them on behalf of the client;
• “robotised advice” means the provision of investment advice or portfolio management (in whole or in part) by means of an automated or semi-automated system used to interact with the client.

7. These guidelines apply in full to all firms providing investment advice and portfolio management services, regardless of the manner of interaction with clients. The application of some guidelines is considered particularly important when firms offer “robotised advice” (as previously defined for the purposes of these guidelines) due to limited interaction (or its absence) between clients and firm staff. This is highlighted as appropriate in the text where necessary.
8. The guidelines do not reflect absolute obligations. For this reason, the expression “should” is often used. However, expressions “shall” or “be obliged to” are used when describing requirements from the MiFID II Directive.

4 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on AIFMs and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 (OJ L 174, 1.7.2011, p. 1).
5 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (OJ L 302, 17.11.2009, p. 32).

Purpose
9. The purpose of these guidelines is to clarify the application of certain aspects of appropriateness-related requirements under the MiFID II Directive in order to ensure a common, uniform and consistent application of Article 25(2) of the MiFID II Directive and Articles 54 and 55 of the MiFID II Delegated Regulation.
10. ESMA expects that these guidelines will promote better convergence in the interpretation and supervisory approaches regarding appropriateness-related requirements under the MiFID II Directive by highlighting a number of important issues and simultaneously increasing the value of existing standards. ESMA helps ensure firms' compliance with regulatory norms and foresees appropriate strengthening of investor protection.
Compliance and reporting obligations
Status of guidelines
11. This document contains guidelines issued in accordance with Article 16 of the ESMA Regulation6. In accordance with Article 16(3) of the ESMA Regulation, competent authorities and financial market participants make every effort to comply with the guidelines.
12. Competent authorities to which these guidelines apply should adhere to them by incorporating them into their national legal and/or supervisory frameworks as appropriate; this also applies when certain guidelines primarily concern financial market participants. In that case, competent authorities should ensure via supervision that financial market participants adhere to the guidelines.
Reporting requirements
13. Competent authorities to which these guidelines apply must notify ESMA whether they comply or intend to comply with the guidelines, stating reasons for non-compliance when they do not comply or do not intend to comply, within a period of two months from the date of publication of the guidelines on ESMA's website in all official EU languages.
14. Firms are not obliged to report on compliance with these guidelines.

6 Regulation (EU) No 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC.

Guidelines on certain aspects of MiFID requirements relating to appropriateness I.I INFORMATION FOR CLIENTS ON THE PURPOSE OF THE APPROPRIATENESS ASSESSMENT Relevant legislation: Article 24(1), (4) and (5) of the MiFID II Directive and Article 54(1) of the MiFID II Delegated Regulation General guideline 1.
15. Firms should inform their clients in a clear and simple manner about the appropriateness assessment and its purpose, which is to enable the firm to act in the best interests of the client. This should include a clear explanation that it is the firm's responsibility to conduct the assessment so that clients understand why certain data are requested from them and that the timeliness, accuracy and completeness of this data are important. These information may be provided in a standardised form.
Supporting guidelines
16. Information on the appropriateness assessment should help clients understand the purpose of the requirement. They should encourage them to provide accurate and sufficient data on their knowledge, experience, financial situation (including their ability to bear losses) and investment objectives (including their risk tolerance). Firms should highlight to clients that it is important to collect complete and accurate data so that the firm can recommend products or services appropriate for them. Without this data, firms cannot provide clients with investment advice and portfolio management services.
17. Firms decide for themselves how to inform their clients about the appropriateness assessment. The form used should, however, allow for controls to verify that information has been provided.
18. Firms should avoid emphasising or creating the impression that the client decides on the appropriateness of investments or determines which financial instruments suit their risk profile. For example, firms should avoid indicating to the client that a specific financial instrument is appropriate or requiring the client to confirm that a specific instrument or service is appropriate for them.
19. Any disclaimer (or other similar forms of statement) intended to limit the firm's liability for the appropriateness assessment should in no way affect the characterisation of services provided to clients in practice nor the assessment of the firm's compliance with the relevant requirements. For example, when collecting client data required to conduct the appropriateness assessment (such as investment time horizon / holding period or information related to risk tolerance), firms should not claim that they do not assess appropriateness.

20. To clarify for clients the services provided via robotised advice which they may not understand, firms should, in addition to providing other requested information, do the following:

• provide a very clear explanation of the exact degree and extent of human involvement and whether and how the client can request human interaction;
• explain that the answers provided by clients will directly affect the determination of the appropriateness of investment decisions recommended or made on their behalf;
• describe the sources of information used to provide investment advice or portfolio management services (e.g. if an online questionnaire is used, firms should explain that answers to questions may be the exclusive basis for robotised advice and whether the firm has access to other client data or accounts);
• explain how and when client data will be updated in relation to their situation, personal circumstances, etc.

21. Provided that all data and reports provided to the client are in line with relevant provisions (including the obligation to provide data on a durable medium), firms should also carefully consider whether their written communications are designed to be effective (e.g. communications are directly accessible to clients, not hidden or incomprehensible). For firms offering robotised advice, this may particularly include:

• highlighting relevant information (e.g. by using design features such as pop-up windows);
• considering whether some information needs to be accompanied by interactive text (e.g. using design features such as tooltips) or other means to provide additional details to clients who seek further information (e.g. via a frequently asked questions section).
  I.II GET TO KNOW YOUR CLIENT AND YOUR PRODUCT
  Measures necessary for understanding clients
  Relevant legislation: Article 16(2) and Article 25(2) of the MiFID II Directive and Articles 54(2) to (5) and Article 55 of the MiFID II Delegated Regulation.
  General guideline 2.

22. Firms must establish, implement and maintain appropriate policies and procedures (including appropriate tools) that enable them to understand the key facts about their clients and their characteristics. Firms should also ensure that the assessment of data collected from their clients is carried out consistently, regardless of the manner in which this data was collected.

Supporting guidelines
23. Firms' policies and procedures enable them to collect and assess all data required to conduct the appropriateness assessment for each client, taking into account the elements set out in guideline 3.
24. For example, firms may use questionnaires (and in digital form) completed by their clients or data collected during conversations with them. Firms should ensure that the questions they ask their clients are easy to understand and that any other method of collecting information is designed to obtain exactly the data required for the appropriateness assessment.
25. When compiling questionnaires to collect data from their clients for the purpose of conducting the appropriateness assessment, firms should be careful and take into account the most common reasons why investors might answer questions incorrectly. In particular:

• attention should be paid to the clarity, comprehensiveness and thoroughness of the questionnaire, avoiding misleading, confusing, imprecise and overly technical language;
• the structure should be carefully developed and avoiding directing investor choices (font, line spacing...);
• it is necessary to avoid asking too many questions at once (collecting data on a number of items with one question, particularly when assessing knowledge and experience as well as risk tolerance);
• firms should carefully consider the order in which they ask questions to collect information efficiently;
• in order to ensure the collection of necessary information, the option to avoid answering should not generally be offered in questionnaires (particularly when collecting data on investors' financial situation).

26. Firms should also take appropriate measures to assess whether the client understands investment risks and the link between risk and return, as this is a key factor enabling firms to act in accordance with the best interests of the client when conducting the appropriateness assessment. When asking questions about this, firms should clearly and simply explain that answering them helps determine the client's risk profile (risk tolerance) and the type of financial instruments (and risks they contain) that would be appropriate for them.
27. Data required to conduct the appropriateness assessment cover various circumstances that may influence, for example, the analysis of the client's financial situation (including their ability to bear losses) or investment objectives (including their risk tolerance). Examples of such client circumstances include the following data:

• marital status (particularly the client's legal ability to dispose of property that may also belong to their partner);
• family situation (changes in the client's family situation can affect their financial situation, e.g. a newborn child or a child of university age);
• age (which is mainly important to ensure the correct assessment of investment objectives, in particular the level of financial risk the investor is willing to bear, and the holding period / investment time horizon, indicating willingness to hold investments over a certain period);
• employment-related situation (level of job security or the fact that the client is close to retirement can affect their financial situation or investment objectives);
• need for liquidity for certain investments or the need to finance future financial obligations (e.g. purchasing property, education costs).

28. ESMA considers it good practice for firms to consider non-financial elements when collecting data on clients' investment objectives and, in addition to the elements set out in paragraph 27, to collect data on environmental, social and governance factors preferred by the client.
29. When determining the necessary data, firms should take into account the impact that any significant change related to this data may have on the appropriateness assessment.
30. Firms should take appropriate measures to effectively assess whether their clients understand the key characteristics and risks associated with the types of products offered by the firm. For the correct assessment of client knowledge and experience, it is particularly important that firms establish mechanisms to avoid self-assessment and ensure consistency of the answers provided by the client7. Data collected by the firm on client knowledge and experience should be considered together with the aim of a comprehensive assessment of their understanding of products and risks included in recommended transactions or portfolio management.
31. It is also important that firms assess the client's understanding of basic financial terms such as investment risk (including concentration risk) and the risk-return relationship. For this purpose, firms should consider applying indicative, comprehensive examples of loss/return levels that may arise in relation to the level of risk taken and should assess the client's reaction to such scenarios.

7 See guideline 4.

32. Firms should compile their questionnaires so that they can collect the necessary data from clients. This may be particularly relevant for firms providing robotised advice services due to limited human interaction. To ensure compliance with requirements relating to this assessment, firms should also consider factors such as:

• whether the firm can conclude on the basis of data collected via online questionnaires that the advice provided is appropriate for their clients based on their knowledge and experience, financial situation as well as their investment objectives and needs;
• whether the questions in the questionnaire are sufficiently clear and/or whether the questionnaire is designed to provide clients with additional explanations or examples as needed (e.g. using design features such as tooltips and pop-up boxes);
• whether human interaction is available to clients (among other things via e-mail and mobile phones) during the completion of online questionnaires;
• whether measures have been taken to address inconsistent client answers (such as introducing design features in the questionnaire that alert clients when their answers appear inconsistent and encourage them to reconsider those answers; or introducing a system that automatically flags seemingly inconsistent data provided by the client for firm review or subsequent action).

Scope of data to be collected from clients (proportionality) Relevant legislation: Article 25(2) of the MiFID II Directive and Articles 54(2) to (5) and Article 55 of the MiFID II Delegated Regulation.
General guideline 3.
33. Before providing investment advice or portfolio management services, firms should collect all “necessary data”8 on client knowledge and experience, financial situation and investment objectives. The scope of “necessary” data may vary and within it the features of the investment advice or portfolio management services to be provided, the type and characteristics of investment products to be considered as well as client characteristics should be taken into account.
Supporting guidelines
34. When determining “necessary” data, firms should, with regard to client knowledge and experience as well as financial situation and investment objectives, take into account the following:

8 The term “necessary data” should be understood as the data that firms must collect to meet the appropriateness requirements under the MiFID II Directive.

• type of financial instrument or transaction that the firm may recommend or conclude (including complexity and risk level);
• nature and scope of services provided by the firm;
• client's needs and circumstances;
• type of client.

35. While the scope of data to be collected may differ, the rule always applies that recommendations or investments made on behalf of the client must be appropriate for them. In accordance with MiFID Regulation, firms are allowed to collect the level of data appropriate for the products and services they offer, or in relation to which clients request specific investment advice or portfolio management services. This principle does not allow firms to reduce the level of protection to which clients are entitled.
36. For example, when firms enable clients access to complex9 or risky10 financial instruments, they should carefully consider whether they need more detailed client data than when dealing with less complex and risky instruments. In this way, firms can assess the client's ability to understand and financially bear the risks associated with those instruments11. For such complex products, ESMA expects firms to conduct a detailed assessment, including, inter alia, client knowledge and experience, including, for example, their ability to understand the mechanisms that make an investment product “complex”, regardless of whether the client has already traded such products (for example derivatives or leveraged products), how long they have been trading them, etc.
37. For illiquid financial instruments12 “necessary data” to be collected include data on the time period during which the client is willing to hold the investment. Since financial situation data must always be collected, the scope of this data may also depend on the type of financial instruments proposed or in which positions are taken. For example, for illiquid or risky financial instruments, “necessary data” to be collected may include all of the following elements as necessary to determine whether the client's financial situation allows them to invest or have invested on their behalf in such instruments:

• the client's regular income and total income, whether they receive income on a permanent or temporary basis and sources of this income (e.g. employment, pension, investment income, rental income, etc.);

9 As defined by the MiFID II Directive and taking into account the criteria set out in guideline 7.
10 Each firm determines in advance the risk level of financial instruments included in its investor offering, taking into account, as appropriate, possible guidelines issued by the competent authorities supervising the firm.
11 In any case, to ensure that clients understand investment risk and potential losses they may bear, the firm should present these risks in a clear and understandable manner as much as possible, preferably using pictorial examples of loss ratios in the event of poor investment performance.
12 Each firm determines in advance which financial instruments included in its investor offering it considers illiquid, taking into account, as appropriate, possible guidelines issued by the competent authorities supervising the firm.

• assets owned by the client, including liquid funds, investments and real estate, which includes financial investments, movable assets and real estate investments, pension funds and cash deposits, etc. When appropriate to the circumstances, firms should also collect information on the conditions of