FESCO

​

The Forum of European Securities Commissions
F E S C O

Date: November, 1999
Ref.: Fesco/99-052g

IMPLEMENTATION OF ARTICLE 11 OF THE ISD:
CATEGORISATION OF INVESTORS FOR THE PURPOSE OF CONDUCT OF BUSINESS RULES

Consultation paper
November 1999

- Introduction

-Criteria for defining professional investors:

I.- Categories of investors who are considered to be professionals

II- Investors who may be treated as professionals on request

II.1.- Identification criteria

1. Large size entities
2. Small size entities and private individual investors

II.2.- Procedure

Introduction

1. Article 11 of the Investment Services Directive (ISD) states that rules implementing its principles must be applied in such a way as to take into account the professional nature of the person for whom the service is provided. In accordance with this provision, conduct of business rules must take account of the client's knowledge and experience in the area of investment services and instruments.

2. For the members of FESCO⁽¹⁾, implementing an appropriate differentiation between categories of investors for the purposes of the conduct of business regime is a necessary complement to the process of harmonising conduct of business rules. Together, progress on these two issues should contribute to an increase in the flow of financial services within the European Economic Area, by making regulation both more uniform (and therefore easier to comply with) and less prescriptive for professional clients.

3. While other investors will require a level of protection that reflects their lesser expertise, professional investors need fewer externally imposed protections. Professionals may be expected to be able to protect their own interests and those of clients. In any case of course, professionals will not only be expected to be able to protect the interests of their clients, they will be legally required to protect them, by conduct of business rules or otherwise.

4. For the members of FESCO, this implies that certain investors considered to be professionals (as defined later on) may be presumed to be experts in all investment services and products, or at least sufficiently knowledgeable and prudent to take the initiative of seeking additional information and advice where this appears necessary for a particular transaction or type of transaction (in such circumstances they may ask to benefit from a higher level of protection as described below).

5. The members of FESCO agree that conduct of business rules should include a definition of the professional investor and provide for a streamlined application thereof to such investors in order to avoid over-burdensome regulation.

This does not mean that the provision of investment services between professional investors should not be subject to any conduct of business rules at all, but that there is no need in such situations for the full range of detailed investor protection rules. Only a few general principles, and possibly a limited number of standards for certain specific types of services and transactions, as well as any additional rules agreed by the parties concerned, should apply to inter-professional relationships.

6. FESCO members will seek to implement the definitions and standards set out in this paper in their regulatory objectives and, when possible, in their respective rules. If a FESCO member does not have the authority to implement a certain definition or standard, it will commend the definition or standard to its government and to the responsible regulatory authority.

7. The members of FESCO wish to stress that the conduct of business regime for professionals is an exceptional regime, i.e. it should be considered as an exception to the application of the standard conduct of business rules which aim to ensure adequate protection for less sophisticated investors.

8. The members of FESCO recognise that the implementation of the definition of professional investor is inevitably linked to the contents of the applicable rules of conduct.

As the determination of comprehensive common standards on Conduct of Business Rules warrants further study (currently underway), the scope of this paper is limited to the criteria that should be used to categorise investors as professionals.

FESCO is also committed to drafting standards at a later stage defining the conduct of business regime that will apply to inter-professional relationships. The members of FESCO will come back to this paper to consider whether the harmonised standards are suitable to the proposed categories of professional investors.

Criteria for defining professional investors

9. Professional investors are those who may be deemed to possess the experience, knowledge and expertise to make their own investment decisions and properly assess the risks they incur.

I. Categories of investors who are considered to be professionals

10. The members of FESCO agree, subject to what is said below in §11, that the following should all be regarded as professionals in all investment services and instruments described in the ANNEX of the ISD.

a) Entities which are required to be authorised or regulated to operate in the financial markets⁽ⁱ⁾:

• Credit institutions⁽ⁱⁱ⁾,
• Investment firms⁽ⁱⁱⁱ⁾,
• Collective investment schemes and management companies of such schemes,
• Pension funds and management companies of such funds,
• Insurance companies.

b) National governments, Central Banks, international and supranational institutions such as the World Bank, the IMF, the ECB, the EIB and other similar international organisations.

11. The entities mentioned in §10 are considered to be professionals. They must however be allowed to request non-professional treatment; i.e. they may opt for a higher level of protection.

This higher level of protection must be provided when a party to a contemplated transaction that is considered to be a professional enters into a written agreement with its counterpart that it shall not be treated as a professional for the purposes of the applicable conduct of business regime. Such agreement should specify whether this applies to one or more particular services or transactions, for one or more types of product or transaction, or generally.

It is the responsibility of the entity considered to be a professional investor to opt for a higher level of protection where it is unable to assess the risks involved.

II. Investors who may be treated as professionals on request:

II.1 Identification criteria

a) Large size entities

12. The members of FESCO consider that the following list of investors will often not require the full protection of Conduct of Business Rules

• financial institutions^(iv)
• large industrial and commercial corporations,
• large institutional investors other than those mentioned in paragraph 10 such as portfolio companies, or investment trusts whose purpose is to invest in financial instruments;
• commodity dealers,
• public sector bodies such as regional or local governments
• issuers of listed financial instruments, i.e. entities whose securities (equity instruments or other) are admitted to trading on a regulated market (or a particular segment of a regulated market such as the Official List)

Investment services providers should therefore be allowed to treat any of the above investors as professionals provided the criteria and procedure mentioned below are fulfilled. These investors should not however be presumed to possess market knowledge and experience comparable to that of the authorised, regulated financial entities listed in §10.

13. The industrial and commercial corporations and institutional investors referred to in the 2^nd and 3^rd indents of §12 may be allowed to waive the full protection subject to the fulfilment of one of the following size requirements:

• paid-up capital or net assets of at least 10 million euros,
• balance sheet total of at least 100 million euros.

b) Small size entities and private individual investors

14. The members of FESCO consider that investors other than those mentioned in §12, including private individual investors, may be allowed to waive the full protection of Conduct of Business Rules.

15. Any such waiver of the protection afforded by the standard conduct of business regime shall be considered valid only if an adequate assessment of the expertise, experience and knowledge of the client, undertaken by the investment service provider, gives reasonable assurance, in light of the nature of the transactions or services envisaged, that the client is capable of making his own investment decisions and understanding the risks involved.

The above assessment should include a test comparable to the relevant aspects (experience and knowledge) of the fit test applied to managers and directors of entities licensed under European Directives in the securities field. In addition, one or more of the following conditions should be satisfied:

1. The investor transactions were conducted for large volumes on the relevant market at an average frequency of 10 per quarter for the last eight quarters;
2. The investor net assets exceed 2 million euro;
3. The size of the investor's financial instrument portfolio, defined as including cash deposits and financial instruments (within the meaning of Section B of the Annex of the ISD) exceeds 1 million of Euro.

II.2 Procedure

16. Investors defined in Section II.1 above may waive the benefit of the detailed rules of conduct only where the following procedure is followed:

1. they must state in writing to the investment service provider that they wish to be treated as a professional investor, either generally or in respect of a particular investment service or transaction, or type of transaction or product;
2. the investment service provider must give them a clear written warning of the protections they will lose;
3. they must state in writing that they are aware of the consequences of losing such protections.

Before deciding to accept any request for waiver, investment services providers should be required to take all reasonable steps and to obtain all necessary documents to ensure that the client requesting to be treated as a professional investor meets the relevant requirements stated in Section II.1 above. Investment firms must keep record of the checks carried out while performing the assessment.

17. Firms, who grant waivers from the detaile​d rules of conduct, must implement appropriate written internal policies and procedures to categorise investors and to ensure that investors eligible for professional treatment continue to comply with the applicable criteria.

FOOTNOTES

⁽¹⁾ The Forum of European Securities Commissions (FESCO) assembles the following 17 Statutory Securities Commissions of the European Economic Area (EEA): Bundes-Wertpapieraufsicht (Austria); Commission bancaire et financière/Commissie Voor Het Bank- en Financiewezen/ Kommission fûr das Bank- und Finanzwesen (Belgium); Finanstilsynet (Denmark); Rahoitustarkastus (Finland); Commission des opérations de bourse (France); Bundesaufsichtsamt für den Wertpapierhandel (Germany); Capital Market Commission (Greece); Financial Supervisory Authority (Iceland); Central Bank of Ireland; Commissione Nazionale per le Società e la Borsa (Italy); Commission de surveillance du secteur financier (Luxembourg); Stichting Toezicht Effectenverkeer (Netherlands); Kredittilsynet (Norway); Comissão do Mercado de Valores Mobiliàrios (Portugal); Comisión Nacional del Mercado de Valores (Spain); Finansinspektionen (Sweden); Financial Services Authority (United Kingdom). The European Commission attends FESCO meetings as an observer. The Chairman of the IOSCO European Regional Committee is also invited as an observer. FESCO is chaired by Georg Wittich, Chairman of the Bundesaufsichtsamt für den Wertpapierhandel (Germany). The Conseil des Marches Financiers (France) participates in meetings of the expert group on investor protection.

The Secretariat of FESCO is located: 17 place de la Bourse, 75082 PARIS CEDEX 02 (Tel.: 33.1.53.45.63.61, fax.: 33.1.53.45.63.60).

⁽ⁱ⁾ This list should be understood as including all authorised entities carrying out the characteristic activities of the entities mentioned: entities authorised by a Member State under a European Directive, entities authorised by a Member State without reference to a European Directive, and entities authorised by a non-Member State.

⁽ⁱⁱ⁾ Within the meaning of the first indent of Article 1 of Directive 77/780: "Credit Institution" means an undertaking whose business is to receive deposits or other repayable funds from the public and to grant credits for its own account."

⁽ⁱⁱⁱ⁾ Within the meaning of point 2 of Article 1 of Directive 93/22: "Investment firm" shall mean any legal person the regular occupation or business of which is the provision of investment services for third parties on a professional basis. For the purposes of this Directive, Member States may include as investment firms undertakings which are not legal persons if:

• their legal status ensures a level of protection for third parties' interests equivalent to that afforded by legal persons, and

• they are subject to equivalent prudential supervision appropriate to their legal form."

^(iv) Within the meaning of the point 6 of Article 1 of Directive 89/646: "Financial Institution" shall mean an undertaking other than a credit institution the principal activity of which is to acquire holdings or to carry on one or more of the activities listed in points 2 to 12 in the Annex.": These pints read as follows:

"2. Lending 
3.Financial leasing. 
4.Money transmission services. 
5. Issuing and administering means of payment (e.g. credit cards, travellers' cheques and bankers' drafts). 
6.Guarantees and commitments. 
7. Trading for own account or for account of customers in: 
(a) money market instruments (cheques, bills, CDs, etc.);
(b) foreign exchange; 
(c) financial futures and options; 
(d) exchange and interest rate instruments; 
(e) transferable securities. 
8. Participation in share issues and the provision of services related to such issues. 
9. Advice to undertakings on capital structure, industrial strategy and related questions and advice and services relating to mergers and the purchase of undertakings. 
10. Money broking.
11. Portofolio management and advice.
12. Safekeeping and administration of securities."