Closing Borders? UK Follows Italy’s CONSOB in Unprecedented Inbound MiFID II Passport Removal

The UK Financial Conduct Authority (FCA) has taken action to stop four Cypriot investment firms from continuing to offer contracts for difference (CFDs) to UK investors. The action marks the first time that the FCA has used its power to remove inbound MiFID passporting rights under Directive 2014/65/EU (MiFID II). The FCA’s action follows a similar move by the Italian financial services regulator, the Commissione Nazionale per le Societa e la Borsa (CONSOB), and potentially signals a more interventionist and restrictive approach by European host-state regulators to inbound passporting firms. 

Background

Hoch Capital Ltd, Magnum FX (Cyprus) Ltd, Rodeler Ltd and F1Markets Ltd are four Cyprus-based investment firms regulated by the Cyprus Securities and Exchange Commission (CySEC). The business of these firms is to provide consumers with the ability to trade CFDs through an online platform. Between 2013 and 2018 each of these firms obtained permission to conduct cross-border services to the UK under MiFID II. This approach is known as passporting. Under the MiFID II passport, the firms were required to comply with the conduct of business requirements of MiFID II, as transposed into Cypriot law.

On 1 June 2020, the FCA announced that it had found each of the four firms to have acted contrary to the requirements of MiFID II, as implemented into Cypriot law, in several respects. Specifically, the FCA found that all four firms (i) used misleading marketing material, (ii) employed aggressive sales tactics, and (iii) failed to conduct appropriateness assessments of the compatibility of their products with their customers. The FCA also found evidence that some of the firms may have charged unjustified or undisclosed fees and inappropriately classified customers as ‘professional investors’ enabling such customers to invest using significantly increased leverage, greatly increasing the potential losses. 

As a result of transacting through the four firms, many customers sustained significant financial losses. In several cases the loss exceeded £100,000. In order to secure an appropriate degree of protection for consumers, on 28 May 2020, the FCA to took the unprecedented step of exercising its power of intervention in respect of these incoming passporting firms by requiring each of the four firms to (i) stop selling CFDs to UK customers, (ii) close existing positions with UK customers, (iii) return UK customers’ money, and (iv) notify UK customers of the FCA’s action. Although the firms are entitled to seek a review of the FCA’s action, the intervention is significant as it is the first time the FCA has used its power to remove passporting rights from a firm.

The FCA’s action reflects similar action taken by CONSOB to prohibit Hoch Capital Ltd and Rodeler Ltd from passporting investment services and activities in Italy in early December 2019.

Legal Basis & Procedure 

Article 86 of MiFID II contains the power for host-state regulators to take precautionary measures against inbound passporting firms and underlies the CONSOB’s and the FCA’s action. In the UK, it is implemented in Part XIII of the Financial Services and Markets Act 2000 (FSMA). The specific power and procedure for such interventions in the UK’s implementing regime are largely contained in FSMA sections 194 (grounds), 196 (power), 197 (procedure) and 199 (additional procedural steps for certain EEA firms in certain cases).

MiFID II Article 86(1) provides that where a host-state regulator has ‘clear and demonstrable grounds’ for believing that an EU investment firm acting in its territory under the MiFID II passport is not complying with the obligations arising from MiFID II (which do not confer powers on the host-state regulator), the host-state regulator shall refer its findings to the firm’s home-state regulator. 

If following such referral, despite the measures taken by the home-state regulator, the firm persists in acting in such a way that ‘is clearly prejudicial to the interests of host Member State investors or the orderly functioning of markets’ (MiFID II Article 86(1)), the host-state regulator, after informing the firm’s home-state regulator, may take all the appropriate measures needed in order to protect investors and the proper functioning of the markets. This shall include the possibility of preventing offending investment firms from initiating any further transactions within the host-states’ territory. The European Commission and ESMA shall be informed of such measures without undue delay (Article 86(1)(b) of MiFID II).

Comment

Following the FCA’s action, the CySEC fully suspended the regulatory authorisations of Rodeler Ltd and Hoch Capital Ltd and partially suspended the regulatory authorisations of Magnum FX (Cyprus) Ltd and F1 Markets Ltd. It is interesting that the CySEC did not take this action prior to the FCA’s intervention on the basis of the FCA’s initial notification of the issues. This is all the more peculiar given the CONSOB’s action to prohibit Hoch Capital Ltd and Rodeler Ltd from passporting investment services and activities to Italy occurred as far back as early December 2019. Following the FCA’s action, in early June 2020, the CySec proceeded to revoke the permissions of three other Cypriot CFD firms to conduct regulated activities on a cross-border passport to the UK.

The CySEC’s reluctance to intervene at an earlier stage in relation to the initial four firms and subsequent action in relation to the latter three firms may indicate political sensitivities regarding the passport revocation process. These sensitivities are reflected in the European Commission and ESMA notification process in MiFID II Article 86(1)(b) and paragraph 8.7.2 of the FCA’s Enforcement Guide which provides that ‘when it is considering action against an incoming firm, the FCA will co-operate with the firm's Home State regulator as appropriate.’ In this respect it is noteworthy that both the FCA and the CONSOB interventions were the first of their kind. The fact that these powers were exercised suggests an erosion of political sensitivities. 

Whilst the UK’s expected departure from the EU financial services regime on 1 January 2021 may limit the FCA’s ability to exercise these powers again, the FCA’s intervention is still significant. The FCA is a very well regarded sophisticated financial regulator—often viewed as a lead regulator. As such, other European regulators will likely take an interest in the FCA’s analysis and action and this may increase their own appetite to exercise inbound passport revocation powers. 

The current choppy political and economic waters created by Covid-19 and Brexit may add to the appetite for taking such action. In these difficult times for consumers it will be difficult for host-state regulators to wait at length for home-state regulators to act. Coupled with the blue-prints for action now provided by the FCA and the CONSOB, the direction of travel might be to a more interventionist and restrictive approach by host-states to inbound passporting firms. Firms in regulatory crosshairs should watch out. The borders might be closing. 

John Ahern is a Partner at Covington & Burling LLP, London.

Nikesh Pandit is a Pupil Barrister at 4-5 Gray’s Inn Square.