Accepting Customers For Business (Client Categorisation)

Question 1

According to the FCA handbook, what is a client?

Answer 1

A person to whom the firm provides, intended to provide, or has provided:

1. A service in the course of carrying on a regulated activity.
2. In the case of MiFID or equivalent third country of business, and ancillary service (reporting/ settlement services).
3. The FCA handbook’s definition for a “client” also includes:

A. A potential client -
I.e. someone who might become a client soon.

B. In the case of financial promotion communicated by a firm to a client, the client is a client of the firm
I.e. If the firm promotes its services - the person it promotes to is treated as a client.

C. The client of a representative appointed to act in the course of business within the firm, is a client
I.e. a representative working for a firm on behalf of someone - that person is also considered a client.

Question 2

Before conducting investment business with or for any client - a firm must take reasonable care to establish the status of the client.

EU’s MiFID introduce us to main categories of “client” and one for “customer” what are these?

Answer 2

1. Retail clients.
2. Professional clients.
3. Eligible counterparties.

1 & 2 are customers and 3 is client

Note:
A. FCA principals sometimes refer to “a client” and in other occasions to “a customer”

B. The requirements do not extend to eligible counterparties. (Client)

Question 3

What is the need for EU MiFID to introduce categories for client and customer?

Answer 3

1. Each category of “client” has different levels of regulatory protection.
2. Categorisation of clients allows to tailor regulatory requirements according to the knowledge and experience of clients.
3. MiFID provides flexibility to move between categories given that certain criteria is met.
4. Professional clients and retail clients can move between categories generally OR based on the types of products, services and transactions.
5. Eligible counterparty can request treatment as a professional or retail client.
6. The movement between categories changes the level of regulatory protection they can afford

Question 4

Under MiFID II - with regards to moving between categories. What is not allowed?

Answer 4

1. An elective professional client cannot “opt up” to be categorised as an eligible counterparty
2. Movement between categories changes the level of regulatory protection afforded.

Question 5

Briefly explain what a “retail client” is

Answer 5

1. They are afforded the most regulatory protection.
2. Under MiFID II - a local authority is classified as a retail client BUT -
   A. they can “opt up” to a professional client status
   B. To do so, they should be investing on behalf of a Local Government Pension Scheme (LGPS) pension fund
   C. They must satisfy the qualitative and modified version of the quantitative “opt up” requirements (mix of knowledge/ experience and financial thresholds)

Question 6

Briefly explain what a “professional client” is

Answer 6

1. Considered to be more experienced, knowledgeable and sophisticated.
2. Able to assess their own risk and are afforded fewer regulatory protections.

Question 7

Briefly explain what “eligible counterparties” are

Answer 7

1. These are investment firms, credit institutions, insurance companies, UCITS and their management companies and other regulated financial institutions.
2. In certain cases, they also include other undertakings.
3. MiFID rules apply in a more relaxed way (“light touch” regulation) - when investment firms deal with eligible counterparties, they don’t have to follow the same strict protections that apply to retail/ professional clients
4. The assumption is that large firms have enough knowledge and resources to manage their own without needing extra regulatory safeguards.

Question 8

What is a “per se” professional client? (unless it’s an eligible counterparty)

Answer 8

A “per se” professional client -

1. Is a business/ organisation that is automatically considered a professional client due to its nature and activities, unless it qualifies as an eligible counterparty (which has even fewer protections).
2. These entities are assumed to have the knowledge and experience to manage financial risks, so they don’t get the same level of regulatory protection as retail clients.

Question 9

What comes under a “per se” professional client (unless they’re an eligible counterparty)?

Answer 9

Per se professional clients include:

1. Financial firms - which are legally required to be regulated, like investment firms and banks.
2. Government-related entities - e.g. national or regional governments, public bodies that issue debt (e.g., local councils raising money through bonds), central banks, or international organizations (like the IMF or World Bank).
3. Institutional investors - main business is investing in financial instruments, like hedge funds or pension funds.

Question 10

What is the criteria for large businesses/ undertakings (related to MiFID) to be a “per se” professional client?

Answer 10

1. A balance sheet of a total of €20 million.
2. A net turnover of €40 million or,
3. Own funds of €2 million.

Question 11

What is the criteria for large businesses/ undertakings (NOT related to MiFID) to be a “per se” professional client?

Answer 11

1. Be a company/ corporate body with at least £5 million in called-up share capital (money shareholders have committed to the company).

OR

2. Be a large business that meets at least two of these three financial size tests:

A. A balance sheet total (assets minus liabilities) of at least €12.5 million.
B. An annual turnover (total sales revenue) of at least €25 million or,
C. An average of 250 employees or more throughout the year.

Question 12

Explain the process and criteria a firm must follow to treat a client as an elective professional client under MiFID.

Answer 12

1. QUALITATIVE TEST: Assessment of the Client’s Expertise -
   A. Firm must check if the client has the experience, knowledge, and understanding of risks to make their own investment decisions.
2. QUANTITATIVE TEST - For MiFID or third-country businesses
   A. Client must meet at least two out of three of the following criteria:
   • Made significant transactions in the relevant market at least 10 times per quarter over the last four quarters.
   • Financial instrument portfolio (cash and investments) exceeds €500,000.
   • Worked in the financial sector for at least 1 year in a professional role requiring knowledge of investments.
3. WRITTEN PROCEDURE - All to be stated in writing
   A. Client must provide in writing that it wishes to be treated as a professional client either generally or in respect to a particular service, transaction or product.
   B. The firm must give written warning to the client about the loss of regulatory protections.
   C. Client must confirm in a separate document that they understand and accept the risks of losing those protections.

Question 13

What is an eligible counterparty and what are their responsibilities?

Answer 13

1. An eligible counterparty is a type of client that receives the lowest level of regulatory protection under MiFID.
2. They are recognised as a “per se” eligible counterparty or an elective eligible counterparty client.
3. They are experienced and knowledgeable enough to manage investment risks on their own.
4. The “light touch” regulation/ regime applies to eligible counterparties. The regime says that they do all/some of the following:
   A. Execute orders on behalf of the client.
   B. Deal on their own account.
   C. Receive and transmit orders.

Question 14

What are some of the entities that are automatically recognised as “per se” counterparties?

Answer 14

1. Investment firms.
2. Credit institutions (banks).
3. Insurance companies.
4. UCITS (Undertakings for Collective Investment in Transferable Securities) and their management companies.
5. Pension funds and their management companies.
6. Other regulated financial institutions under European or national laws.
7. Companies exempt from MiFID under certain rules (Article 2(1)(k) or (l)).
8. National governments and their public bodies dealing with public debt.
9. Central banks and supranational institutions (like the European Central Bank or IMF).

Question 15

When Can a Firm Treat a Client as an Elective Counterparty for Non-MiFID Business?

Answer 15

1. The client is a business (undertaking) and:
   A. Is already a per se professional client, or
   B. Formally requests to be treated as an eligible counterparty.
2. The firm receives explicit confirmation from the client that they agree to be treated as an eligible counterparty in non-MiFID or equivalent third-country business.
3. Clients can opt to be treated as an eligible counterparty - they MUST request it or confirm their agreement in writing. This means they accept lower regulatory protections when dealing with the firm.

Question 16

Explain what “client agreements” are and what do they mean?

Answer 16

1. MiFID II criteria -
   A. Firms must have written agreements with their clients, whether they are professional or retail clients, for each investment/ related provided
   B. This is not just for new clients, but for each service offered.
2. Agreement should cover -
   A. Terms of the Agreement - outline the rules and conditions of the services the firm is providing.
   B. Information About the Firm and Its Services - provide details about itself, including:
   I. How the client can communicate with the firm.
   II. Potential conflicts of interest.
   III. The firm’s authorized status (i.e., it’s legally allowed to provide these services).
3. Record Keeping -
   A. The firm must keep a copy of the client agreement for as long as the client relationship lasts.
   B. For Pension and Long-Term Agreements (FSAVC) - firm must keep these records forever, even after the relationship ends.