In a significant move to enhance regulatory practices within Cyprus’ financial sector, the Cyprus Securities and Exchange Commission (CySEC) has recently issued two essential circulars, C603 and C604. These circulars provide detailed guidelines and directives to ensure strict adherence to international standards and foster a secure financial environment for all stakeholders.
Circular C603: ESMA Guidelines on MiFID II Product Governance Requirements
Issued on 12th October 2023, Circular C603 informs Cyprus Investment Firms (CIFs), UCITS Management Companies (UCITS MC), and Alternative Investment Fund Managers (AIFMs) about the European Securities and Markets Authority (ESMA) Guidelines on MiFID II product governance requirements. These guidelines, published on 03/08/2023, and being effective from 03/10/2023, establish consistent supervisory practices and ensure the uniform application of MiFID II requirements related to product governance. They are applicable to a wide array of financial institutions involved in the manufacturing or distribution of financial instruments and structured deposits.
Please find below the key points arising from the above mentioned ESMA Guidelines:
1. Introduction to MiFID II Product Governance Requirements:
- MiFID II regulations mandate firms to define and evaluate target markets for their financial products.
- Manufacturers and distributors must ensure their products meet the needs and characteristics of identified target markets.
2. Manufacturer’s Responsibilities:
- Manufacturers must define a “positive target market” for each product, considering client type, knowledge, financial situation, risk tolerance, and objectives.
- Manufacturers should also identify a “negative target market” for clients incompatible with the product features.
- Sustainability-related objectives influence the positive target market; however, sustainability factors aren’t considered for negative target market assessments.
3. Distributor’s Obligations:
- Distributors should assess the positive target market defined by the manufacturer and identify clients compatible with the product.
- Distributors are required to define their “own” target market if the manufacturer hasn’t provided one, ensuring an appropriate and proportionate approach.
- Firms distributing products not complying with MiFID II regulations should refrain from including them in their assortment.
4. Target Market Identification Process:
- Manufacturers and distributors should consider the complexity and risk profiles of products when identifying target markets.
- The negative target market indicates clients for whom the product is incompatible and sales to this group should be rare, requiring substantial justification.
- Deviations from the target market should be documented, justified, and reported if relevant for the product governance process.
5. Application to Wholesale Markets and Professional Clients:
- Professional clients’ assumed knowledge and experience should be considered when defining target markets.
- Professional clients acting as distributors must comply with distributor obligations.
- Some products may have broadly defined target markets, including both retail and professional clients, while others, especially complex products, have narrowly defined target markets.
6. Application to Pre-existing Products:
- Products manufactured before January 3, 2018, should fall under MiFID II product governance requirements.
- Target markets should be assigned to these products, with reviews conducted following MiFID II guidelines.
7. Conclusion and Compliance:
- Firms must adhere to MiFID II regulations, ensuring products align with defined target markets and client needs.
- Clear documentation, assessment, and periodic reviews are crucial for compliance.
CySEC, in its circular, emphasizes the importance of these guidelines by integrating them into its supervisory framework. Regulated Entities are urged to diligently apply the guidelines, ensuring compliance with the specified regulatory standards.
Circular C604: EBA Guidelines on Outsourcing
CySEC, on 13/10/2023, also issued Circular C604 to inform Cyprus Investment Firms (CIFs) about the Guidelines released by the European Banking Authority (EBA) on 25/02/2019 regarding outsourcing arrangements. CySEC has incorporated these Guidelines into its supervisory and regulatory practices.
These Guidelines are applicable to CIFs falling under sections 9(1), (3), and (4) of the Prudential Supervision of Investment Firms Law of 2021, specifically those with initial capital requirements of €150,000 and €750,000. They outline internal governance arrangements and risk management protocols that CIFs must follow when outsourcing functions, especially critical or important ones. The Guidelines also provide guidance on how competent authorities should review and monitor these arrangements.
In Circular C604, CySEC urges CIFs to review and adjust existing outsourcing agreements to align with the Guidelines. If the review and adjustment of critical or important function outsourcing agreements are not completed by 30/06/2024, CIFs must inform CySEC through its portal, detailing the planned measures or exit strategy.
Additionally, CySEC emphasizes that CIFs must document all existing outsourcing arrangements (excluding those with cloud service providers) in accordance with Section 11 of the Guidelines after the first renewal date of each arrangement but no later than 30/06/2024.
You can access the EBA Guidelines on outsourcing arrangements here.
For the Prudential Supervision of Investment Firms Law of 2021, please refer to this link.
The issuance of Circulars C603 and C604 underscores CySEC’s dedication to fostering transparency, consistency, and adherence to international standards within Cyprus’ financial landscape. By aligning with ESMA Guidelines on MiFID II product governance requirements and EBA Guidelines on outsourcing, CySEC aims to create a robust framework that ensures the integrity of financial operations. Regulated Entities are urged to familiarize themselves with these guidelines, ensuring swift and accurate implementation. Through these directives, CySEC continues to fortify the financial sector, promoting stability and confidence among investors and market participants alike.