Brexit forced UK investment firms to find more creative ways to maintain access to investors domiciled in Europe. Whilst some member states in Europe have either introduced in the aftermarket of Brexit or always had local third country regimes – allowing for foreign investment firms to register and provide investment services within their territories – this approach is not commonly adopted across Europe. The European wide third country regime for investment services under MiFIR is also far from being applicable in practice for the lack of equivalence determinations as at today.  

The MiFID directive contains provisions for tied agents. In the very recent past, the use of tied agents has increased exponentially to the point that it attracted attention from European supervisory authorities. In a bid to mitigate the risk of regulatory arbitrage in the application of these rules across different member states in Europe, ESMA issued a briefing on the supervisory expectations when appointing MiFID Tied agents. 

The supervisory briefing from ESMA is not new policy and does not trigger any comply or explain mechanism by national supervisory competent authorities. It is essentially a tool to promote supervisory convergence. The briefing covers the expectations of supervisory authorities when investment firms appoint tied agents and use them on an on-going basis. 

What is a MiFID Tied Agent 

Tied agents derive their authorisation to provide certain specific investment services from the principal firm they represent and do not need to undergo a distinct authorisation process themselves. The MiFID directive defines tied agents to be either natural or legal persons. They operate under the full and unconditional responsibility of one investment firm only and their role is to promote investment and other ancillary services on behalf of the principal investment firm they work for. In a very restrictive interpretation of the provisions of the MiFID directive, tied agents are merely extensions or allies of the principal firm. Think of an investment firm adding a call centre operated by tied agents to boost its outreach to certain investors, same as adding tied agents with language skills or in a particular territory to increase sales. The use case for tied agents was seen at inception in the insurance world in certain southern European countries, where firms would hire these figures to boost outreach and sales.  

When hiring tied agents, European investment firms are not limited by the perimeter of their own member state of establishment. MiFID directive indeed allows investment firms to hire these figures also when the natural or legal persons are based outside of their own home state. There are of course differences in the underlying principles and mechanisms governing the appointment of tied agents in these two situations. MiFID directive receives respectively under article 34 and 35 the two distinct fundamental rights related to the freedom to provide services as well as freedom of establishment in Europe. The appointment of tied agents based in the same member state of the principal investment firm falls under the freedom to provide services scenario. When MiFID firms appoint tied agents based outside of their home member state, however, that use of tied agents will be assimilated to a request for the establishment of a branch in that host member state under the freedom to establishment principle. 

The freedom-to-provide-services principle allows MiFID tied agents to carry out their activities on behalf of the principal firms also on a cross border basis in Europe based on the existing passport authorisations of the principal firm. Whilst in principle the freedom of establishment would confine their activities to the perimeter of their home state, which is also the case of the branch, in practice there would be no limitation for them to operate also cross border in Europe.   

The UK Appointed Representative 

Part of the reason why ESMA introduced the supervisory briefing on MiFID tied agents is Brexit driven. It is no secret that UK investment firms have mostly made use of MiFID tied agent arrangements in the immediate aftermath of Brexit to continue to access investors across Europe. By becoming tied agents of European investment firms, UK investment firms have found a short-term solution to the loss of passporting rights. When looking at tied agents from the perspective of UK investment firms, it helps to have fully grasped the difference between this concept and the UK appointed representative.  

For as long as a definition of tied agent will be retained under the UK regulatory framework, an appointed representative will also be a tied agent. However, profound are the differences between the UK appointed representative and the MiFID tied agent. The notion of appointed representative in the UK regulatory framework for financial services is essentially designed as an exemption to the main prohibition under the local Financial Services and Markets Act. Where only authorised persons can carry out financial services activities, by virtue of an agreement with principal investment firms and subject to abiding to the conditions therein, appointed representatives are allowed to carry out investment activities independently and without needed distinct authorisation to do so. They are nevertheless subject to the monitoring of their principal investment firms. And where the relation with the principal firm must be disclosed to third parties, the appointed representative is not bound to act on behalf of the principal firm as the MiFID tied agent is required instead. Where the use case of MiFID tied agents in the aftermath of Brexit was for UK investment firms to continue to have access to European investors, the predominant interpretation of this European concept has been morphed at inception on the more relaxed and business-oriented model of the UK appointed representative.  

A Conservative Take on MiFID Tied Agents  

In its briefing, ESMA wants to offer a different and more conservative take on the use of MiFID tied agents, with a very literal interpretation of the corresponding provisions under the MiFID rules. This approach does not go against the business climate we generally witness in Europe. To the contrary of the UK, where leasing models for investment services licenses were introduced quite early in the process, contributing to the leadership of the UK within the Union, European firms would typically obtain MiFID licenses for the exclusive purpose of carrying out the related regulated activity and for no other reason, let alone lending it. We believe it to be a fair conclusion that where the use of the leasing model in Europe has flourished for what concern fund management, the same is not the case yet for the investment services.  

Against this rather conservative backdrop, it is of no surprise that the expectations of supervisory authorities in this context, as defined by ESMA, do insist on a notion of MiFID tied agent that is essentially an extension of the principal firm. To the contrary of appointed representatives, MiFID tied agents shall operate within the clear boundaries of the agency relationship with the principal investment firm on whose behalf they are acting. And where this approach has implications for the tied agents themselves, it also comes with consequences for principal firms. According to ESMA, investment firms shall be required to substantiate how the hire of a particular tied agent might add to their broader operations and plans. ESMA also hints to the fact that the benefits derived from hiring a particular tied agent for the overall business of the principal investment firms shall be accounted for in a business plan.  

Many are the implications of this approach. Amongst other things, inevitably this spells capacity constraints for principal investment firms in Europe on the number of tied agents they will be able to hire. How many tied agents are enough – or too many – to boost the activities of one principal investment firm? This approach will put pressure on the growth of the leasing model across Europe for what concerns investment services.   

A Different Formula for MiFID Tied Agents  

One of the interesting points raised by the ESMA briefing is of course related to the existence of sufficient substance in the EU domiciles where tied agents will be domiciled. One of the risks of the MiFID tied agent model is that it can facilitate the circumvention of the loss of passporting rights vis-à-vis the European Union. That is clearly the case when UK investment firms, by virtue of being hired as tied agents of European investment firm, can continue to offer out of London their investment services and activities across Europe as if Brexit never happened.  

MiFID tied agents established as legal persons will have to possess sufficient substance in the European domiciles where they are established. Whilst the related requirement will be dictated by and large by local laws, with requirements depending to a varying degree on the European domicile at issue, we can expect that substance will be interpreted as having a physical presence, local directors and employees.  

But ESMA also goes a step further for what concerns the public disclosure of the tied agent principal relationship. ESMA expects tied agents to present themselves as operating on behalf of the principal investment firm they belong to when dealing with clients. Codifying a practice already existing in the market in Europe, this requirement is construed by ESMA to mean that it is expected that a dedicated email address of the principal investment firm is used by tied agents when approaching clients. The ramifications of this approach are deep, including that the MiFID principal firm will be the contracting entity with clients for the business brought by the tied agents and not the tied agent or any other third company for that matter.  

Local versus Global 

The race to find the new capital of financial services in Europe – the new London – started as soon as the results of the Brexit referendum were made public. As at today, no other capital in Europe has yet been able to take on this role fully and become the new European global hub for the entire spectrum of financial services. Different European capitals have been able to offer an alternative to London only for certain financial services. That is because of language barriers, bureaucracy and different standards for local business practices and customs.   

For what concerns investment services under MiFID, the choice nowadays seems to be restricted to a very narrow list of continental and southern European domiciles. On the one hand, the European domiciles known as fund hubs – or European gateway for funds – have signalled very clearly from the onset their intention to remain selective in the business and capital they attract. They have dissuaded indirectly or more overtly anybody who tried to propose that these could also become MiFID hubs. On the other, some European domiciles, so far mostly with local business and capital, are slowly starting to pop up on the radar of the global industry as places where it would be in principle possible to carry out a European MiFID business based on the leasing model.  

Conclusions 

The ESMA briefing represented a significant tightening of the conditions for the offer across Europe of the leasing model for the provision of investment services under MiFID and will have a toll on its growth going forward. Whilst the response to the briefing has been varied and national competent authorities across Europe are interpreting it somewhat differently, there have been already repercussions in the industry.  

We have witnessed so far no significant growth in the number of providers of MiFID services on a leasing model across Europe. These also seem to have established themselves in a handful of critical domiciles. The approach of the national competent authorities in these domiciles seems also to be very different, with some adhering more strictly to the briefing than others. Coupled with that there is also a more selective approach of these providers, who are now able to both dictate their prices and cherry-pick the firms and groups they want to offer their MiFID tied agent arrangements and services to.