ESMA issues guidelines on MiFID II suitability requirements

On 6 November 2018, the European Securities and Markets Authority (ESMA) issued guidelines on certain aspects of the MiFID II suitability requirements.

Pursuant to EU Directive 2014/65/EU (MiFID II), the guidelines specify how authorities and firms should provide investment advice and portfolio management to retail clients.

The purpose of the guidelines is to clarify the application of certain aspects of MiFID II suitability requirements in order to ensure a common, uniform and consistent approach with the aim of strengthening investor protection.

The majority of the guidelines relate to "know your client" and "know your product" issues. ESMA provides detailed information, which firms can apply to better understand their clients. This information includes:

• the most common reasons why investors could fail to answer questionnaires correctly; and
• those elements affecting the analysis of a client’s financial situation or investment objectives when collecting data necessary to conduct a suitability assessment.

ESMA provides supporting guidelines (with examples) regarding the information firms should consider in relation to a client’s knowledge and experience, financial situation and investment objectives.

Examples are given of the complex, risky or illiquid financial instruments that should be treated with caution. ESMA reminds firms that the nature of the client and the service requested may also influence the level of detailed information about the client that is available for collecting.

The guidelines also deal with the reliability of client information. ESMA stresses that:

• client self-assessments should be counterbalanced by objective criteria;
• firms should not only investigate the desirable risk-return characteristics of future investments but they should also take into account the client’s risk perception; and
• firms should apply mechanisms to address the risk of the tendency of clients to overestimate their knowledge and experience.

ESMA also provides guidance on the frequency of updating client information, client information for legal entities and groups, and the arrangements necessary to understand investment products.

Another important part of the guidelines relates to the issue of how to match clients with suitable products. In this context, ESMA offers details on the arrangements necessary to ensure the suitability of a given investment.

ESMA emphasises that when a firm conducts a suitability assessment based on the client’s entire portfolio, it should ensure an appropriate degree of diversification. It also details costs and how complex products should be. In respect to costs and the benefits of switching investments, ESMA reminds firms about the importance of taking into account both the monetary and non-monetary factors of costs and benefits.

The guidelines will come into effect 60 days following the date when a competent authority reported to ESMA that it intends to comply. The deadline for each authority to so report is 6 January 2019.

For more information and expert advice on these guidelines, please do not hesitate to contact us directly.