Client consent to execution policy and execution of orders outside a regulated market or MTF - COBS Provision

The vexed question of how clients consent to a best execution policy in general, and provide permission for their orders to be handled away from regulated exchanges in particular, is covered in COBS 11.2.25 and 11.2.26. As we shall see.

Section 11.2.25, COBS Rules

COBS Rules
11.2.25

(1) A firm (other than a management company providing collective portfolio management services for a UCITS scheme or an EEA UCITS scheme) must obtain the prior consent of its clients to the execution policy.

(2) In the case of a management company providing collective portfolio management services for an ICVC that is a UCITS scheme, or for an EEA UCITS scheme that is structured as an investment company, the management company must obtain the prior consent of the ICVC or investment company to the execution policy.

(3) In the case of a management company that is the ACD of an ICVC that is a UCITS scheme, (2) does not apply where the ACD is the sole director of the ICVC.

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Commentary

From CESR's "Best Execution under MiFID" Questions and Answers document of May 2007 (CESR/07-320):

Q20 How do clients consent to the execution policy?

20.1 An investment firm that executes orders or decisions to deal should obtain the prior consent of its clients to its execution policy. CESR observes that for consent to be valid, the legal provisions of the relevant Member State relating to the giving of consent must be satisfied, without prejudice to what is said in Q14 through Q16 about the information that the firm should provide to clients.
20.2 A firm should obtain the prior express consent of its clients before executing their orders outside a regulated market or MTF.
20.3 There are no comparable requirements for firms when they transmit or place orders with other entities for execution but do not execute orders or decisions to deal themselves.

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Section 11.2.26, COBS Rules

COBS Rules
11.2.26 A firm must obtain the prior express consent of its clients before proceeding to execute their orders outside a regulated market or an MTF. The firm may obtain this consent either in the form of a general agreement or in respect of individual transactions.

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Commentary

Products which don't trade on a regulated market or MTF

While at first blush it reads as though 11.2.26 should apply to all orders, even those which cannot be traded on a regulated market in any circumstances (otc swaps for example), the confines of common sense and logic have not entirely escaped the European Commission. In its "Questions on Single Market Legislation" resource, it notes:

However, on a purposive reading of the express consent requirement, an investment firm does not have to obtain express consent from its clients where the relevant instruments are not admitted to trading on a regulated market or MTF.

This view was confirmed in CESR's "Best Execution under MiFID" document:

21.2 CESR considers that on a purposive reading of the "express consent" requirement, an investment firm does not have to obtain express consent from its clients where the relevant instruments are not admitted to trading on a regulated market or MTF.

=====Products which trade OTC - can the transaction a consent to execute off regulated market?===== In order to comply with this rule, the safest course is to ask clients for a generic permission to execute trades off regulated markets or MTFs across the board. Some clients might object, however, to such a wide-ranging permission.

You can of course ask instead for consent "in respect of individual transactions" (per the wording of 11.2.26). This might seem unfeasible, but consider that for many products that might oherwise be caught (especially OTC transactions) the very act of transacting in a certain way - if that way necessarily entails trading outside a regulated market or MTF - amounts to express consent to trade in that way.

And that is actually a pretty fundamental get-out.

There is an unspoken distrinction in the COBS rules between:

• "agency" or "quasi-agency" orders: orders whereby a broker receives instructions from client and then turns around and interacts with third party venues (including regulated markets, MTFs but also unregulated venues like systematic internalisers), without involvement of the client, to fill that order); and
• "bilateral" transactions where client trades with the broker directly in a principal capacity and any transaction between the broker and the market is by way of hedge and not fulfillment of the customer's order. These are things like OTC derivatives under an ISDA Master Agreement; spot FX trades and so on.

Consent and Express Consent

From the "Best Execution under MiFID" Q&A document:

Q21 What is the difference between "consent" and "express consent"?

21.1 Where MiFID requires "prior express consent", CESR considers that this entails an actual demonstration of consent by the client which may be provided by signature in writing or an equivalent means (electronic signature), by a click on a web page or orally by telephone or in person, with appropriate record keeping in each case.

Conduct of Business

This is an article about the FCA’s conduct of business rules, known by its chapter in the FCA Sourcebook, COBS, which implement, among other things, MiFID (directive 2004/39/EC (EUR Lex) and implementing directive 2006/73/EC (EUR Lex)).