IMC Chapter 3 - 3.2 - Client Categorisation

Question 1

Name the 3 categories of clients.

Answer 1

There are three categories of client:

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

Question 2

Define what is meant by ‘Consumer’

Answer 2

A natural person who is a retail client.

Question 3

Define what is meant by ‘Customer’

Answer 3

Retail clients and professional clients, but not eligible counterparties.

Question 4

Define what is meant by ‘Client’

Answer 4

Any or all of retail clients, professional clients, and eligible counterparties

Question 5

List the 4 types of persons defined as clients of a firm.

Answer 5

1. In relation to MiFID business, a person to whom the firm provides a service or an ancillary service
2. A potential client
3. In relation to the financial promotion rules, a person to whom a financial promotion is communicated by or on behalf of the firm
4. A client of an appointed representative of the firm

Question 6

When must a firm notify a client of its categorisation?

Answer 6

Before providing any services.

Question 7

What 2 things must be included when notifying a client of their category?

Answer 7

1. Their right to a different categorisation.
2. Any limitations to the level of client protection

Question 8

Technically is an eligible counterparty a client?

Answer 8

No it’s not, technically speaking.

Question 9

Define an eligible counterparty.

Answer 9

Eligible counterparties are the most knowledgeable and experienced parties in the markets.

Question 10

What happens when firms conduct business with eligible counterpaties?

Answer 10

When these parties conduct certain business with each other it becomes difficult to identify who is the firm and who is the client.

Question 11

Define what a retail client is.

Answer 11

A retail client is a client who is not a professional client or an eligible counterparty. This will normally be individuals and small businesses.

Question 12

Name the 2 types of professional clients.

Answer 12

1. A per se professional client
2. An elective professional client

Question 13

What is the difference between a per se professional client and an elective professional client?

Answer 13

A per se professional client is automatically a professional client.

An elective professional client chooses to be a professional client.

Question 14

List the 5 criteria used to identify if a client is a per se professional client.

Answer 14

This is the full list of per se professional clients.

1. Firstly, it is organisations required to be authorised or regulated to operate in the financial markets, such as a credit institution or an investment firm.
2. Next, in relation to MiFID business, an undertaking can be a ‘per se’ professional client if it meets two out of the three tests below:

• Balance sheet total of €20m
• Net turnover of €40m
• Own funds of €2m

3. In relation to non-MiFID business the tests are different:

• A company or limited liability partnership (LLP) with called up share capital of at least £5m; or
• A company meeting two of the following three size requirements:
  
  • Balance sheet total of €12.5m
  • Net turnover of €25m
  • Average number of employees: 250

4. A national or regional government, a public body that manages public debt, a central bank, an international or supranational institution (such as the World Bank or the International Monetary Fund) or another similar international organisation.
5. An institutional investor whose main activity is to invest in financial instruments, such as a company created to securitise assets (a special purpose vehicle).

Question 15

Why would a client choose to be an elective professional client?

Answer 15

Charged lower fees by the firm.

Question 16

What are the 3 things a client must comply with in order to be treated as a professional client?

Answer 16

1. The ‘qualitative test’
2. The procedures
3. The ‘quantitative test’

Question 17

What is the ‘Qualitative test’?

Answer 17

In particular, the ‘qualitative test’ requires the firm to undertake an adequate assessment of the expertise, experience and knowledge of the client. This must give reasonable assurance, in light of the nature of the transactions or services envisaged, that the client is capable of making its own investment decisions and understands the risks involved.

Question 18

List the 3 things the procedures require.

Answer 18

The procedures require that:

1. The client must state in writing that it wishes to be treated as a professional client (either generally or in respect of a particular service or transaction or type of transaction or product).
2. The firm must give the client a clear written warning of the protections and investor compensation rights the client may lose.
3. The client must state in writing, in a separate document from the contract, that it is aware of the consequences of losing such protections.

In summary, this is a three-way process. The client states it wants this treatment, the firm provides details of the consequences and the client confirms it understands this.

Question 19

Does the ‘quantitative test’ apply to all business?

Answer 19

The ‘quantitative test’ only applies to MiFID business.

Question 20

List the three requirements used in the ‘quantitative test’.

Answer 20

1. The client has carried out transactions, of significant size, on the relevant market at an average frequency of ten per quarter over the previous four quarters
2. The size of the client’s financial instrument portfolio (defined as including cash deposits and financial instruments) exceeds €500,000
3. The client has relevant work experience. In particular, the client works, or has worked, in the financial sector for at least one year in a professional position. This position must require knowledge of the transactions or services to be undertaken

Question 21

How many of the 3 requirements of the quantitative test must be satisfied for a client to pass the test?

Answer 21

2

Question 22

What category is given to local authorities under MiFID II?

Answer 22

Under MiFID II,local authorities are treated as retail clients. However, if the local authority is investing on behalf of a local government pension scheme, they can opt up to elective professional client.

Question 23

What if a client no longer meets the test?

Answer 23

There should be systematic reviews of professional clients to ensure that they still meet the requirements. If the firm becomes aware that an elective professional client no longer fulfils the relevant initial conditions for elective status, the firm may need to recategorise the client as a retail client. If the client is recategorised, it must be notified of this.

Question 24

Name the 2 types of eligible counterparties.

Answer 24

1. Per se eligible counterparty
2. Elective eligible counterparty

Question 25

Define eligible counterparty business.

Answer 25

• Account dealing
• Executing client orders
• Transmission of orders (or ancillary services)

Essentially eligible counterparty business can be summarised as acting as principal, as a broker, or transmitting to a third party with an eligible counterparty.

Question 26

List 10 per se eligible counterparties.

Answer 26

1. An investment firm
2. A credit institution
3. An insurance company
4. A UCITS scheme (or its management company)
5. A pension fund (or its management company)
6. Another authorised or regulated EEA financial institution
7. Certain own account dealers in commodities or commodity derivatives
8. A national government (including a body dealing with public debt)
9. A central bank
10. A supranational organisation, such as the International Monetary Fund or World Bank

Question 27

Who is the status of being an elective eligible counterparty available to?

Answer 27

Any undertaking that is a per se professional client (except an institutional investor).

Question 28

In relation to MiFID business what are the rules surrounding elective eligible counterparties?

Answer 28

In relation to MiFID business, the firm must obtain express confirmation from the client that it agrees to be treated as an eligible counterparty (this confirmation may be either in the form of a general agreement or in respect of each individual transaction). A client can choose, therefore, to be a professional client for one type of business and choose to be an eligible counterparty for another business type.

Question 29

Name the 3 types of clients that cannot be eligible counterparties.

Answer 29

As an eligible counterparty is provided with less protection, three types of clients cannot be eligible counterparties.

These are:

1. Individuals
2. Other institutional investors e.g. Special Purpose Vehicles (SPVs)
3. Elective professional clients

Question 30

What are the ways a per se eligible counterparty and a per se professional client may be treated?

Answer 30

A per se eligible counterparty may be treated as a professional client or a retail client; and a per se professional client may be treated as a retail client. This may be done either on the firm’s own initiative or at the request of the client.

Question 31

How must a firm treat a per se eligible counterparty that asks to be subject to conduct of business protections?

Answer 31

Where a per se eligible counterparty asks to be subject to conduct of business protections, the firm must treat that client as a professional client (unless the client expressly requests treatment as a retail client).

Question 32

What happens in relation to MiFID business, if a per se eligible counterparty or a per se professional client requests treatment as a retail client?

Answer 32

In relation to the MiFID business, if a per se eligible counterparty or a per se professional client requests treatment as a retail client, it must enter into a written agreement with the firm specifying the scope of the new categorisation (i.e. what services or transactions it applies to).

Question 33

What must a firm have in place to categorise its clients?

Answer 33

A firm must have in place appropriate written internal policies and procedures to categorise its clients.