MiFID II Transaction Reporting and what it means for your clients

Investment providers have to ask for a lot of information these days, and it isn’t always clear why.

In a previous article I looked at FATCA and CRS, which are rules about identifying a client’s country of tax residence and, in some cases, country of citizenship. This is about spotting individuals from one country who are sheltering assets for tax reasons in another country.

If you’re wondering why your clients get asked about nationality, it may be to do with MiFID II transaction reporting. This is completely unrelated set of rules, but there are some similarities and overlap in respect of the information being asked for.

In this article, I’ll explore the background to these rules, how they’re used and more importantly what they mean in practice. I’ll also identify a couple of scenarios that can catch people out.

Background

The Markets in Financial Instruments Directive 2014, usually known as MiFID II, is a piece of EU legislation that came into force in July 2014.

It was introduced alongside the Markets in Financial Instruments Regulation (MiFIR). Together, these acts create the legal framework for securities markets, with the aim of making them more competitive, transparent and resilient. MiFID 1, which had been in effect since 2007, was repealed as part of this.

While MiFID II came into force in July 2014, the actual implementation date wasn’t until 3 January 2018. The UK retained these rules following its exit from the EU in 2020, albeit with some changes.

Transaction reporting is one part of these rules, and this is what this article will focus on. They aren’t new rules, as they appeared in MiFID I, but MiFID II expanded their scope.

Under these rules, investment firms executing transactions, such as investment platforms or stockbrokers, are required to report details of the transaction as quickly as possible to the FCA and no later than the following working day. As such, there is a tremendous amount of data now being sent to financial regulators.

Since their introduction, the use of these rules has developed, and they’re now the FCA’s primary tool for detecting and preventing market abuse. The Bank of England was also able to use transaction reports to unpick the bond crash following the Truss-Kwarteng mini budget in 2022.

Investment providers can also use the data to check for system issues and irregularities, to identify weaknesses and to ensure good customer outcomes.

Reportable instruments

It’s important to understand which transactions are reported, and here the rules refer to “reportable instruments”. In short, these are any investments that are traded on a stock exchange. This mainly means equities, investments trusts and ETFs, although some derivatives are also included in the definition.

It’s important to mention that other investment funds such as unit trusts and OEICs are not reportable.

Whenever a reportable instrument changes hands, the transaction must be reported to the FCA. Typically, these will be sales on the open market, but it includes any situation where there’s a change in beneficial ownership, such as investments being gifted to a spouse, paid out of a discretionary trust or inherited on death.

If an investment provider isn’t able to report a transaction, perhaps due to not having the right information, it may refuse to carry it out.

Nationality

In order to fulfil its reporting requirements, the investment provider needs two pieces of information from the client – their nationality and their National Client Identifier. Both of these need further explanation.

Nationality itself is not defined in the rules – it simply follows the rules of the countries in question. Where it gets a bit more complicated is where a client has dual nationality.

For the purposes of transaction reporting, one nationality is given priority over the other, and this is determined by a strict hierarchy (which is available on the FCA website). The hierarchy is essentially alphabetical, but it’s based on the two-letter ISO code for the country. A client can’t decide which nationality to put forward.

So, for example, if a client is dual national Spanish and French, it’s Spanish that takes priority as Spain is higher in the hierarchy. (‘ES’ comes before ‘FR’.)

At the very bottom of the hierarchy is ‘all other countries’. Therefore, if a client is dual national and one of their nationalities is a non-EU nationality, it’s the EU nationality that takes precedence.

Note that UK nationality is still in the hierarchy despite the UK no longer being in the EU. Therefore, for a client with UK nationality and Irish nationality, for example, it’s their UK nationality that takes precedence as the UK (‘GB’) is above Ireland (‘IE’) in the hierarchy.

National Client Identifier (NCI)

In addition to nationality, the investment provider will require the National Client Identifier (NCI) for your client. This is specific to their nationality, and the different countries have allowed different NCIs.

For the most part, these are tax ID references or personal identifier codes. In the UK, for example, the NCI is the National Insurance Number (NINO).

Some countries allow two or three different types of NCI. The majority also allow a concatenation of numbers and letters based on nationality, date of birth and name.

Concatenation itself is a generic term, but the transaction reporting rules have a set format for this particular concatenation that is the same across the board.

A small number of countries only allow one reference, this being the main tax code, and they don’t allow concatenation. Spain only allows the tax identification number (código de identificación fiscal). Italy, Iceland and Estonia are similar, and this can create challenges.

In a situation, for example, where a client was born in Spain to Spanish parents but moved to the UK at a young age, they’ll have a UK NINO but they’re very unlikely to have a Spanish tax identification number having never worked there. As Spain is above the UK in the hierarchy, it’s the Spanish NCI that the investment provider will insist on, and some providers may refuse to open an account for them without it.

It’s worth touching back on the definition of reportable instruments here. Some providers may be happy to open the account but block access to equities, ETFs and investment trusts. If you’re able to find suitable investments for your clients that are unit trusts or OEICs, this may be a way forward.

Legal Entity Identifier (LEI)

Where the investment account holder is an entity, no nationality or NCI is required. Instead, the entity is required to obtain a Legal Entity Identifier (LEI). This is a 20-digit alphanumeric code that is unique to that entity.

An LEI can be obtained from a Local Operating Unit (LOU). In the UK, the London Stock Exchange is an LOU but there are several others. Unfortunately, buying an LEI comes at a cost – around £50 to £100 depending on the LOU. There is also a renewal fee, which is typically around £50.

Entities that will require an LEI are trusts, limited companies and charities. Small Self-Administered Schemes (SSASs) will also require one. However, SIPPs won’t. Nor will bare trusts with a sole beneficiary. In those latter two scenarios, it would be the member’s or beneficiary’s nationality and NCI that would get reported.

Decision maker

So far, we’ve focused on the details of account holder. However, it’s important to be aware that details of the ‘decision maker’ are also included in the report.

The starting assumption is that the client is the decision maker, but this won’t always be the case. The two scenarios you’re most likely to come across are powers of attorney and discretionary investment mandates.

With the former, it means the investment provider will need the nationality and NCI of the attorney (assuming it is actually the attorney signing off the investment decisions). With the latter, it will need the LEI of the firm making discretionary decisions.

Deceased clients

One scenario where advisers may need to pay particular care is where investments are being passed onto beneficiaries following the death of a client.

As mentioned earlier, this represents a change in beneficial ownership. But given that most EU countries don’t have executors like in the UK, the rules don’t reflect how this intermediate stage of the process works in the UK where assets are collected and held by an executor before distribution, and this can create unintended consequences.

Under UK law, the executor legally owns the assets within the estate. However, from a transaction reporting perspective, it is viewed as a transaction between the deceased and the beneficiary. (The rules specifically say the deceased is the ‘seller’.) Whereas from a UK legal perspective we might tend to view it as a transaction from deceased to executor to beneficiary.

In practice, if the beneficiary held an account on a different platform from the client, the transaction to change beneficial ownership would be happening mid-flight between the two platforms. This type of transaction is challenging to report, and many platforms are unable to do it, so may refuse to allow it.

One solution to this is for the beneficiary to open an account on the same platform as the deceased client. The transaction would be taking place all on the one platform, making it straightforward to report. The beneficiary would then be free to transfer their holding to their platform of choice.

(Similar cross-platform issues can arise with spouses gifting assets to each other and discretionary trusts distributing assets to beneficiaries.)

There can also be challenges around investment purchases as well. While executors won’t typically be buying new assets with estate funds, there may be situations where they want to instruct the existing discretionary manager to continue managing or rebalancing the portfolio. Under the transaction reporting rules, there is no mechanism to report the deceased or the executor as the ‘buyer’. If the transaction can’t be reported, the investment provider may refuse to allow it.