Proposal for a Directive of the European Parliament and of the Council on investment services and regulated markets, and amending Council Directives 85/611/EEC, Council Directive 93/6/EEC and European Parliament and Council Directive 2000/12/EC
Date: 2002-11-19
Institutions: European Commission
Subjects: approximation of laws, financial legislation, financial market, freedom to provide services, investment bank, investment company, proposal (EU), stock exchange

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Proposal for a Directive of the European Parliament and of the Council on investment services and
regulated markets, and amending Council Directives 85/611/EEC, Council Directive 93/6/EEC and
European Parliament and Council Directive 2000/12/EC

(2003/C 71 E/07)

COM(2002) 625 final — 2002/0269(COD)

(Submitted by the Commission on 19 November 2002)

EXPLANATORY MEMORANDUM

Proposal for a Directive on investment services and regulated markets

SECTION I — BACKGROUND TO THE PROPOSAL

1. What is the Investment Services Directive?

The Investment Services Directive, adopted in 1993, sought to establish the conditions in which authorised
investment firms and banks could provide specified services in other Member States on the basis of home
country authorisation and supervision. Services eligible for a passport under the existing ISD include
brokerage, dealing, individual portfolio management, reception and transmission of investor orders, and
underwriting/placing activities. In addition, the ISD enshrined the right of direct or remote access of any
authorised ISD firm to participate in trading on exchanges/regulated markets in other Member States. To
support the effective exercise of this right, the ISD introduced elements defining some characteristics for
mutually recognised exchanges which imposed some conditions on the operation of those markets. The
ISD is therefore the legal instrument which seeks to translate Treaty freedoms into practice in respect of
investment services and organised trading of financial instruments. (see annex 1 for detailed overview of
Directive 93/22/EEC).

2. Europe's fast-changing financial landscape

Market based financing is playing an increased role in the financing of European large and medium sized
enterprises and in the allocation of European savings. Orderly, transparent and effectively regulated
financial markets can serve as an important motor for wealth-creation. In Europe, corporate borrowers
have recently turned to financial markets as an alternative source of finance to bank-lending: the number
and value of new issues soared in the late 1990s as companies sought access to cheap, dis-intermediated
funding to finance ambitious investment projects. Increased supply found a ready demand as investors
turned to market-based investments as a means of bolstering risk-adjusted returns on savings and for
provisioning for retirement.

Recent reverses suffered by equity markets do not weaken the case for market-based financing. However,
they highlight the importance of a robust legal and regulatory framework if investor confidence and
liquidity are to be nurtured and financial markets are to thrive. Financial markets can survive periodic
bouts of volatility, cyclical corrections or under-performance of individual stocks. They will not survive the
erosion of investor confidence if markets are disorderly, opaque and susceptible to market abuse or if
intermediaries fail to discharge their fiduciary obligations to the end-investor. The present proposal forms
part of a coherent programme of legislative measures to facilitate the emergence of integrated and efficient
European capital markets, while imposing proportionate checks and balances to avoid market excess and
protect investors.

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The integration of EU equity and corporate bond markets holds out the prospect of significant reduction in
trading costs and the cost of equity/corporate bond finance. New research suggests that the static efficiency
benefits of establishing integrated, deep and liquid equity and corporate bond markets alone are likely to
be significant — involving a permanent reduction in the cost of equity capital by 0,5 %, triggering an
increase in investment, employment (0,5 %) and GDP (1,1 %). The benefits of efficient capital markets will
be optimised by pooling liquidity, and allowing supply and demand for financial instruments to interact on
a pan-European basis. This will maximise the depth of trading interest, reduce stock-specific volatility and
limit adverse price impacts for large trades. Pooling of blue-chip liquidity, and the end to geographical
diversification strategies can free up capital for new issues markets and venture capital. The introduction of
the euro has already paved the way for full integration of unsecured money markets, and significantly
boosted integration of sovereign and financial debt markets. Market participants are now looking to extend
the same trading and portfolio management strategies to equity business and other asset markets. All of
these factors lie behind the recent strong trend growth in cross-border trading of financial instruments:
over the last five years, cross border equities trades have been growing at 20-25 % per annum.

In view of the contribution that competitive and flexible market-based financing can make to growth,
employment, the Lisbon and Stockholm European Councils have placed integration of European financial
markets at the heart of the European economic reform agenda. Harnessing the benefits requires the
removal of obstacles to investment transactions together with a comprehensive programme of measures
to align national regulatory regimes across all stages of the trading cycle: from disclosure obligations at the
time of issue, common guidelines governing trading and the behaviour of market participants, to finali-
sation and reporting of completed transactions. Building on the FSAP, the Commission has tabled a series
of proposals for EU legislative measures which seek to lay the foundations for a coherent regulatory
framework for integrated financial markets. This ambitious programme of legislative action holds the
key to an important and enduring increase in Europe's employment and wealth-creating potential. The
new proposal is an integral part of this programme.

Directive on investment services and regulated markets and related EU legislative measures

A new ISD will, by harmonising rules for dealing with or on behalf of clients or for own account
and promoting the transparent functioning of organised trading systems, facilitate the integration of
secondary markets in financial instruments. However, these measures are a necessary but not a
sufficient condition for allowing effective cross-border interaction of all potential buy and sell
interests in a given instrument. The FSAP identified a number of areas which call for EU-level
solutions if a single financial market

Rules harmonising the content and format of disclosure of relevant information by issuers: one of the key
roles of financial markets is to reflect all available information relating to a financial instrument in
its price. Rules on the information to be disclosed by the issuer at initial offer (prospectus) and on
an ongoing basis, are vital if all EU investors and traders are to arrive at an equally informed
judgement of the value of a prospective investment (ensure that they are not comparing apples and
pears). To this end, the FSAP instigated a comprehensive programme of action in respect of
financial information. This encompasses the proposal for Prospectus Directive, emerging work on
regular reporting (and ad-hoc disclosure of price-sensitive information) and the (politically agreed)
Regulation on International Accounting Standards. The existence of a modernised system for issuer
disclosure is also crucial to the ISD objective of allowing regulated markets to compete for liquidity
by admitting partner country securities to trading without triggering duplication of disclosure
obligations.

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Safeguarding market integrity, preventing market abuse: In an integrated financial market, an investor in
one Member State will be able to trade securities issued in a second Member State through the
systems of a market in a third Member State with a counterparty located in a fourth. Faced with
such a scenario, it is crucial that there be a watertight and effective EU regime for detecting and
punishing market abuse. Supervisory authorities, market operators and market participants must
behave scrupulously, exercise vigilance and cooperate effectively where necessary to prevent cross-
jurisdictional abuse from sapping investor confidence. The Market Abuse Directive (now close to
agreement) clearly defines prohibited behaviour and establishes stringent disciplines to police and
punish abusive practices throughout the EU.

Allowing collective investment schemes to exploit single market freedoms: Collective investment schemes
have emerged as a powerful force for managing and intermediating private savings. UCITS currently
have a capitalisation of between 3-4 billion euro. The recently agreed UCITS directives will cement
the single market framework for unit trusts and mutual funds by expanding the range of collective
savings vehicles which can distribute products EU-wide and provide for mutual recognition of fund
manager qualifications.

impediments to the
Promoting efficient and competitive clearing and settlement of cross-border trades:
finalisation of cross-border securities transactions are coming into sharper focus. A high degree
of inter-connectivity between different links in the clearing and settlement chain is crucial
if
investors undertaking a transaction on a market in another EU member State are to be able to
repatriate title to those securities without incurring undue costs, delay or risks of ‘failed trades’.
There is now a growing understanding of the myriad legal, tax and regulatory obstacles which stand
in the way of efficient clearing and settlement of cross-border trades. Some parties to the debate
have expressed the view that different ownership and organisational structures for these activities
may also result in strategic barriers to competitive provision of clearing and settlement. The
Commission has recently published a Communication (COM(2002) 257) mapping out a number
of strategic orientations and inviting interested parties to help identify EU-level policy responses.

3. Why do we need a new Directive?

The existing Directive no longer provides an effective framework for undertaking investment business on a
cross-border basis in the EU. It does not establish clear ground-rules within which competition and
consolidation of
trading infrastructures (exchanges and other trading venues) can take place. The
principal shortcomings of the existing ISD include the following:

1. ISD does not provide sufficient harmonisation to allow effective mutual recognition of investment firm
licenses. As a result, the effectiveness of the ISD passport has been heavily mitigated by dual/multiple
supervision of cross-border business;

2. ISD contains outdated investor protection disciplines: the relevant safeguards must be updated to take
account of new business models, market practices and related risks. Investor protection rules also need
to be reviewed to compel firms acting on behalf of end-investors to make active use of new trading
opportunities to get the best deal on the client's behalf. This will ensure that competition between
different types of order-execution venue works to the advantage of the end-investor rather than his/her
disadvantage;

3. ISD does not span the full range of investor-oriented services (e.g. advice, new distribution channels) or
financial dealing (e.g. in commodity derivatives). Some of these activities, when undertaken as the main
or regular occupation of the firm, may pose material risks to investors or market efficiency/stability
which could be addressed through the application of ISD and related disciplines;

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4. ISD does not address the regulatory and competitive issues that arise when exchanges start competing
with each other and with new order-execution platforms. At the time of ISD adoption, competition
between exchanges/trading systems was non-existent. Now, competition between different methods of
trade-execution (exchanges, new trading systems, in-house order execution by investment firms) is the
principal regulatory challenge confronting EU securities supervisors. The few underdeveloped ISD
provisions relating to regulated markets do not provide a sound regulatory framework within which
markets and systems can compete for liquidity, and in which investment
firms may undertake
off-exchange order execution in the context of providing other services to clients;

5. ISD provides for an optional approach to the regulation of market structure creating a formidable
stumbling-block to the emergence of an integrated and competitive trading infrastructure. Article 14(3)
of the existing Directive allows national authorities to stipulate that retail investor orders be executed
only on a ‘regulated market’ (‘concentration rule’). A number of Member States have availed of this
option to favour the interaction of retail investor orders on centralised public order books operated by
regulated markets. Other Member States have elected not to use this option and have left responsibility
to the investment firm to determine how best it can secure ‘best execution’ for its clients. This has
resulted in greater diversity of order-execution methodologies in these countries. Such fundamental
divergences as to the regulation of market structure have, in turn, given rise to discrepancies between
national
trading conventions, rules on market operation, scope for competition between order-
execution platforms, and the behaviour of market participants. These constitute a significant obstacle
to cross-border transactions and fragment liquidity;

6. ISD provisions relating to designation of and cooperation between competent authorities are under-
developed: the present Directive is insufficiently clear regarding allocation of enforcement responsi-
bilities within Member States, and does not establish a sound basis for cross-border supervisory
cooperation. A fully integrated single financial market requires that proscribed behaviour be pursued
and punished with equal severity across the EU. A further pre-condition for an integrated and orderly
single market is that there be full and immediate cooperation and information flow between national
authorities. Current ISD provisions for supervisory cooperation were designed for a context in which
linkages between national financial markets were less intensively employed. These mechanisms need to
be substantially revamped:

7. ISD provisions are inflexible and out-of-date: ISD has to be rewritten because it is unable to respond to
pressing regulatory issues caused by evolving market structure and business and supervisory practices.
The need to revise ISD testifies to the futility of trying to regulate financial markets by hard-coding
provisions in immutable legislation. In the light of the favourable responses of the European Council
and EP to the recommendations of the Lamfalussy committee, it is proposed to amend key provisions
of the Directive to allow for adoption of legally binding implementing measures the through comi-
tology procedure. This procedure will be used in strict conformity with the inter-institutional under-
standing between the European Parliament, Council and Commission.

Given the extensive shortcomings of the existing ISD, and the need to render it more responsive to
structural change in EU financial markets,
is more effective and
rational to replace the existing text in its entirety. The new proposal incorporates those provisions of
the existing ISD which have proved their worth. It builds on the national supervisory and enforcement
structures which give effect to the existing ISD. Proposed changes to its scope represent an organic
evolution rather than radical change. By building on the foundations established by the existing Directive,
it is hoped to limit the extent of legal, institutional and supervisory adjustment which will be required to
implement a new text.

the Commission considers that

it

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A new approach to EU financial rule-making

The Financial Services Action Plan drew attention to the underdeveloped EU legal framework for
securities markets, and the significant opportunity costs resulting from the regulatory fragmentation
of EU liquidity. It identified a number of initiatives to create a legislative framework to support the
emergence of a single deep and liquid financial market. As part of this package, the Commission
published a Green Paper in November 2000 exploring a number of themes relating to the operation
of the ISD. In the light of the 68 responses to the Green Paper, the Commission concluded that a
wide-ranging review of the Directive was required.

The recommendations of the Lamfalussy Committee of Wise Men, endorsed by the Stockholm
European Council in March 2001, have heavily shaped the preparation of this proposal:

1. Consultation of market practitioners and interested parties: since publication of the original Green
Paper, Commission services have twice solicited the reactions of interested parties, in an open
and inclusive way, to informal and preliminary thinking on the scope and form of ISD revision.
A first consultation, which comprehensively mapped out possible modifications to the Directive,
was published in July 2001. These preliminary orientations were discussed in an open hearing,
attended by 150 interested parties, in Brussels in September 18-19 2001. 77 submissions were
received in response to this consultation. Responses prompted a reconsideration of a number of
important facets of the original orientations which were criticised as over-prescriptive and
inimical
to competition and innovation in the provision of order-execution services.
Consequently, the Commission published a substantially revised set of orientations for ISD
revision in March 2002. The revised orientations were again subjected to rigorous scrutiny in
open forum (22 April 2002) attended by 200+ participants. The present proposal has been
drafted on the basis of a careful consideration of the 107 responses to these revised orientations.

2. More effective and market-responsive single market rules: the Lamfalussy committee advocated a
systematic and rational distinction between high level principles to be harmonised through
EU Directives and the promulgation of uniform, legally binding but adaptable implementing
measures under ‘comitology’. Under this structure, CESR will prepare detailed technical advice, in
the light of reactions to open consultation, to mandates issued by the Commission. This two-tier
structure for securities law was proposed as a means of reconciling continuity in democratically
established core regulatory principles, with detailed harmonisation required to support cross-
border organisation of securities trading and services, and the flexibility needed to adapt to
rapidly evolving market practice in fast-moving financial markets. The far-sighted EP plenary
vote/inter-institutional agreement on implementation of the Lamfalussy proposals, has cleared
the way for the present proposal to be drafted in accordance with the Lamfalussy template.

4. Broad objectives of the new proposal

The proposal for a Directive on investment services and regulated markets aims to strengthen the capacity
of the EU legislative framework to serve two over-arching regulatory objectives:

1. the protection of investors and market integrity by establishing harmonised requirements governing the

activities of authorised intermediaries;

2. the promotion of fair, transparent, efficient and integrated financial markets: this goal will, in particular,
be furthered by the development of ground-rules governing the negotiation and execution of trans-
actions in financial instruments on organised trading systems and marketplaces, and by investment
firms.

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The new Directive is discussed below under the following headings:

— measures to promote an efficient, transparent and integrated financial trading infrastructure;

— provisions governing provision of investment services, with a view to protecting investors and fostering

market integrity;

— proposed extensions to the scope of the Directive;

— other issues (clearing and settlement, supervisory cooperation).

SECTION II — AN EFFICIENT, TRANSPARENT AND INTEGRATED TRADING INFRASTRUCTURE

1. Competition and fragmentation

In Europe, as elsewhere, the functions of market intermediary and marketplace have historically been
performed by distinct types of institution. At the time the ISD was adopted, exchanges enjoyed a national
franchise for the organised matching of buy/sell
Intermediaries
competed with each other in the provision of services to end-investors, issuers and for ‘over-the-counter’
(OTC) dealing. This institutional dichotomy allowed a clear distinction between the reach of investor-facing
protections — which applied only to intermediaries — and market-facing rules designed to uphold the
transparent and efficient functioning of markets — which applied primarily to exchanges. Since the
the EU financial marketplace has become more complex and the boundary
adoption of
between marketplaces and intermediaries has become blurred.
IT has allowed the core-business of
exchanges to be replicated at low-cost by non-exchange systems and for exchanges to reinvent themselves
as competitive market players: there are now more players, more trading options.

interests in locally issued securities.

the ISD,

New developments in EU financial trading

The following technology-driven trends have transformed the financial trading landscape:

1.

inter-exchange competition: the era of utility-run stock exchanges, acting as a single uncontested
national liquidity-point, is gone. Profit-driven exchanges are now competing directly for order
flow and listings, seeking to expand activities through cross-border mergers or vertically inte-
grating along the clearing and settlement chain;

2. competition from alternative trading systems: new entrants are providing alternative venues for
investors. These systems are now the
own-account trading by institutional and professional
principal organised trading venues for bond trading. However, they account for only 1 % of
equity trading volumes in the EU (a much lower share of equity transactions than in US);

3.

increased internal execution of client orders within investment firms: the concentration of brokerage in
the hands of a diminishing number of investment firms and banks is creating a situation in
which large volumes of client orders can be executed ‘in-house’ — either by crossing one client
order against another or executing against proprietary position of broker-dealers. A diminishing
balance of retail investor orders which cannot be executed internally is routed to exchanges for
execution. This practice is well established in jurisdictions which have not introduced a ‘concen-
tration rule’: in these countries, available information suggests that many large institutions are
currently internalising between 15-30 % of client order flow.

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Before examining the regulatory challenges associated with competition in trade-execution arrangements, it
is important to note the following:

As far as overall market efficiency is concerned, regulatory measures that directly restrict competition
between trade execution arrangements do not seem to deliver improvements in price-formation which
would justify an intrusive intervention in market structure to favour exchange execution. Recent analysis of
prices of transactions in almost all equities traded on leading European exchanges does not provide any
support for the proposition that concentrating transactions on exchanges improves market efficiency (as
measured by effective average spreads). (Chart 1) (source: London Economics, 2002).

Chart 1: Effective spread

To the absence of any static efficiency benefits from directly regulating market structure must be added the
dynamic costs to the marketplace as a whole of restricting participant choice, competition between trading
systems and innovation. Competition between trade-execution arrangements can deliver dynamic benefits
if it brings down transactions costs, brings additional
liquidity to the markets, supports sophisticated
trading strategies and helps to streamline transaction settlement. Although other factors are also at
work, some support for this proposition may be found in the fact that EU regulatory regimes which
allow for competition between exchanges and other forms of trading method are characterised by higher
stock market capitalisation (170 % of GDP) and liquidity (as measured by turnover 407 % of GDP) when
compared to Member States which favour trading on-exchange (80 % and 130 % respectively). Recent
evidence, based on US trading, suggests that this increased turnover and market capitalisation increase
should fuel a further reduction in trading costs.

These benefits will not be confined to professional market participants. In-house internalisation of client
orders can benefit clients in a number of ways: speedier execution, price improvement, and reduction in
costs associated with settlement of trades directly within the system of the investment firm. Competition
between intermediaries should result in some of these benefits being passed-through to end-investors.
These benefits cannot be taken for granted. One of the objectives of this proposal
is to create the
conditions under which off-exchange execution of client orders only occurs where there is a demonstrable
advantage for the client. However, the experience with the Retail Service Providers in the UK demonstrates
that off-exchange execution can deliver price improvements for retail investors in 7 out of 10 trades.

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trade-execution arrangements is nothing new:
Competition between exchanges and other types of
exchanges in all Member States have long been confronted with competition from non-exchange
execution for at least some types of trade. Even those Member States which require concentration of
retail
investor orders on a ‘regulated market’, already allow competition between exchanges and other
trading methods for professional and institutional trades. Furthermore, all Member State trading cultures
recognise that exchange order-books are not the optimal trading method for all types of transaction.
Central order-books exist alongside ‘over the counter’ and upstairs trading for a range of transactions.
A number of regulated markets are now seeking to marry the advantages of quote-driven and order-driven
trading under one roof. The diversity of trading arrangements in different Member States is tacit recog-
nition that a regulatory framework which favours one type of trade-execution venue will not be able to
accommodate the wide variety of
trading interests and strategies which make up a competitive
marketplace.

If an integrated European financial market is to deliver its full potential, the regulatory environment should
allow for the coexistence of different market microstructures, competition between trading systems, and
increased competition in trade-
freedom of choice for investors and market participants. Nevertheless,
execution does present new challenges for the regulatory system in protecting investors and promoting
orderly and efficient markets. The new Directive on investment services and regulated markets must
provide a coherent and effective framework for managing these challenges. Many of the most complex
and contentious issues surrounding ISD revision stem from the blurring of the market-place/intermediary
boundary and consequent intensification of competition within and between different types of trade-
execution. These challenges can be examined from 3 perspectives:

Fragmentation, and efficient price formation

The dispersal of trading across a number of order-execution venues can result in the fragmentation of
buying and selling interest into shallow and disconnected liquidity pockets. If unchecked, this process
could work to the detriment of the two critical attributes of a successful financial market — liquidity and
efficient price-formation. In particular, fragmentation can result in wider bid-ask spreads, increased adverse
price impacts for trades, and reduced opportunities to trade. Both inter-exchange competition, and
competition between exchanges and other types of order-execution venue can contribute to fragmentation.

There is a growing consensus amongst financial regulators and commentators that an effective trans-
parency regime can allow the benefits of competition between trade-execution venues to be reaped,
while limiting any adverse consequences for overall market efficiency.
transparency — in
essence the widespread availability of information relating to current opportunities to trade and recently
completed trades — is generally regarded as central to both the fairness and efficiency of a market, and in
particular to its liquidity and quality of price-formation’.

‘Market

Efforts to counter the potential adverse effects of fragmentation through appropriate transparency rules
should, at the outset, take account of the full range of trade execution arrangements if they are to represent
a comprehensive solution. ‘It would be desirable to have a coherent transparency regime for an asset class
that applies across all market venues.’ A transparency regime which is confined to regulated markets and
in effect. Off-exchange
ignores ‘off-exchange’ trade execution will be partial
trading which improves on prices prevailing on regulated markets may embody trading information which
is relevant for the investment judgements of other market participants in the same way as on-exchange
trading. On this basis, it is argued that other market participants should be able to factor information on
such trades or trading interests into their investment decisions and thereby maximise the efficiency of price
formation.

in reach and sub-optimal

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However, transparency may come at a price in terms of reduced liquidity provision to market participants.
Forcing dealers and broker-dealers to display the terms at which they are willing to buy or sell instruments
may reduce their ability to trade at a profit, and expose them to strategic trading by other market
In this way, rules which are designed to promote an absolute level of transparency —
participants.
information on all current opportunities to trade, all of the
where all market participants possess all
time — would oblige dealers and broker-dealers to expose their trading positions to such an extent
that they would no longer be willing to provide liquidity support to the market. This would complicate
trading for market participants and investors, particularly in respect of block trades, trades in illiquid
stocks, programme trading, and could add to price volatility. Therefore, caution is needed before extra-
to off-exchange trading where market
polating exchange-type regulation and transparency rules
participants place their own capital at risk.

Investor protection

The structural changes in financial trading and order-execution can also give rise to particular investor
protection concerns. One particular concern in this regard concerns the scope for conflicts of interest
within broker-dealers which may execute client orders internally against proprietary trading positions — a
process widely referred to as ‘internalisation’. The integrated broker-dealer has an incentive to place the
interests of its trading desks before the interests of the client. The existence of this conflict of interest raises
the question of whether investors/clients can be confident that broker-dealers will comply with their
over-riding duty to act
interest are already
commonplace under the existing ISD and under those national regimes which allow broker-dealers to
execute client orders outside the rules of a ‘regulated market’. However, these conflicts of interest may be
exacerbated where the investment firm has an active strategy of internalising client order flow and mini-
mising the orders that have to be finalised on-exchange.

the client. These conflicts of

in the best

interests of

A related issue is that market fragmentation may undermine the representativeness of on-exchange prices
which have traditionally served as an anchor for ‘best execution’ policies. ‘Best execution’ rules generally
provide that investment firms are considered to have discharged their duties to a client when its orders are
executed on a ‘regulated market’ or at a price equal to or better than that prevailing on the ‘regulated
market’. Widespread order-execution away from the ‘regulated market’ could drain liquidity away from
exchanges and undermine the representativeness of reference prices established on regulated markets.
Under this scenario,
‘best execution’ policies which benchmark broker performance against the price
obtaining on regulated markets lose their relevance as a base-line of protection for clients. Furthermore,
faced with fragmentation of trading across disconnected systems and markets, investors or their brokers
may not be aware of or have access to the best available trading opportunities. It is important to note that
the experience of markets which allow off-exchange order-execution does not lend much empirical support
to these claims: bid-ask spreads in shares traded on the LSE SETS order-book have continued to narrow
despite the conclusion of a large volume of retail investor orders outside the SETS order-book.

Regulatory arbitrage

Trading through multilateral trading facilities (MTFs) and off-exchange order execution by investment firms
can reduce the volume of transactions finalised through the order-book of an exchange. Inevitably, this has
prompted the question of whether new trading entities should be able to compete with exchanges for
order-flow without incurring comparable regulatory overheads. In particular, should broker-dealers which
internalise large volumes of client orders — and which on this basis are sometimes portrayed as assuming
the role of ‘market-places’ — be asked to comply with exchange-type regulation? The answer to this
question requires an objective assessment of whether it is correct to assimilate in-house execution with the
operation of a marketplace. It further requires an understanding of how different regulatory requirements
need to be adapted to the mechanics and risks of different methods of trade-execution.

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2. Guiding principles for regulating trade-execution

ISD revision represents a unique opportunity to define the rules of the game so that order-execution —
whether conducted on regulated markets, through MTFs or via off-exchange transactions by investment
firms — is undertaken in a way which serves investor interests and the overall efficiency of the financial
system. The way in which these issues are resolved will also have an important and direct bearing on the
competitive relationship between different sets of market participants. In developing its response to the
above issues, and deciding a balanced approach to the different regulatory trade-offs, the Commission has
been guided by the following principles:

1. ISD revision should create the foundations for an integrated and competitive trading infrastructure. A
fully integrated financial market is one in which buy and sell interests in a given financial instrument
can interact seamlessly and instantaneously across EU-borders irrespective of the location of the market
participants or the systems/means through which trading interests are expressed. In this regard, national
‘options’ concerning the handling and execution of retail investor orders — which account for some
90 % of the number of transactions, but only 10 % of value — are fundamentally at odds with the
objective of a single financial market. They create a fault-line not only in terms of the regulatory and
competitive situation of trading platforms in different Member States, but also in terms of the regu-
lation of intermediaries, and protection to be offered to investors. If a revised ISD is to pave the way for
an integrated and efficient financial market, it must — above all else — resist the siren call of an
opt-in/opt-out approach to market regulation. In view of its potential to hinder the alignment of market
regulation on a common model the proposal does not envisage the renewal of the ‘concentration rule’
option.

2. ISD should respond effectively to demonstrable risks to investor protection and market efficiency. The
emergence of a more heterogeneous and complex trading environment calls for a proportionate
response from regulators if investor interests and overall market efficiency are to be safeguarded.
Investors must have confidence that brokers actively exploit new trading opportunities in order to
obtain the ‘best deal’ on client's behalf. Client interests must not be adversely affected by the existence
of conflicts of interest when they rely on broker-dealers to execute their orders. Market professionals,
issuers and regulators have a shared interest in ensuring that liquidity is not fragmented into shallow
and disconnected pockets.

These concerns require the introduction of a package of measures to ensure that the dispersal of trading
across multiple marketplaces and through diverse trading channels does not fragment liquidity and
prevent market participants from identifying mutually advantageous potential trades. At the heart of
this package is an effective transparency regime which seeks to ensure that appropriate information
regarding the terms of recent trades and current opportunities to trade at all marketplaces, trading
facilities and other trade-execution points is made available to market participants on an EU wide-basis.
The proposal will also introduce enhanced obligations to ensure that intermediaries make active use of
this information so as to get the best deal for their clients.

The proposal also recognises that brokerage clients should be allowed to express any preference that
they may have as regards the channels through which their order may be executed. Information which
may be relevant to the choice of broker or perception of quality of execution-service should be
provided up-front so as to allow the client to make an informed judgement. To this end,
it is
proposed that the retail investor should give its prior consent, either on a general or on a trade by
trade basis (see 3.5), before its orders are executed elsewhere other than on a ‘regulated market’ or
Multilateral Trading Facility.

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3. ISD rules should be proportionate and work with the grain of the market. Market efficiency and
investor protection objectives should be pursued through regulatory interventions which constitute a
proportionate response to demonstrable risk. They should take account of technology and market-based
remedies, and impose as little restriction on competition and innovation as possible. This philosophy
has informed the proposal in the following ways:

— No prohibition: ISD revision should not prohibit or otherwise impede, through application of
unjustified or inappropriate regulatory requirements, order-execution outside traditional market-
places/exchanges. Competition from new trading places has spurred exchanges to innovate and
develop new sources of competitive advantage. There is no reason to believe that these benefits
have now been exhausted or that regulatory road-blocks should be erected to create captive
order-flow for a certain category of marketplace.

— No compulsion: The proposal will not require an entity to be licensed as a ‘regulated market’ in
order to undertake order execution on an organised basis.
‘Multilateral trading facilities’, which
operate trading interest display and execution systems, will be allowed to operate these systems
on the basis of an investment firm licence subject to compliance with customised regulatory
requirements (see below).

trade execution by investment

— No-one size fits all framework: Differences in regulatory treatment should not undermine the ability
of institutions/exchanges, operating subject to a particular regulatory regime, to attract liquidity.
limiting regulatory arbitrage does not amount to a case for blanket application of
However,
exchange-type regulation to other systems of methods of executing investor orders. Instead, ISD
revision should establish comparable regulatory requirements for comparable order-execution
methodologies. On this basis, multilateral trading facilities, which mimic exchange functionality
for display and interaction of trading interests, will be subject to a variation on exchange-type
firms when dealing or
rules for trading functions. However,
providing services to clients should not be equated with the operation of an organised market/
order-book. The business, mechanics and regulation of multilateral trading systems and markets is
fundamentally different from that of trade-execution by investment firms — even when the latter
are internalising client orders. In particular, internal execution of client orders does not allow clients
to trade at their discretion with other clients through systems operated by the investment firm.
Furthermore, any transparency rules for quote-based dealing should not make it impossible for
dealers to placing proprietary capital at risk in a manner that may improve market liquidity and
smooth market functioning. ISD revision must, therefore, strike a careful balance between concerns
relating to regulatory arbitrage and the need to allow liquid providers sufficient margin to operate. It
is not a question of opting in favour of one type of one market structure at the expense of the other
(order-driven versus quote-driven). The proposal seeks to create a regulatory framework which
supports the co-existence of different trading channels, subject to the necessary safeguards for
overall market efficiency and the interests of end-investors.

In the light of the above considerations, this proposal seeks to establish a coherent and risk-sensitive
framework for regulating the main types of order-execution arrangement currently active in the
European financial marketplace. It proposes proportionate regulatory interventions to contend with
the specific investor protection and market efficiency risks associated with each of the different trading
methodologies. It addresses the competitive and regulatory interactions that arise when different trading
platforms and methods exist alongside each other but subject to different permutations of market and
investor-facing regulation. It aims to create a situation in which trading interests, regardless of the
medium through which they are expressed or where they are located in the EU, are able to interact
with each other on a cross-border basis in real-time so that liquidity is fully responsive to price-differ-
entials.

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Central to realisation of these goals is a comprehensive set of rules requiring transparency of trading
information. This regime encompasses all main categories of execution method for equities transactions
— regulated markets, MTFs, and off-exchange execution by investment firms. These transparency
obligations aim to allow the effective, real-time, cross-border interaction of trading interests without
which a single financial market cannot be said to exist. This regime will also permit competition and
innovation in trade-execution, or services which include trade-execution, without jeopardising efficient
price-formation. It will do so in a manner that promotes the disclosure of as much trade information as
is possible, taking account of the fact the same degree of transparency is not suitable for all business
models. This transparency regime will be an important guarantor of the fairness and efficiency of EU
financial markets, and of investor access to the best deal for the size and type of trade that they are
considering. It is not the only guarantor.

The proposal also envisages a range of other actions to ensure that off-exchange execution of client
orders takes place only where it can be demonstrated to be in the best interests of the client. A
particularly important feature of the proposal
is the emphasis placed on enforcement of a more
active and dynamic form of ‘best execution’ obligation to ensure that investment firms consider a
wide range of trading opportunities when trading on behalf of their clients. The proposal envisages
a reinforced ‘best execution’ obligation which will force investment firms to undertake a regular
assessment of which execution venues represent offer the most favourable terms for transactions,
and to be able to demonstrate that it is making use of those venues on behalf of its clients. This
‘best execution’ obligation is the mechanism which will ensure that trading information made available
under transparency obligations results in changes to the order-routing decisions of investment firms. In
this way, it will ensure that competition between trading venues translates into price-improvement for
the end-investor. It will also help to ensure that liquidity flows to the most efficient trading points. At
present, liquidity in Europe tends to be very sticky and continues to be concentrated on the market of
first listing — even where there are reasons to believe that alternative trading venues may offer better
prices. Whilst there is no directly comparable experience of using ‘best execution’ to inter-link the range
of competing trading venues that co-exist in Europe, new ‘smart order routing’ applications are now
available in the market place which will enable investment firms to monitor prices and depth across all
EU exchanges and other principal trading venues.

Taken together, these proposals constitute an important step towards a regulatory regime for an integrated,
efficient and investor-friendly EU financial market. The key elements of the concrete proposals as they
relate to the 3 main categories of trade-execution format currently active in the EU marketplace will be
briefly presented.

3. High level principles for regulated markets (title III)

The proposal preserves the particular status and authorisation regime for regulated markets which is at the
heart of the existing ISD, and is now firmly entrenched in all Member States securities rule-books. A
‘regulated market’ comprises not only a trading venue where the negotiation and exchange of financial
instruments is organised under a set of rules which embody different kinds of trading features. It is more
than that: it encompasses a broad set of functions, represents a distinct organisational form, and embodies
particular trading features. Admission of an instrument to trading on a ‘regulated market’ also serves as
trigger for the application of provisions of a number of related legislative measures. In recognition of these
considerations, the ISD treats the operation of a ‘regulated market’ as an activity warranting a separate
regulatory regime.

The existing ISD establishes a limited number of legal features that should be respected by all EU regulated
markets. These embryonic elements are not sufficient to represent a common basis for the regulation/
supervision of the principal EU financial trading venues. regulated markets are now becoming increasingly
European in terms of the investor base, membership and range of instruments admitted to trading. Market
conditions on one ‘regulated market’ will henceforth have instantaneous and important repercussions for
trading and market participants in other markets. Against this backdrop, the absence of a common
regulatory template risks presenting a significant impediment to the objective of an integrated, efficient
and orderly trading infrastructure.

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The proposal requires Member States to impose certain specified obligations on the ‘regulated market’,
which it shall fulfil under the supervision of a designated competent authority. The latitude given to the
‘regulated market’ to design its trading rules, access conditions and reliance on it as a first line of defence
for surveillance of trading on its systems is in recognition of the proximity to trading and self-interest of
the latter in maintaining the quality of business performed under its systems.

The ISD proposal therefore seeks to establish a common set of high level principles authorisation,
regulation and supervision of regulated markets so as to:

— identify the competent authority and applicable law (article 33): the proposal seeks to eliminate
uncertainty as regards the relevant competent authority under whose exclusive jurisdiction the
activity of the ‘regulated market’ will fall. This will prevent scope for jurisdictional conflict or legal
uncertainty which could have deeply damaging consequences for the legal finality of business done on
the market;

— introduce requirements relating to the operator of the market (article 34): This provision requires the
management personnel to be fit and proper, and to be endowed with financial resources needed to
ensure the orderly functioning of the financial market. Once recognised as being in compliance with
this provision, the market operator will be entitled to operate an MTF, without having to obtain an
additional authorisation to operate such a facility. The fitness and properness of the market operator
and the resources at its disposal should also be taken into account if the market operator of an already
established Regulated Market wishes to establish a ‘regulated market’ in another Member State;

— define organisational requirements for the ‘regulated market’ so as to ensure its fair, orderly and
transparent operation. Relevant provisions in this regard include article 36 (trading rules) and article
39 (access of participants to market);

— establish comprehensive pre and post-trade transparency obligations to apply to orders/quotes

displayed in the market and details of completed trades in equity transactions;

— pre-trade transparency (article 41): order-driven systems will be required to make public a part of
their order-book. In quote-driven markets, designated market-makers will be required to publish an
indication of bid/offer prices for some specified quotation size(s). The range of orders/quotes to be
disclosed will be defined under comitology. In view of the fact that requiring display of orders/
quotes of large sizes or in illiquid securities may deter market participants from bringing trades to
the regulated market, these obligations shall not be applicable to such trades;

— post-trade transparency (article 42): regulated markets will have to make public the price, volume
and time for all trades in equity instruments concluded under the rules and systems of the market
on a reasonable commercial basis. Deferred reporting of trade details will be permitted for trades of
large size and in illiquid securities.

— Admission of instruments to trading (article 37): this provision sets the high level principles under
which a ‘regulated market’ can admit instruments to trading on its systems, while allowed the detailed
implementing measures to give effect to these principles to be developed at level 2. In brief, the
‘regulated market’ should implement generic admission requirements, which have received prior
public approval and which aim to ensure the free negotiability and effective settlement of instruments.
The minimum conditions which instruments should fulfil in order to meet these requirements will be
clarified at level 2. This clarification allows for differentiation between products admitted to trading on
different market segments and is not intended to prevent regulated markets from applying more
demanding admission requirements to its market segments. Article 37 also seeks to create a legal
context
in which regulated markets are able to admit to trading instruments which have been
constituted and issued in another jurisdiction and where the market has taken steps to verify that
the issuer is in compliance with its initial and other ongoing disclosure obligations.

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— Suspension and removal of an instrument from trading (article 38): this provision foresees circum-
stances and conditions under which the competent authority or the Regulated Market can to suspend
or remove an instrument from trading. It also establishes the framework for dealing with suspension or
removal on a fragmented marketplace. When a competent authority decides to suspend or prohibit
its decision shall be immediately applicable to all the trading under its
trading on an instrument,
jurisdiction (either on RMs, MTFs or OTC/internalisation). The competent authority will also have to
inform about the suspension or removal to competent authorities in other Member States.

4. New core service for ‘Multilateral Trading Facilities’ (MTFs)

The proposal envisages the introduction of a new core ISD service relating to the operation of an MTF.
This will allow entities operating such systems to be authorised as an investment firm subject to a
customised regulatory regime. There is a sizeable and growing population of these systems. Their func-
tionality does not correspond directly with the existing ISD services, and this has led to some uncertainty
as to the appropriate basis on which to license and supervise these entities. The recognition of MTFs as a
new category of investment firm is intended to clarify the nature of this business for the purposes of EU
law, and to allow for the application of a common set of customised regulatory disciplines to deal with
(market-facing) risks. On this basis, MTFs will be able to make their facilities and services available to users
throughout the EU on the basis of home country authorisation.

The proposed definition of MTF draws on the extensive analysis and 2 rounds of open market consultation
undertaken by the Committee of European Securities Regulators (CESR). The proposed definition captures
systems which support the multilateral disclosure of firm orders/indications of interest between the system
users and the execution of orders resulting from the interaction of buy/sell interests expressed through the
system. It also includes ‘auction-crossing’ systems where user orders are executed against a reference price
imported from outside the system. The common feature of these systems is that they support autonomous
trading decisions by the system users, without there being any intercession of the system operator to
facilitate trades or participate itself (against a proprietary trading book) in transactions with system users.
There is no active or discretionary role of the system operator in pre-selecting, recommending or otherwise
bringing together of trading interests. The system supports and facilitates direct user interaction with other
system users. This form of functionality means that MTF possess many of the exchange-kind features and
give rise to some of the same regulatory issues as regulated markets. For this reason, the proposed
regulatory treatment under revised ISD focuses on the fair, orderly and transparent organisation of
trading through the system.

The proposed MTF obligations are modelled on the market-facing principles which apply to the trading
system functionality of regulated markets. These obligations are also heavily informed by the recently
published CESR standards for ‘Alternative Trading Systems’. The key provisions of the proposal concern:

— Organisational requirements for MTF (article 13): MTF will be required to apply transparent and
objective commercial criteria in admitting its users. The potential user base for MTFs comprises
market participants who are willing to trade at own risk and without the benefit of agency protections.
In addition, the provision lays down obligations to ensure the objective, fair and expeditious handling
of trading interests expressed through the MTF;

— pre and post-trade transparency obligations in respect of equity transactions concluded on MTFs
(articles 27 and 28): the basic obligations are aligned with the level of transparency foreseen for
trading interests in equity transactions when concluded or displayed through a ‘regulated market’.
Possibilities for deferral of
trade reporting, and the range/depth of pre-trade disclosure will be
similar to those required of regulated markets. Auction-crossing systems and other types of MTF
which do not involve prior disclosure of firm indication for prices may be exempted from the
scope of the pre-trade transparency obligation;

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— waiver from agency obligations for transactions concluded on the MTF (article 22): Users of the MTF
are professional or active market participants trading on their own account and at their own risk and
capable of assuming responsibility for their investment decisions. They do not expect the operator of
the MTF to offer them agency protections. Consequently, conduct of business and other investor
protections will not be relevant to the type of trading conducted through an MTF. In view of this,
the proposal foresees that MTF will be required to limit participation to ‘eligible counterparties’. The
proposal does not envisage forcing MTF to admit freely non-system users for the purposes of trading
against a bid or offer which is publicly displayed pursuant to article 27.

— Right for MTF to place screens in other Member States (article 29): In parallel with the provision
allowing regulated markets to place trading screens or operate other arrangements to enable remote
members located in other Member States to have access to and trade on the ‘regulated market’, it is
proposed to recognise a similar right for investment firms operating MTFs under the free provision of
services.

In order to ensure that this new category of investment firms has provisioned for relevant risks arising firm
its activities, they will be required to hold initial capital and an additional amount of own funds in
accordance with Directive 93/6/EEC (CAD). Capital requirements and endowment shall take account of
relevant regulatory developments in the EU and other international for a, particularly those pertaining to
capital charges on operational risk.

The proposal does not consider adequate to establish mandatory admission requirements for the
instruments traded at the MTF. The MTF is a pure trading functionality where its participants may
decide what specific financial instrument to trade. However, when in the systems of an MTF is traded
on a regular basis an instrument that is also traded in a ‘regulated market’, the MTF should take the
necessary steps to verify the compliance of
the instrument/issuer with the relevant provisions of
Community law (i.e. disclosure).

5. Trade execution by investment firms

The proposal envisages a systematic modernisation of the obligations incumbent on investment firms
when they execute transactions outside the rules and systems of a ‘regulated market’ or MTF. This
review has been prompted by two distinct considerations:

— to contend with particular concerns relating to the possible conflicts of interest which arise when

integrated houses (broker-dealers) execute client orders internally;

— to provide an effective and proportionate response to concerns that off-exchange order execution by
dealers and broker-dealers may undermine efficient price-formation, and in doing so, potentially
weaken ‘best execution’ policies.

Conflicts of interest in (internalising) broker-dealers

The debate surrounding ‘internalisation’ has thrown into sharper relief the already commonplace conflict of
interest that arises when investment firms cumulate the functions of broker and dealer. Execution of client
orders against the firms' proprietary positions begs the question of whether investors can be confident that
their interests are paramount when the broker-dealer acts on their behalf. These concerns are exacerbated
where an investment firm implements systems and procedures to maximise the number of client orders
executed against proprietary positions or other client orders.

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The assessment of the need for additional checks and balances on investment firm trade execution must
take account of the range of investor-facing obligations with which investment firms must already comply,
and which circumscribe the manner in which an investment firm can execute client orders. ‘Best execution’
requirements, in particular, mean that the investment firm does not have unlimited discretion about how it
executes orders on behalf of clients. However, the Commission considers that existing disciplines for
to contend with the possibility that
investor protection must be significantly tightened in order
conflicts of
their clients. The ISD
proposal seeks to place proportionate and effective safeguards on a definitive and firm legal footing. In
particular, it is proposed to:

in integrated broker-dealers operate to the detriment of

interest

— introduce a new self-standing provision on conflict of interests covering, inter alia, those that arise in
integrated broker-dealer houses (article 16). This provision seeks to ensure that the investment firm is
interest between the
organised so that client interests are not adversely affected by conflicts of
brokerage and dealing business of the firm. Broker-dealers will be required to identify, prevent or
otherwise manage conflicts of interest so that they do not adversely affect clients interests. Legally
binding implementing measures which specify the types of administrative and organisational
arrangements that broker-dealers need to introduce will be developed at level 2;

— reinforce ‘best execution’ obligations (article 19): the investment firm will be obliged to be able to
demonstrate that it has made best endeavours to obtain the best deal for the client. This obligation
limits the possibilities for internal execution to situations where this matches or betters the terms at
which the client order could be finalised on a ‘regulated market’ or in the wider market.

— establish client order-handling rules (article 20): these rules will ensure that client orders are processed
expeditiously and according to objective rules of precedence and priority. These stipulations seek to
ensure that the investment firm takes active steps to facilitate execution of the client order, and that the
client's interests are not adversely affected by self-interested or negligent handling by the firm. In
addition, it is proposed that client limit orders, which the firm is not in a position to execute itself
at the specified terms, be traded into the wider market.

Off-exchange trade execution and efficient price formation

Transparency rules are the principal means through which it is proposed to safeguard the efficiency of
price formation and sustain ‘best execution’ in an environment where trade-execution is being performed
on a range of markets and systems throughout the EU. Quotes offered and details of off-exchange trades
completed by investment firms may also embody information which is relevant for the valuation of
instruments by other market participants. A critical issue is therefore to what extent and in what form
should transparency obligations be imposed on off-exchange trade-execution by investment firms. The
basic presumption is that pre and post-trade transparency rules should apply to off-exchange trade
execution by investment firms unless other considerations — trade-off with liquidity provision, compliance
costs — outweigh any benefits. The following sections set out the conclusions of the Commission on
whether and/or how ISD should impose transparency obligations on investment firms.

(a) Post-trade transparency obligations (article 26)

Against the backdrop of global competition between markets and trading systems and the growing
preponderance of parallel trading in blue-chip securities, post-trade transparency obligations can play an
important role in reconstituting liquidity and inter-linking different trading venues. Swift publication of
price and volume details in respect of completed trades will allow professional market arbitrageurs to shift
liquidity in response to observed bid/offer prices at different trading venues. Transparency rules which
overlook the sizeable and growing volume of off-exchange/MTF trading will, by definition, be partial in
scope and sub-optimal in effect.

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It is therefore proposed to introduce an obligation for all investment firms concluding trades in equity
instruments (once these are admitted to trading on a ‘regulated market’) to disclose publicly, as close to
real-time as possible, the price and volume of completed trades. Possibility of deferred reporting for large
trades or trades in illiquid equities is foreseen in order to allow traders to unwind large positions before the
existence of their exposure is made known to other market participants. By allowing for deferred reporting
of large trades, the proposed post-trade transparency rule avoids exposing proprietary trading positions
and limits any conflict with liquidity provision.

Investment firms are afforded considerable flexibility as to the arrangements through which they comply
with this obligation. A base-line obligation is that they report the details of completed off-exchange trades
to any ‘regulated market’ of which they are a member (and with which they will already have established
2-way data feeds). Such links, once established, can allow investment firms to report trades at low cost.

(b) Pre-trade transparency obligations

In preparing the proposal for revision of the ISD, the Commission services have given careful consideration
to the imposition of pre-trade transparency obligations on off-exchange transactions of investment firms.
The reason for contemplating such an obligation stems from the basic presumption that maximising the
flow of trading information to market participants will enhance the price-formation process. Judged from
the perspective of ‘best execution’ or efficient price-formation, it is not enough to know the conditions
under which the last trade was concluded. The fact that a particular execution-point represented the best
deal for the last trade provides no guarantee to market participants and investors that it will also offer the
best terms for the next deal. Judged against the benchmark of an absolute ‘best execution’ obligation,
market participants and investors could benefit from access to information on all current trading oppor-
tunities — not only those available on regulated markets and MTFs. Investment firms, in processing of
investor orders or by publishing quotes to other market participants, may possess or generate information
which could also influence the overall market valuation of given instrument.

However, given the fundamental differences between bilateral dealing or order-execution by investment
firms and exchanges, pre-trade transparency obligations designed for regulated markets and MTFs cannot
be directly extrapolated to dealers and broker-dealers. Trading interests expressed through a public
order-book are knowingly disclosed to other market participants. This allows wider disclosure of those
trading interests to be mandated without undue concern about any potential consequences for proprietary
positions of market participants. The same is not true of dealers whose ability to undertake their business
is inextricably bound up with their ability to make quotes on a selective or discretionary basis. It would be
investment firms to disclose
counterproductive from the perspective of liquidity provision, to compel
extensive details of their trading book to the wider marketplace.

these considerations,

In view of
to introduce pre-trade transparency
requirements for investment firms in the form of a client limit order display rule (article 20(4)) and a
quote disclosure rule for retail size orders in shares (article 25).

the Commission proposes

The client limit order display rule will require the investment firm immediately to make public client limit
orders which it is unable or unwilling to execute itself at the specified price. Limit orders are a particularly
powerful price-signal because they specify clearly the precise value which that investor attaches to the
transaction. In certain marketplaces limit orders are becoming a normal or event the predominant form in
which investor orders are expressed. Some 62,9 % of orders for small transactions of less than 5 000
shares in CAC 40 stocks on Euonext Paris (in September 2001) were expressed in the form of limit orders.
This proportion increases as the size of the transaction increases.

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The client limit order display rule will ensure that investment firms do not withhold price-relevant
information — embodied in the terms of a non-executed client limit order — from other market
participants. The rule seeks to ensure that this information is made public in a way that the relevant
information is immediately and easily visible to other market participants and the marketplace as a whole.
The rule allows the possibility for non-disclosure of limit orders in respect of large transactions or where
requested by the client. The rule would also not prevent the investment firm from concluding the trans-
action in-house as long as this is done immediately so as to offer the benefits of fastest and most expedient
execution to the client, and subject to the express prior consent of the client. Given the growing prepon-
derance of limit orders, and their importance as a source of price-relevant information, the client order
display rule represents an important safeguard for overall market efficiency.

In addition, the Commission proposes to introduce an obligation for investment firms which operate a
trading book to make public a bid and offer price for a specified transaction size for the most liquid shares
(a ‘quote disclosure’ rule). This provision reflects the basic presumption in favour of maximising the
volume of trading information. The overall price formation process and the effective enforcement of
‘best execution’ will be enhanced if (large) dealers and broker-dealers are required to advertise the terms
at which they are willing to conclude transactions.

Such a rule will provide other market participants with some indication of the terms on which the
investment firm stands ready to conclude transactions for the specified transaction size in the share in
question. This will expand information on current opportunities to trade, and allow even greater number
of execution possibilities to be considered for ‘best execution’. In the case of broker-dealers which inter-
nalise client orders, it will require those firms to disclose some prior indication of the terms and conditions
at which they are able to match client ‘market orders’ (orders for execution at the best available price).

As explained previously, a quote disclosure rule should avoid over-exposing the positions of dealers to the
extent that they are unable to trade positions at a profit, and lose the incentive to act as a permanent point
of liquidity in the market place. However, a review of theoretical and empirical material of the US
experience suggests that the concern that pre-trade transparency will impede liquidity provision seems
only to be borne out for transactions which are large in size or in illiquid securities. An appropriately
calibrated pre-trade transparency rule does not seem to hinder dealers and market-makers from continuing
to provide liquidity support to the market on a profitable basis. The SOES (‘small order execution system’)
rules operated by the NASD provide a working example of how quotation rules can be designed which
stipulate specified quotation sizes to be displayed, and which take account of different levels of liquidity in
the stocks concerned. Moreover, US experience suggests that quote disclosure may enhance trading
volumes and overall market liquidity at the displayed bid/offer and quote sizes.
In the light of US
is proposed that mandatory quote disclosure should be
it
experience with quote disclosure rule,
confined to retail-size transactions in highly liquid equities.
it should not constitute a
significant impediment to proprietary dealing by banks.

In this way,

The introduction of a quote disclosure rule will impose some compliance costs on investment firms as
regards the publication of quotes. In particular, they will have to ensure that the mandated bid and offers
are visible and accessible to market participants on a continuous and real-time basis — preferably through
firms as possible. These costs will be
systems which consolidate quotes from as many investment
minimised through appropriate specification of the scope of the obligation and the reporting methods.
The proposed quote disclosure rule also allows for small dealers, which are unlikely to be significant
contributors to liquidity or price-formation for shares, to be exempted from the scope of the obligation.

6. Conclusions on the regulation of trade execution

The proposed Directive for revision of the ISD seeks to create a regulatory framework in which obligations
are tailored to the specific risk-profile of different market participants, and which takes account of
competitive and regulatory interactions between different
trading formats so as to maintain overall
market efficiency. The following table summarises the salient features of this regulatory regime.

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Synopsis of regulatory framework for different methods of trade-execution

Market integrity

Trading processes

Conflict of interest vs.
client orders

Best execution

Post-trade

Pre-trade

Regulated
Market

Market moni-
toring

supervisory

Prior
approval

N/A

Capacity to detect
and report
atypical trades

supervisory

Prior
approval

N/A

N/A

N/A

MTF

Dealer

Broker-dealer

Comply with
market abuse
Directive

Comply with
market abuse
Directive

N/A

N/A

N/A

Client order
handling rules

Admin and
organisational
arrangements

Reinforced
gation

obli-

per

as

Same
trades on
regulated market

Full reporting of
all
on
trades
market. Deferral
for large trades

Depth/range to be
specified — not
for
illiquid
trades

large

for
As
market

regulated

As per
market

regulated

per

as

Same
trades on
regulated market

Quote
for large dealers

disclosure

Client order
handling and quote
disclosure for large
B/Ds

Broker

Comply with
market abuse
Directive

(some) client
order handling
rules

N/A

Reinforced
gation

obli-

Same as per
trades on
regulated market

N/A

SECTION III — INVESTOR PROTECTION AND THE INVESTMENT FIRM REGIME (TITLE II)

The proposed Directive will harmonise the initial authorisation and operating conditions for investment
firms established in the EU. The relevant provisions embody a high level of protection for investors/clients
which rely on investment firms for advice, to intervene in the market on their behalf, or to manage their
personal
investment portfolios. Clients of such firms should be confident that duly authorised firms,
wherever authorised in the EU, will act diligently and in their best interests. To the extent that these
conditions are established, duly authorised investment firms should be able to provide services to clients in
other Member States on the basis of their home country authorisation and ongoing supervision by their
domestic competent authority.

The provisions of the existing ISD are not sufficient to serve these twin objectives:

— the investor protection disciplines of the existing ISD are outdated. They do not provide sufficient
leverage over the manifold conflicts of interest that arise when investment firms perform a wider range
of client-oriented and own-account activities under one roof. They do not create effective obligations
for investment firms to make use of the increased array of order-execution facilities for their clients.
The current proposal envisages a systematic overhaul of the provisions relating to authorisation and
ongoing supervision of investment firms so as to rectify these deficiencies;

— the existing Directive does not establish the bed-rock of harmonised investor protection obligations
needed to support mutual recognition of authorisation and operational requirements. A combination of
overly generic principles, unsupported by operational guidance and undermined by ample provision for
‘general good’ derogations, has limited the ability of investment firms to exercise their Treaty freedoms
on the basis of home country supervision. In revamping the ISD, it is proposed to enshrine a high level
of investor protection and on this basis to clarify that investment firms providing services freely in
other Member States shall operate subject to control only of their home country supervisor.

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To remedy these deficiencies, the proposal envisages a far-reaching modernisation and reinforcement of the
obligations that investment firms must comply with when providing services to clients or acting in the
marketplace, as well the rights to which investment firms are entitled by virtue of ISD authorisation. The
relevant provisions encompass:

— conditions for initial authorisation, including organisational requirements (articles 4-14):

— general operating conditions including conflict of interest identification and management (articles

15-17);

— obligations of investment firms when providing services to clients, including conduct of business rules,

best execution obligations and client order handling rules (articles 18-22);

— requirements to uphold market efficiency and integrity including transparency obligations (articles

23-28);

— provisions governing the rights of investment firms (articles 29-32).

The most substantive adjustments to the content of key investor protections are presented in this section.
The obligation for investment firms to comply with transparency obligations for off-exchange transactions
has been discussed extensively in the previous section and will not be presented again.

1. Capital adequacy (articles 11 and 17)

As under the existing Directive, compliance with the initial and ongoing capital requirements, as laid down
by Directive 93/6/EEC, is a pre-condition for authorisation and operation as an investment firm.

The proposal for ISD revision envisages modification of the Capital Adequacy Directive to clarify that
investment firms which provide only the service of investment advice shall be exempted from obligation
under the Capital Adequacy Directive. This clarification is achieved through art. 62 which proposes to add
a 4th indent to Article 2(2) of 93/6/EEC which clarifies that investment firms which are authorised to
provide only the service of investment advice are not to be regarded as investment firms for the purposes
of CAD. This special treatment of investment advisors for the purposes of the capital adequacy Directive is
in addition to the existing exemption for investment firms which receive and transmit client orders
without holding money or assets on their behalf.

A special treatment with respect to capital requirements can be justified by the fact that these entities do
not represent a source of counterparty or systemic risk to other market participants, and that clients are
not exposed to the risk of direct loss of funds and assets when dealing with advisors. The main regulatory
risk associated with this activity is the legal/operational risk that could arise from failure to respect ‘due
diligence’ when providing investment recommendations to individual clients. The proposal envisages the
introduction of obligation to hold professional indemnity insurance to contend with these risks and to
allow the firm to meet any damages owed to clients awarded compensation resulting from inadequate
performance of these activities. This obligation, and the amounts of professional indemnity insurance cover
to be held are based on the corresponding provisions of the Directive on insurance Mediation.

In the context of the ongoing review of capital requirements, the Commission is developing proposals
which will change the current regime. In so doing, the Commission will have full regard to the situation of
low risk investment firms, including investment advisors.

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2. Conflicts of interest (article 16)

It has become imperative to create a self-standing provision of the ISD to govern the expanding range of
circumstances in which the various interests of the investment firm, its managers and employees may
conflict with those of its clients. The expanding range of activities that many investment firms and banks
undertake under one roof by has increased potential for conflicts of interests between these different
activities and those of clients. This is allied to the greater prevalence of inducements, and well-established
concerns relating to conflicts between clients. The patchy treatment of conflict of interests under the
existing ISD does not allow for a coherent or effective response to these matters which are critical for
the defence of clients.

The introduction of a separate provision which allows for the elaboration of detailed implementing
measures through comitology, will allow regulators to react in a concerted and tailored way to types of
conflict of interest which warrant particular attention. This would for example allow for targeted inter-
ventions in respect of conflicts arising from, for example, the accumulation of financial analysis/research
and brokerage or underwriting/placing activities, or client order execution by broker-dealers.

The proposed provision establishes an obligation for investment firms to, first, identify conflicts of interest
that arise in their business activities which might prejudice the interests of their clients. Investment firms
would then be required to either:

— Prevent those conflicts of interest from adversely affecting the interests of clients; or

— establish organisational and administrative arrangements which allow them to manage these conflicts

of interest in such a way that the interests of clients are not adversely affected.

The provision does not prescribe the nature of organisational or administrative arrangements that shall be
considered appropriate for management of different forms of conflict of interest, or way in which conflicts
of interest must be disclosed where relevant. The provision foresees that detailed implementing measures
be adopted at level 2 to provide guidance on these points.

Where the firm has sought to manage conflicts of interest through the establishment of organisational
arrangements but it cannot be ascertained with reasonable confidence that these conflicts of interests no
longer potentially prejudice the interests of clients, the firm shall disclose the existence of these residual
conflicts of interest to the client. Disclosure may, where appropriate or necessary, be generic.

3. Conduct of business rules when providing services to clients (article 18)

Conduct of business rules are one of the mainstays of investor protection. Implementation of the present
provision has been hampered by a lack of clarity as to interpretation of the main operational concepts
(professional/retail investor), ambiguity as regards the role of home and host authorities in enforcing these
obligations, overlap with market integrity issues, and inclusion of unworkable tests (‘look through’). The
provision has been extensively reworked to update the rudimentary and ambiguous principles laid down in
the existing Directive. conduct of business regimes. This revamping of underlying principles takes full
account of the standards for investor protection which have recently been adopted by CESR.

A key objective of this overhaul has been to allow the provision of clear and legally binding guidance on
the implementation of the broad principles. To this end, the provision provides for the adoption of
common conduct of business rules through comitology. It is provided that these detailed rules will
differentiate in their application between investment services and between professional and retail clients
who require different forms and intensity of agency protection. Annex 2 to the proposal sets out criteria
and procedures for determining when a client can be categorised as a ‘professional client’ for the purposes
of applying the relevant light-touch conduct of business rules. This classification mechanism is based on
the work developed by CESR in consultation with market practitioners. Detailed implementing rules will
also be applied in a differentiated manner to investment or ancillary investment services and/or to different
service formats (e.g. portfolio management and ‘execution-only’ brokerage) or instruments.

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In the event of branch operations, it is proposed that the host authority assume responsibility for enforcing
conduct of business. The host authority is in greatest proximity to the branch and is better placed to detect
and intervene infringements of
firm-client
business at branch level means that investment firms do not see any difficulty in cooperating with host
authorities in this domain.

transactional obligations. The management of

firm-client

4. Best-execution (article 19)

An effective ‘best execution’ obligation for investment firms can help to ensure that fragmentation of
trading across diverse execution venues works to the advantage of clients rather than to their disadvantage.
An active ‘best execution’ policy will ensure that investment firms consider trading conditions on a range
of trading venues, and make use of ‘smart’ order-routing techniques in order to seek out the best bargains
for their clients. In doing so, it will allow competition between brokers to drive improvements in execution
quality to the benefit of the investor. This should result in improved brokerage services for clients
compared to current practice whereby firms are only required to match the prevailing price on the
local regulated market.

‘Best execution’ rules are also important from a broader market efficiency perspective. The operation of an
integrated financial market requires that orders to buy and sell financial instruments interact effectively,
freely and instantaneously with each other on a cross-border basis. Requiring investment firms to consider
trading conditions on a reasonable range of execution venues, and to route orders to the venues offering
the best prices, will ensure that liquidity responds quickly to price differentials. In this way, an effective
‘best execution’ policy helps to ensure that liquidity flows to the most efficient and competitive trade-
execution venues and serves as a guarantor of overall market efficiency.

Given these important considerations, a key feature of ISD revision is to establish a separate provision
governing the ‘best execution’ obligations of brokers/broker-dealers. The first element of the provision
establishes the obligation for all investment firms acting on behalf of clients to exercise due diligence to
ensure that the order is executed in the conditions that are most favourable to the client. It establishes a
general benchmark against which the execution of client orders may be judged in a context where
transactions in the instrument in question are potentially being concluded on a variety of marketplaces.
This benchmark emphasises, in the first instance, the best net price to the client. However, allowance is
made for other factors which may influence the optimal handling of the order such as the time and size of
order. These considerations may be particularly relevant for professional clients with larger orders which
may require more sophisticated handling.

The competent authority is required not to verify that the investment firm obtains the best price in respect
of all transactions that it undertakes on behalf of clients: instead, the competent authority should verify
that the investment firm operates procedures which maximise the probability of its clients obtaining ‘best
execution’ having regard to the best terms that are available at the different execution-points that make up
the marketplace. An important aspect of a successful provision will be to provide an indication of the
conditions under which an investment firm can be considered to have undertaken reasonable endeavours
to obtain best execution on behalf of its client — notably by ensuring that it has access to a sufficient
range of the venues which consistently deliver ‘best execution’.

that the investment firm regularly review the
A third element of the provision is the requirement
procedures that it operates so as to obtain ‘best execution’ on behalf of its clients. In this regard,
it
should continually assess and update the arrangements which it employs to execute client orders to
ensure that these are delivering the best possible result for client orders.

The key elements of the ‘best execution’ obligation are derived from the CESR conduct of business
rule-book. The provision foresees the adoption of detailed measures, through comitology, to clarify
how critical elements of this new test are to be interpreted and implemented.

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5. Client order handling rules (article 20)

Rules regarding the way in which client orders are processed and executed can enhance confidence in the
impartiality and quality of execution services. The proposal therefore requires that investment firms
establish processes which provide for the fair and expeditious handling of client orders. Fairness and
expediency for the purposes of this provision are to be understood not by reference to the quality of
execution of a given client order relative to conditions in the wider marketplace (‘best execution’), but
relative to the handling of other client orders or proprietary transactions of the investment firm.

This provision recognises that investor should be fully aware of different channels through which his order
may be executed. Information provided up-front to the investor should allow him to make an informed
judgement as to which are the potential risks and benefits attached to each of the different channels
available. By default, the Directive establishes that when the investor does not express his preference his
orders are to be routed to those channels, such as regulated markets or MTF, that do not give rise to
potential concerns as regards the protection of the interests of the investor (notably conflicts of interest).
To this end, the client should give its express consent before its orders are executed elsewhere other that
on a ‘regulated market’ or MTF (this is through OTC dealing or against proprietary positions/internali-
sation). The investment firm will have the right to decide whether this prior consent will be obtained on a
general (e.g. at the outset of the relationship) or on a trade-by-trade basis. This consent, when obtained on
a general basis, will have to be renewed annually.

In the case of limit orders, where the client specifies conditions that prevent the prompt execution of the
order, the firm shall take steps to facilitate prompt execution — either by routing it to a ‘regulated market’
or MTF, or disclosing the limit order to the market in some other way so as to allow other market
participants the opportunity to trade at the specified terms.

6. Dealing with eligible counterparties (article 22)

OTC trades between financial institutions and specialised trading entities, such as commodity dealers, are
generally undertaken on a principal-to-principal basis. These transactions do not involve the application of
conduct of business/agency protections. However, the existing Directive does not clarify what obligations,
if any, are owed to counterparties in the event of a transaction that does not involve provision of a ‘service
to a client’. It is therefore proposed to provide explicit treatment this type of inter-counterparty trading
relationship in the ISD.

The provision clarifies that, in the event of a transaction involving an investment firm and an ‘eligible
counterparty’, the obligations that would be owed to a client under ‘conduct of business rules’ do not hold.
It therefore creates a safe harbour for investment firms authorised to deal with a population of ‘eligible
counterparties’ without triggering the application of agency obligations. Investment firms should simply
confirm with the counterparty, at any stage prior to or during (but not after) the conclusion of the
transaction, that the latter accepts to trade without the benefit of agency protections for one or more
transactions. The scope of the ‘eligible counterparty’ category is heavily informed by the corresponding
definition adopted by CESR for the purposes of the counterparty regime. For the purposes of ISD, eligible
counterparty includes the following entities:

— Authorised credit institutions, investment firms and insurance companies;

— Member States have the option of authorising additional categories of locally domiciled entity as an

eligible counterparty.

The fact that an entity falls within the category of ‘eligible counterparties’ is without prejudice to its right
to request the investment firm to treat it as a ‘client’ benefiting from conduct of business protections.

7. Conclusions on the investment firm regime

The proposed modifications to the investment firm regime will:

— strengthen key investor protections which are contained in embryonic form in the existing Directive;

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— allow them to be developed and enforced in respect of an ever-changing kaleidoscope of investment

services;

— ensure that investment firms conduct their business in a manner that sustains overall market integrity

and efficiency;

— provide for the uniform interpretation and enforcement of these disciplines across the EU.

These modifications to the ISD investment firm regime therefore lay the foundations for a modern
investment firm regime which is capable of responding to the main investor protection and market
efficiency challenges that are set to arise in an integrating and constantly evolving financial marketplace.

SECTION IV — SCOPE OF THE DIRECTIVE

It is proposed to expand the scope of the Directive to integrate some investor-facing activities or dealing
activities that are financial
in character, are widely offered to investors, clients, or financial market
participants, and/or which give rise to investor or market-facing risks which could usefully be addressed
through the application of core ISD disciplines. The most notable changes (apart from the inclusion of
MTF operation which is extensively dealt with in section 2) relate to the inclusion of investment advice,
financial analysis, and commodity derivatives.

1. Investment advice (annex I, section A)

It is proposed to recognise investment advice as an autonomous and increasingly important financial
business in its own right.
Its inclusion as a core ISD service should help to provide a regulatory
framework which addresses the investor-facing risks specific to this business in a proportionate and
flexible manner. The principal implications of inclusion in ISD will be that:

— investment advisors become subject to initial authorisation and ongoing obligations established by the
ISD. Proportionate and appropriate supervisory disciplines are warranted to deal with the risk to
Inclusion in ISD
investors of unsuitable advice or unprofessional/unethical conduct by advisors.
would,
in particular, offer basic ‘conduct of business’ protections to investors when dealing with
advisors authorised or located in another Member State (via remote communication technologies);

— entities (including natural persons) providing investment advice as their principal/exclusive activity, will
be required to be licensed as an ‘investment firm’ within the meaning of the ISD as opposed to being
subject to specialised national regimes, as at present;

— firms providing investment advice on a ‘stand-alone’ basis will be able to conduct business, on a
cross-border/remote basis, with clients throughout the EU under the sole control of their home
country authority. At present, the benefit of an ISD passport for advice is reserved to banks and
investment firms providing existing core services. However, most investment advisors operate only in
small geographical markets and see limited interest in an ISD passport.

The proposal seeks to establish a situation in which inclusion in this regulatory framework should not
impose unjustified or over-onerous regulatory demands on investment advisors. To this end, the proposal
provides for customised capital adequacy treatment for firms providing only investment advice (cf. section
3.1).

In view of the large population of investment advisors — 4 000 IFAs in UK, 7 000 advisors in Italy, even
larger numbers in Germany — and the currently limited cross-border dimension of this business, the
inclusion of this service has been challneged on the grounds that it will entail signifcant investment in
authorisation and supervision in return for limited benefit in terms of functioning of the single financial
market. In recognition of these concers, it is proposed to allow competent authorities to delegate the
functions of authorisation and monitoring of these entities to duly constituted and resourced self-regu-
latory bodies.

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investment firms to cumulate investment advice with other
ISD revision will allow multi-functional
services. In this case, the revised ISD will entail stringent conflict of interest management and disclosure
by such entities in order to ensure that the interests of the investor are paramount when advice is
provided.

2. Financial analysis (annex I, section B)

The provision of general investment recommendations in respect of transactions in financial instruments to
clients or the public at large,
in the form of financial analysis or research or other forms, must be
undertaken to high professional and ethical standards in order to avoid adversely affecting the interests
of the recipients of this information. The inclusion of financial analysis and research as a non-core service
will avoid bringing specialised and independent research with in the scope of the Directive and focus
regulatory attention on those entities which combine research/analysis with other investment business in a
way that may give rise to conflicts of interest.

3. Commodity derivatives (annex I, section C)

It is proposed to include commodity derivatives within the scope of the new Directive so as to bring the
organised trading and intermediation in these instruments within the scope of the ISD. The exclusion of
commodity derivatives from the existing ISD definition of financial instruments has the following impli-
cations:

— investment firms cannot benefit from the ISD passport for the cross-border provision of investment
services in commodity derivatives — even though, the capital Adequacy Directive requires them to
hold capital reserves against any trading book exposures in commodity derivatives;

— specialised commodity dealers are not covered by ISD rights or obligations;

— exchanges and other

inter alia, organised trading in
commodity derivative instruments cannot rely on ISD provision for admission of remote members
or provision of trading screens.

trading arrangements which provide for,

Having considered the many aspects of this complex issue, the Commission proposes that commodity
derivatives be included within the scope of ISD. The absence of single market framework for this business
is anachronistic, particularly when one considers parallel steps taken to liberalise underlying commodity
and energy markets. This will allow disciplines for preventing market abuse and maintaining orderly
markets to be placed on a common EU-wide footing.

The extension of the ISD to commodity derivatives business must take account of certain features specific
to trading in these instruments, as well as the predominantly ‘wholesale/professional’ nature of the market
participants. In particular, the proposal recognises the widespread presence of experienced traders active in
the market for hedging/commercial reasons or acting exclusively on behalf of their parent companies or
affiliated subsidiaries. These are not holding themselves out as market-makers/dealers and should not be
required to hold an ISD licence to deal on own account. Art. 2(2) and 2(8) make clear that such entities
are not investment firms. Given their experience in trading in these instruments, Member States could
classify some or all commodity traders as ‘eligible counterparties’ which are able to trade in the
marketplace without requiring ‘conduct of business’ protections.

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Specialised dealers in commodity derivatives have been active on national marketplaces, without being
subject
to harmonised capital adequacy requirements, without occasioning prudential or systemic
problems. Nevertheless, it cannot be excluded that such entities incur and themselves become a source
of counterparty risk to other market participants. However, at this juncture, there is no consensus on the
prudential arrangements that should be imposed on entities engaged in dealing in commodities derivatives
as their main business. The proposal therefore provides that specialised dealers in commodity derivatives
shall not be considered as investment firms for the purposes of the ISD. In determining whether the main
business of the firm is dealing in commodity derivatives, the activities of the firm shall be considered at a
group/consolidated level. Given that traders see the advantage that a passport will bring when doing
business in other Member States, and that financial regulators see benefits in being able to supervise
and police financial arbitraging undertaken by entities whose sole function is to run a trading book, albeit
in a specific class of financial instruments, it is proposed to review this exemption 2 years after the entry
into force of this Directive. That review shall take account of any need to adapt the prudential framework
to take account of any specificities of this business.

The definition of commodity derivatives to be used for the purposes of this Directive has been carefully
considered so as to limit its reach to instruments which are constituted and traded in such a way as to give
rise to regulatory issues comparable to traditional financial
instruments. The definition of commodity
derivatives employed for the purposes includes certain futures contracts traded on regulated markets (or
MTF) which are physically settled where those contracts possess the characteristics of financial instruments.
In this respect, regard may be had to whether, inter alia, they are cleared and settled through a recognised
clearing houses, give rise to daily margin calls, are priced in reference to regularly published prices,
standard lots, delivery dates or standard terms as opposed to the price being specified in individual
contracts. The definition also includes other contracts for differences such as swaps which are settled
only in cash and where the amounts to be settled are calculated by reference to values of a full range of
underlying prices, rates, indices and other measures. The definition does not include physically-settled spot
or forward exchange or commodities.

SECTION V — OTHER KEY FEATURES OF PROPOSAL

1. Clearing and settlement

The proposal does not seek to establish a harmonised framework for the authorisation, ongoing super-
vision and mutual recognition of entities engaged in the provision of clearing and settlement activities. The
Commission recognises that robust and efficient linkages between competitive providers of post-trading
services are needed to bring about a situation in which a cross-border transaction can be undertaken on
comparable terms to a purely domestic trade. The efficient clearing and settlement of securities transactions
is also crucial to the orderly functioning of securities markets, the smooth conduct of monetary policy
operations, and the stability of the financial system as a whole. The Commission also acknowledges that
the blurring of the distinction between ‘custodianship’ — a non-core ISD service — and CSDs is giving rise
to concerns relating to regulatory arbitrage between entities licensed under the two regimes. However, it is
precisely because of their systemic importance and the complex technical and public policy considerations
that require a considered response, that the Commission does not believe that these distinct types of
market function should be addressed by ISD.

Merely adding clearing and settlement functions to the list of ISD services, without harmonising the
risk-management practices to be implemented or creating an effective supervisory framework will not
only fail to deliver an effective single market environment for the organisation of these activities: it could
prove counterproductive from the perspective of sound prudential supervision of these entities. Simply
labelling these activities as ISD services is no panacea. A considered view of the regulatory framework
required to support a sound and integrated post-trading infrastructure must first be established. On this
basis, the actions needed to create the legal, administrative, technical and fiscal environment in which
clearing and settlement can be reorganised can be identified and implemented. Discussions on the content
of this programme of action have recently been launched at European level.

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In view of the preceding considerations, the proposal for ISD revision confines its treatment of clearing
and settlement to clarification of the rights of the investment firm and regulated market populations in
terms of access to/choice of clearing and settlement facilities located in other Member States (article 32).
These rights are not absolute: demonstrable prudential concerns on the part of
the supervisor, or
interests of clearing and settlement providers may prevail over the access demands of
commercial
investment firms or market operators.

2. Competent authorities and supervisory cooperation (title IV)

The proposal comprehensively revamps existing provisions on competent authorities and supervisory
cooperation. There are three important strands to this work:

— to clarify the attribution of responsibilities for enforcement of provisions of the Directive (article 45).
Given that ISD is an omnibus Directive, it may require the involvement of a number of competent
authorities to enforce its wide-ranging provisions — particularly so in Member States which have not
grouped financial supervisory responsibilities under one roof. ISD revision is without prejudice to the
configuration of supervisory structures within Member States. It requires that Member States clearly
identify the competent authority which is responsible for enforcement of the individual provisions, so
as to allow this information to be communicated to other Member States. The chapter also establishes
the conditions under which competent authorities can delegate responsibility to other entities including
self-regulatory bodies. Where such delegation is permitted in the individual provisions of the proposal
(e.g. provisions relating to investment advisors, tied agents, regulated markets), it must be undertaken
in accordance with the conditions specified in article 46(2).

— to provide for some convergence in the powers at the disposal of competent authorities so as to pave
the way towards equivalent intensity of enforcement across the integrated financial market. The list of
powers (article 46), and provision for administrative sanctions (article 47) are modelled on similar
provisions which have been introduced in the Prospectus and Market Abuse Directives;

— to upgrade existing provisions on exchange of information between national competent authorities and
strengthen the duties of assistance and cooperation which they owe to each other (articles 51-55).
Existing ISD provisions on supervisory cooperation were designed for a context in which links between
segmented national markets were underdeveloped and infrequently used. The greater intensity and
immediacy of transmission mechanisms between national markets calls for a corresponding intensifi-
cation of cooperation between supervisors. Collaboration of this nature will be all the more necessary if
the confidence needed to support systematic reliance on home country supervision is to be sustained.

3. Use of committee procedures (comitology) to implement provisions

Member States' securities markets are facing dramatic changes and increasing consolidation, driven by new
technologies, globalisation and the effect of the euro. Standard setting is also evolving rapidly. Competition
between securities markets calls for best practice taking new financial techniques and new products into
account. On the other hand, investor protection and confidence has to be maintained at Community level.

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To meet the challenge of regulating modern financial markets, new legislative techniques have to be
introduced. On 17 July 2000, the Council set up the Committee of Wise Men on the Regulation of
European Securities Markets. In its final report, the Committee called for each Directive to be a split
between framework principles and ‘non-essential’ technical implementing measures to be adopted by the
In its resolution on more effective securities
Commission under the Union's committee procedures.
markets regulation in the European Union, the Stockholm European Council welcomed the Commission's
intention to establish a Securities Committee. The Securities Committee, acting in its advisory capacity,
should be consulted on policy issues, in particular for the kind of measures the Commission might propose
at the level of framework principles. In its resolution, the European Council added that, subject to specific
legislative acts proposed by the Commission and adopted by the European Parliament and the Council, the
Securities Committee should function as a regulatory committee in accordance with the 1999 Decision on
comitology to assist the Commission when it takes decisions on implementing measures under Article 202
of the EC Treaty. This Directive follows the guidelines laid down by the Stockholm European Council and
the European Parliament.

The provisions of the proposed Directive seek to confine themselves to a high level statement of the
principal obligations incumbent on national authorities or authorised entities. The statement of high level
principles is supplemented, where appropriate, by the specification of
the principal matters to be
harmonised through detailed implementing measures to be adopted through comitology, and the main
legal and technical concepts which detailed implementing measures should take into account.

The amended proposal identifies the second-tier implementing arrangements that will have to be decided
by the Commission by the committee procedure — for example, adaptation and clarification of certain
definitions or adoption of detailed implementing measures to give effect to the obligations set out in the
Directive. The proposal seeks to limit the use of comitology to those operational provisions where detailed
harmonisation will be crucial to the uniform application of ISD provisions and the smooth development of
the single financial market. Account must also be taken of the heavy investment that must be made in the
promulgation of detailed implementing measures by EU institutions, national competent authorities and
securities supervisors and market practitioners (via their involvement in consultation procedures).

important new
Despite this restrictive approach, the scale of the Directive and the introduction of
‘best execution’) call for extensive use of comitology
disciplines at EU level
powers to give effect to core provisions of the proposal. 20 of the 67 articles provide for some use of
comitology.

(e.g. transparency rules,

Annex 1: Overview of Directive 93/22

a) single passport for investment firms:

The primary objective of the ISD was ‘to effect only the essential harmonisation necessary and sufficient
to secure the mutual recognition of authorisation and of prudential supervision systems making possible
the grant of a single authorisation valid throughout the Community and the application of the principle
of home Member State supervision; whereas, by virtue of mutual recognition, investment firms auth-
orised in their home Member States may carry on or all of the services covered by this Directive for
which they have received authorisation throughout the Community by establishing branches or under
the freedom to provide services’.

Entities (natural and legal persons) which provide, as their regular occupation, investment services listed
in annex to the ISD are required to be licensed and supervised as investment firms in accordance with
the provisions of the Directive. Credit institutions are entitled to provide investment services on the
basis of their 2BCD licence as long as they comply with specified provisions of the ISD (e.g. conduct of
business rules). Article 2(2) of the Directive excludes a number of categories of operator, which would
otherwise be categorised as investment firms, from the scope of the Directive.

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Core services for which an ISD license is compulsory include reception and transmission of orders,
execution of orders (brokerage), dealing, individual portfolio management and underwriting. Firms can
provide a combination of core and non-core services as long as they are explicitly authorised to do so
and this is specified in their license. In addition, licensed investment firms may also provide a range of
non-core services on a cross-border basis on the basis of their ISD licence. The main non-core services
include safekeeping and administration of assets (custodianship), and investment advice. Firms may be
licensed at national level to provide one or more non-core services without being licensed to provide
any of the core services. In such cases, the firm cannot rely on this authorisation when trying to provide
those non-core services in other Member States.

The principal start-up and ongoing obligations imposed on investment firms include:

— Possession of initial and ongoing capital reserves in accordance with the requirements resulting from

CAD (93/6);

— Organisational requirements designed to uphold the orderly conduct of the firms operations (art.

10);

— Conduct of business rules governing the way in which acts in its dealings with and on behalf of its

clients, and when participating in the market (art. 11);

— membership of an Investor Compensation Scheme Directive (art. 12 and Dir. 97/9).

— Reporting of transactions in specified instruments conducted on/off exchange (art. 20).

On the basis of compliance with the minimal harmonisation embodied in these provisions, the
investment firm benefits from the right to:

— Freely provide investment services to clients in other Member States on the basis of home country
supervision, except where otherwise provided for in the provision of the Directive (e.g. Articles 11,
13);

— Establish branches in other Member States for the provision of investment services;

— Benefit from a right of access, on a direct,

indirect or remote basis, to the trading systems of
exchanges/regulated markets in other Member States. This right also extends to membership of
clearing and settlement arrangements which are used to finalise transactions concluded on the
‘regulated market’ in question.

b) conditions for recognition as a ‘regulated market’:

The ISD also introduced the first elements for a common regime for national authorisation and super-
vision of regulated markets. Trading venues organised on a permanent basis, operating in accordance
with publicly approved trading rules, and imposing strict controls on the securities admitted to trading
so as to sustain effective dealing in that instrument, are eligible for authorisation as regulated markets. A
‘regulated market’ is also required make available information ‘to enable investors to assess at any time
the terms of a transaction they are considering and to verify afterwards the conditions in which it has
been carried out’ (cf. Article 21 defining broad pre and post-trade transparency requirements). Conferral
of ‘regulated market’ status requires the market to admit any duly authorised bank or investment firm
from another Member States as a market participant. The ‘regulated market’ benefits from the right to
place trading screens and terminals on the desks of remote/overseas members so as to allow the latter
to participate fully in trading on the market. Under Article 16 of the Directive, the Commission is
required to publish a list of regulated markets on an annual basis.

25.3.2003

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THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE
EUROPEAN UNION,

Having regard to the Treaty establishing the European
Community, and in particular Article 47(2) thereof,

Having regard to the proposal from the Commission,

Having regard to the opinion of the Economic and Social
Committee,

Having regard to the opinion of the European Central Bank,

Acting in accordance with the procedure laid down in Article
251 of the Treaty,

Whereas:

could provide

specified services or

(1) Council Directive of 10 May 1993 on investment services
in the securities field 93/22/EEC (1) sought to establish the
conditions under which authorised investment firms and
banks
establish
branches in other Member States on the basis of home
country authorisation and supervision. To this end, that
Directive aimed to harmonise the initial authorisation and
firms including
operating requirements for investment
the
conduct of business
the
harmonisation
operation of
it
granted Member States the option of allowing retail
investors to request execution of their transactions on a
regulated market.

It also provided for
governing

some
of
regulated markets.

conditions

In this

respect,

rules.

the

legal

framework

developments

(2) In recent years more investors have become active in the
financial markets and are offered an even more complex
wide-ranging set of services and instruments. In view of
these
the
Community should encompass the full range of investor
oriented activities. To this end, is necessary to provide for
the degree of harmonisation needed to offer investors a
high level of protection and to allow investment firms to
provide services throughout
the Community, being a
Single Market, on the basis of home country supervision.
In view of the preceding, Directive 93/22/EEC should be
replaced by a new Directive.

of

(1) OJ L 141, 11.6.1993, p. 27; Directive as last amended by European
and Council Directive 2000/64/EC (OJ L 290,

Parliament
17.11.2000, p. 27).

(3) Due to the increasing dependence of

the

requirements

should be
that

investors on
it is appropriate to include
personal recommendations,
the provision of
investment advice as an investment
service requiring authorisation. Therefore proportionate
imposed on
and relevant
investment advisors
content of
to ensure
personal recommendations is not influenced by factors
other than the financial situation, investment objectives,
knowledge, risk profile and expertise of the client. Those
requirements should not apply to the mere provision of
information of a general nature on financial instruments,
provided that the purpose of that activity is not to help
the client conclude or fulfil a contract for an investment
service or financial instrument. In granting authorisation
to provide investment advice, the competent authority or
body to whom it delegates this responsibility, should be
able to take into account any authorisation conditions
required for registration as an insurance intermediary
which overlap with the requirements laid down in this
Directive.

(4) It

financial

is appropriate to include in the list of

financial
instruments commodity derivatives which are constituted
and traded in such a way as to give rise to regulatory
instruments
issues comparable to traditional
such as certain futures or options contracts traded on
regulated markets, which might be physically settled,
where those contracts possess
the characteristics of
instruments, and swaps which are settled only
financial
in cash and where the amounts to be settled are calculated
by reference to values of a full range of underlying prices,
rates, indices and other measures. In this respect, regard
may be had to whether,
inter alia, they are cleared and
settled through recognised clearing houses, give rise to
daily margin calls, are priced in reference to regularly
published prices, standard lots, standard delivery dates
or standard terms as opposed to the terms of settlement
being specified in individual contracts.

investor

execution of

integrity and overall

system. A coherent

efficiency of
and

(5) It is necessary to establish a comprehensive regulatory
regime governing the
transactions on
financial instruments irrespective of the trading methods
used to conclude those transactions so as to ensure a high
transactions and to
quality of execution of
the
uphold the
financial
risk-sensitive
framework for
regulating the main types of order-
execution arrangement currently active in the European
is
financial marketplace should be provided for.
necessary to recognise the emergence of a new generation
of organised trading systems alongside regulated markets
which should be subjected to obligations designed to
functioning of
preserve
financial markets. With a
a
proportionate regulatory framework provision should be
made for the inclusion of a new investment service which
relates to the operation of Multilateral Trading Facilities
(MTFs).

view to establishing

and orderly

efficient

the

It

C 71 E/92

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Official Journal of the European Union

25.3.2003

(6) Definitions of

regulated market and MTF should be
introduced and closely aligned with each other to reflect
the fact that they represent the same organised trading
should exclude bilateral
functionality. The definitions
firm enters into every
systems where the investment
trade on own account and not as a riskless counterparty
interposed between the buyer and seller. The term ‘buying
and selling interests’ is to be understood in a broad sense
and includes orders, quotes and indications of interest.
The requirement that the interests be ‘brought together
. . . in the system by means of non-discretionary rules set
by the system operator’ means that
they are brought
together under the system's rules or by means of the
system's protocols or
internal operating procedures
(including procedures embodied in computer software).
These rules
should be approved by the competent
authority. The expression ‘non-discretionary rules’ means
that these rules leave the investment firm operating an
MTF with no discretion as to how interests may interact.
The definitions require that interests are brought together
in such a way as to result in a contract, meaning that
execution take place under the system's rules or by means
of the system's protocols or internal operating procedures.

(9) Undertakings which do not provide services for third
parties but the business of which consists in providing
investment services solely for their parent undertakings,
for their subsidiaries, or for other subsidiaries of their
should not be covered by this
parent undertakings
Directive.

(10) Persons who provide investment services only on an inci-
dental basis in the course of professional activity should
also be excluded from the scope of
this Directive,
provided that activity is regulated and the relevant rules
do not prohibit the provision, on an incidental basis, of
investment services.

(11) Firms which provide

investment

consisting
exclusively in the administration of employee-partici-
pation schemes and which therefore do not provide
should not be
for
investment
covered by this Directive.

third parties

services

services

(7) The purpose of this Directive is to cover undertakings the
normal business of which is to provide third parties with
investment services on a professional basis.
Its scope
should not therefore cover any person with a different
professional activity.

(8) Insurance undertakings the activities of which are subject
to appropriate monitoring by the competent prudential-
supervision authorities and which are subject of Council
Directive 64/225/EEC of 25 February 1964 on the
abolition of
restrictions on freedom of establishment
and freedom to provide services in respect of reinsurance
and retrocession (1), First Council Directive 73/239/EEC of
24 July 1973 on the coordination of laws, regulations and
administrative provisions relating to the taking up and
pursuit of direct insurance other than life assurance (2)
and First Council Directive 79/267/EEC of 5 March
1979 on the coordination of laws, regulations and admin-
istrative provisions relating to the taking up and pursuit
of direct life assurance (3) should be excluded.

(1) OJ 56, 4.4.1964, p. 878/64; Directive as amended by the Act of

Accession of Denmark, Ireland and the United Kingdom.

(2) OJ L 228, 16.8.1973, p. 3; Directive as last amended by European
Parliament and Council Directive 2002/13/EC (OJ L 77, 20.3.2002,
p. 17).

(3) OJ L 63, 13.3.1979, p. 1; Directive as last amended by European
Parliament Directive 2002/12/EC (OJ L 77, 20.3.2002, p. 11).

(12) It is necessary to exclude from the scope of this Directive
and other bodies performing similar
central banks
functions as well as public bodies charged with or inter-
vening in the management of the public debt, which
concept
thereof, with the
investment
exception of bodies that are partly or wholly State-owned
the role of which is commercial or
linked to the
acquisition of holdings.

covers

the

(13) It is also necessary to exclude from the scope of this
Directive collective investment undertakings whether or
not coordinated at Community level, and the depositaries
or managers of such undertakings, since they are subject
to specific rules directly adapted to their activities.

(14) Firms that provide the investment services covered by this
Directive should be subject
to authorization by their
home Member States in order to protect investors and
the stability of the financial system.

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Official Journal of the European Union

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(15) The principles of mutual

of

the

that

operations,

programmes

recognition and of home
Member State supervision require
the Member
States' competent authorities should not grant or should
withdraw authorization where factors such as the content
geographical
of
distribution or the activities actually carried on indicate
clearly that an investment firm has opted for the legal
system of one Member State for the purpose of evading
the stricter standards in force in another Member State
within the territory of which it intends to carry on or
does carry on the greater part of
its activities. An
investment firm which is a legal person should be auth-
orized in the Member State in which it has its registered
office. An investment firm which is not a legal person
should be authorized in the Member State in which it has
its head office. In addition, Member States should require
that an investment
firm's head office must always be
situated in its home Member State and that it actually
operates there.

(16) An investment firm authorized in its home Member State
should be able to carry on business throughout
the
Community by whatever means it deems appropriate.

firm,

in the

investment

institutions (1),

special obligations

(17) In the interest of the sound and prudent management of
the
should be
imposed on persons who effectively direct the business
and persons exercising effective control. Since certain
investment
firms are exempted from the obligation
imposed by Council Directive 93/6/EEC of 15 March
1993 on the capital adequacy of investment firms and
they should be obliged to hold
credit
professional
indemnity insurance. The adjustments of
the amounts of that insurance should take account of
framework of European
adjustments made
. . .
Parliament and Council Directive 2002/. . ./EC of
2002 on insurance Mediation. This particular treatment
for the purposes of capital adequacy should be without
prejudice to any decisions regarding the appropriate
treatment of
to
firms under
Community legislation on capital adequacy. No later
than the 31 December 2006, the Commission should
present a report
to the European Parliament and the
Council on the application of these provisions accom-
their
panied where
revision. These proposals should take account of devel-
opments within the Community and other international
fora, particularly those pertaining to capital charges on
operational risk.

by proposals

appropriate

changes

future

these

for

represent a source of
book on a professional basis,
counterparty risk to other market participants, entities
which deal for their own account in financial instruments,
including those commodity derivatives covered by this
Directive, on an ancillary basis to their main business,
should be excluded from the scope of this Directive.

(19) Since

the

prudential

framework

by
Community law is not currently adapted to the specific
situation of undertakings whose main business, when
considered on a consolidated basis, consists of dealing
on own account in commodity derivatives it is appro-
priate to exclude them from the scope of this Directive.

established

(20) In order to protect an investor's ownership and other
similar rights in respect of securities and his rights in
respect of funds entrusted to a firm those rights should
in particular be protected by being kept distinct from
those of the firm. This principle should not, however,
prevent a firm from doing business in its name but on
behalf of the investor, where that is required by the very
nature of the transaction and the investor is in agreement,
for example stock lending.

(21) For the purposes of ensuring that retail investors do not
enter into unsuitable transactions, access to the systems
operated by an MTF should be restricted to investment
firms and credit institutions for the purposes of trading
on own account or on behalf of their customers and
other eligible counterparties.

(22) The procedures

for

the

authorisation, within the
Community, of branches of investment firms authorized
in third countries should continue to apply to such firms.
Those branches should not enjoy the freedom to provide
services under the second paragraph of Article 49 of the
Treaty or the right of establishment in Member States
other than those in which they are established. In view
of cases where the Community is not bound by any
bilateral or multilateral obligations it is appropriate to
that
intended to ensure
provide
for
Community
reciprocal
receive
firms
treatment in the third countries concerned.

a procedure
investment

(18) Since the scope of prudential regulation should be limited
to those entities which, by virtue of running a trading

(1) OJ L 141, 11.6.1993, p. 1; Directive as last amended by European
Parliament and Council Directive 98/33/EC (OJ L 204, 21.7.1998,
p. 29).

(23) The expanding range of activities that many investment
firms and credit institutions undertake simultaneously has
increased potential for conflicts of interests between these
different activities and the interest of their clients. It is
therefore necessary to provide for rules to ensure that
such conflicts do not adversely affect client interest.

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Official Journal of the European Union

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(24) It is necessary to strengthen the Community's legislative
framework to protect investors by enhancing obligations
of investment firms when providing services with or on
behalf of clients. In particular, it is indispensable for an
investment firm acting on behalf of a client, in order to
properly fulfil
to
obtain information on the client's
financial position,
experience and investment objectives and to assess the
suitability, for that client, of services or transactions in
financial instruments which are being considered in the
light of
this
assessment should not require a separate authorisation
to provide investment advice.

its agency obligations to its clients,

information. The performance of

this

(25) By way of derogation from the principle of home country
authorisation, supervision and enforcement of obligations
in respect of the operation of branches, it is appropriate
that the competent authority of the host Member State
assumes responsibility for enforcing conduct of business
in relation to business conducted with clients
rules
through a branch, since that authority is in greatest
proximity to the branch, and is better placed to detect
and intervene
rules
governing firm-client transactions.

infringements of

in respect of

(29) It is appropriate to determine the conditions under which
investment firms can rely on the offices of tied agents. As
it performs a limited range of functions on behalf of one
investment firm, the tied-agent should not be considered
an investment firm itself and should not be eligible to
undertake its activities in other Member States. Member
States should be able to delegate responsibility as regards
the authorisation, registration and supervision of
tied
agents to appropriately resourced and independent self-
regulatory bodies. This Directive should be without
prejudice to the right of tied agents to undertake related
activities in respect of financial services or products not
covered by this Directive, including on behalf of parts of
the same financial group. The conditions for conducting
firm
activities outside the premises of
(door-to-door selling) should not be covered by this
Directive.

the investment

(30) For the purposes of ensuring that conduct of business
rules are enforced in respect of those investors most in
need of these protections, and in reflection of well-estab-
lished market practice throughout the Community, it is
appropriate to clarify that conduct of business rules may
be waived in the case of transactions between eligible
counterparties.

(26) It

is necessary to impose an effective ‘best execution’
obligation to ensure that investment firms execute client
orders on terms that are most favourable to the client.
This obligation should apply to the firm which owes
contractual or agency obligations to the client — irres-
pective of whether that firm executes the order itself or
relies on another intermediary to do so.

(27) In order to enhance confidence in the impartiality and
quality of execution services and to improve the overall
price-formation process, it is essential that the investment
firm which receives a limit order and is unable to execute
such an order on specified terms immediately, routes it to
a ‘regulated market’ or MTF, or discloses the terms of the
trading interest to the market in some other way.

(28) This Directive recognises that investors should be fully
aware of the potential risks and benefits associated with
particular order handling arrangements. To this end, the
clients should give their express consent before their
orders are executed, in particular against the proprietary
positions of the firm. The investment firm should have
the right to decide whether to obtain this prior consent
on a general basis (e.g. at the outset of the relationship) or
on a trade-by-trade basis.

institution nor

(31) The mere fact, however, that an entity which is neither a
credit
firm may be
recognised as ‘eligible counterparty’ should not deprive
to whom
it of
conduct of business or other agency protections are owed.

to be treated as a client

an investment

the right

(32) With the two-fold aim of protecting investors and
ensuring the smooth operation of securities markets,
it
is necessary to ensure that transparency of transactions
is achieved and that the rules laid down for that purpose
apply both to investment firms and to credit institutions
when they operate on the markets. In order to enable
investors or market participants to assess at any time
they are
the terms of a transaction on shares that
considering and to verify afterwards the conditions in
which it has been carried out, common rules should be
established for the publication of details of completed
transactions
and disclosure of details of
current opportunities to trade in shares. These rules are
needed to ensure the effective integration of Member State
equity markets, to promote the efficiency of the overall
price formation process for equity instruments, and to
‘best execution’ obli-
assist
gations. These considerations require a comprehensive
transparency regime applicable to all
in
shares irrespective of their execution by an investment
firm on a bilateral basis or through regulated markets
or MTF.

the effective operation of

transactions

in shares

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(33) In order to ensure a degree of pre-trade information
needed to support the efficient formation of prices in
shares and to allow market participants to determine
the most favourable terms for concluding transactions, it
is appropriate to require investment firms dealing on own
account to make public a firm two-sided quote for trans-
actions of a specified size in respect of liquid shares.

joining or having access

(34) Investment firms should all have the same opportunities
of
to regulated markets
throughout the Community. Regardless of the manner
in which transactions are at present organized in the
it is important to abolish the technical
Member States,
and legal
indirect and remote
access to the regulated markets.

restrictions on direct,

by

and

settlement

investment

systems
firms

throughout
including

(35) In order to facilitate the finalisation of cross-border trans-
actions, it is also appropriate to provide for the access to
the
clearing
Community,
those
operating MTF, irrespective of whether transactions have
been concluded through regulated markets in the Member
firms which wish to
State
participate directly in partner country settlement systems
should have to comply with the relevant operational and
commercial
for membership and the
prudential measures to uphold the smooth and orderly
functioning of the financial markets.

requirements

Investment

concerned.

(36) The authorisation to operate a regulated market should
extend to all activities which are directly related to the
display, processing, execution, confirmation and reporting
of orders from the point at which such orders are
received by the regulated market to the point at which
they are transmitted for subsequent finalisation, and to
activities related to the admission of financial instruments
to trading. This
transactions
concluded through the medium of designated market
makers appointed by the regulated market which are
undertaken under its rules and systems.

also include

should

(37) Operators of a regulated market should also be able to
operate an MTF without being required to obtain
additional authorisation as an investment firm.

(38) The provisions of this Directive concerning the admission
of instruments to trading under the rules enforced by the
regulated market should be without prejudice to the
application of Directive 2001/34/EC of
the European
parliament and of the Council of 28 May 2001 on the
admission of securities to official stock exchange listing

and on information to be published on those securities (1).
A regulated market
should not be prevented from
applying more demanding requirements in respect of
the issuers of
is
considering for admission to trading than are imposed
pursuant to this Directive.

instruments which it

securities or

(39) Member States should be able to designate different
competent authorities to enforce the wide-ranging obli-
gations laid down in this Directive. Such authorities
should be of public nature guaranteeing its independence
of economic actors and avoiding conflicts of interest. The
designation of public authorities should not exclude dele-
gation under
competent
authority.

responsibility of

the

the

(40) It is necessary to enhance convergence of powers at the
disposal of competent authorities so as to pave the way
towards equivalent intensity of enforcement across the
integrated financial market. A common minimum set of
powers coupled with adequate resources should guarantee
supervisory effectiveness.

(41) With a view to protecting clients and without prejudice to
the right of customers to bring their action before the
courts,
it is appropriate that Member States encourage
public or private bodies established with a view to
settling disputes out-of-court, to cooperate in resolving
cross-border disputes, taking into account Commission
Recommendation 98/257/EC of 30 March 1998 on the
principles
for
out-of-court settlement of consumer disputes (2). When
implementing provisions on complaints and redress
procedures for out-of-court settlements, Member States
are encouraged to use existing cross border co-operation
mechanisms, notably the Financial Services Complaints
Network (FIN-Net).

to the bodies

responsible

applicable

(42) It is necessary to reinforce provisions on exchange of
information between national competent authorities and
to strengthen the duties of assistance and cooperation
which they owe to each other. Due to increasing cross-
border activity, competent authorities should provide each
other with the relevant information for the exercise of
their functions, so as to ensure the effective enforcement
of
situations where
infringements or
suspected infringements may be of
concern to authorities in two or more Member States.
In the
strict professional
secrecy is needed to ensure the smooth transmission of
that information and the protection of particular rights.

this Directive

exchange of

information,

including

in

(1) OJ L 184, 6.7.2001, p. 1.
(2) OJ L 115, 17.4.1998, p. 31.

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Official Journal of the European Union

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(43) At its meeting on 17 July 2000, the Council set up the
Committee of Wise Men on the Regulation of European
Securities Markets. In its final report, the Committee of
Wise Men proposed the introduction of new legislative
techniques based on a four-level approach, namely
framework principles,
coop-
eration and enforcement. Level 1, the Directive, should
‘framework’ principles
confine itself
while Level 2 should contain technical
implementing
measures to be adopted by the Commission with the
assistance of a committee.

implementing measures,

to broad general

(44) The Resolution adopted by the Stockholm European
Council of 23 March 2001 endorsed the final report of
the Committee of Wise Men and the proposed four-level
approach to make the regulatory process for Community
securities legislation more efficient and transparent.

(45) According to the Stockholm European Council, Level 2
implementing measures should be used more frequently,
to ensure that technical provisions can be kept up to date
with market and supervisory developments, and deadlines
should be set for all stages of Level 2 work.

(46) The Resolution of the European Parliament of 5 February
2002 on the implementation of financial services legis-
lation also endorsed the Committee of Wise Men's report,
the solemn declaration made before
on the basis of
Parliament the same day by the Commission and the
letter of 2 October 2001 addressed by the Internal
Market Commissioner to the chairman of Parliament's
Committee on Economic and Monetary Affairs with
regard to the safeguards for the European Parliament's
role in this process.

(47) The measures necessary for the implementation of this
Directive should be adopted in accordance with Council
Decision 1999/468/EC of 28 June 1999 laying down the
procedures
implementing powers
the exercise of
conferred on the Commission (1).

for

first

from the

(48) The European Parliament should be given a period of
transmission of draft
three months
to examine them
implementing measures to allow it
and to give its opinion. However,
in urgent and duly
justified cases, this period may be shortened. If, within
that period, a resolution is passed by the European
Parliament, the Commission should re-examine the draft
measures.

(49) With a view to take into account further developments in
the financial markets the Commission should submit

(1) OJ L 184, 17.7.1999, p. 23.

application of

reports to the European Parliament and the Council on
the
the
professional indemnity insurance, the scope of the trans-
parency rules and the possible authorisation of specialized
dealers in commodities derivatives as investment firms.

the provisions

concerning

undertakings

relating
in

to
transferable

(50) Council Directive 85/611/EEC of 20 December 1985 on
the coordination of laws, regulations and administrative
provisions
collective
for
securities (2), Directive
investment
93/6/EEC and Directive 2000/12/EC of
the European
Parliament and of the Council of 20 March relating to
the taking up and pursuit of the business of credit insti-
tutions (3) should be amended in order to align them with
the provisions of this Directive.

of

the

common

establishment

(51) The objectives of creating an integrated financial market
in which investors are effectively protected and the effi-
ciency and integrity of the overall market are safeguarded,
regulatory
require
requirements relating to investment firms wherever they
are authorised in the Community and governing the func-
tioning of regulated markets and other trading systems so
as to prevent opacity or disruption on one market from
the European
undermining the efficient operation of
financial system as a whole. Given that these objectives
may be better
the
Community may adopt measures in accordance with the
principle of subsidiarity as set out in Article 5 of the
In accordance with the principle of propor-
Treaty.
tionality, as set out in that Article, this Directive does
not go beyond what is necessary in order to achieve
those objectives,

achieved at Community level,

HAVE ADOPTED THIS DIRECTIVE:

TITLE I

DEFINITIONS AND SCOPE

Article 1

Scope

This Directive shall apply to investment

1.
regulated markets.

firms and

Articles 12 and 13 and Chapters II and III of Title II shall
institutions authorised under Directive

2.
apply also to credit
2000/12/EC to perform one or more investment services.

(2) OJ L 375, 31.12.1985, p. 3; Directive as last amended by European
and Council Directive 2001/108/EC (OJ L 41,

Parliament
13.2.2002, p. 35).

(3) OJ L 126, 26.5.2000, p. 1; Directive as amended by Directive

2000/28/EC (OJ L 275, 27.10.2000, p. 37).

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Official Journal of the European Union

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Article 2

Exemptions

1.

This Directive shall not apply to:

(a)

insurance undertakings as defined in Article 1 of Directive
73/239/EEC or in Article 1 of Directive 79/267/EEC or
undertakings carrying on the reinsurance and retrocession
activities referred to in Directive 64/225/EEC;

(b) firms which provide investment services exclusively for
for their subsidiaries or for

their parent undertakings,
other subsidiaries of their parent undertakings;

(c) persons providing an investment service where that service
is provided in an incidental manner in the course of a
professional activity and that activity is regulated by legal
or regulatory provisions or a code of ethics governing the
profession which do not exclude the provision of
that
service;

(d) firms which provide

consisting
exclusively in the administration of employee-participation
schemes;

investment

services

(e)

firms which provide investment services which involve
both administration of employee-participation schemes
and the provision of investment services exclusively for
their parent undertakings,
for their subsidiaries or for
other subsidiaries of their parent undertakings;

(f)

the members of the European System of Central Banks and
other national bodies performing similar functions and
other public bodies charged with or intervening in the
management of the public debt;

(g) collective investment undertakings whether co-ordinated at
Community level or not and the depositaries and managers
of such undertakings;

(h) persons dealing on own account in financial instruments as
an ancillary activity to their main business, where that
main business is not the provision of investment services
within the meaning of this Directive or banking services
under Directive 2000/12/EC;

(i) undertakings whose main business, when considered on a
consolidated basis, consists of dealing on own account in
commodity derivatives;

(j)

services

investment

consisting
firms which provide
exclusively in dealing for their own account on financial-
futures or options markets or which deal for the accounts
of other members of those markets or make prices for
them and which are guaranteed by clearing members of
the same markets, and where responsibility for ensuring the

performance of contracts entered into by such firms is
assumed by clearing members of the same markets;

(k) associations set up by Danish pension funds with the sole
aim of managing the assets of pension funds that are
members of those associations;

(l)

‘agenti di cambio’ whose activities and functions are
governed by Article 201 of
Italian Legislative Decree
No 58 of 28 February 1998.

The rights conferred by this Directive shall not extend to
2.
the provision of services as counterparty in transactions carried
out by members of the European System of Central Banks
performing their tasks as provided for by the Treaty and the
Statute of the European System of Central Banks and of the
European Central Bank.

In order to take account of developments on financial
this
the Commission, acting in accordance with the
referred to in Article 59(2), may clarify the

3.
markets, and to ensure the uniform application of
Directive,
procedure
exemptions provided for under paragraph 1 of this Article.

Article 3

Definitions

For the purposes of this Directive, the following defi-

1.
nitions shall apply:

1. Investment firm means any legal person whose regular occu-
pation or business is the provision of investment services
on a professional basis;

2. Investment service means any of the services listed in Section
A of Annex I relating to any of the instruments listed in
Section C of Annex I;

3. Ancillary service means any of the services listed in Section
B of Annex I relating to any of the instruments listed in
Section C of Annex I;

4. Investment advice means the provision of personal recom-
mendation to a client in respect of one or more trans-
actions relating to financial instruments;

5. Execution of orders on behalf of clients means acting as an
agent to conclude agreements to buy or sell one or more
financial instruments on behalf of clients;

6. Dealing on own account means active trading against
proprietary capital, on a regular and professional basis,
resulting in the conclusion of
transactions in one or
more financial instruments;

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7. Client means any natural or legal person seeking the
investment and ancillary services from an

provision of
investment firm;

market, such as treasury bills, certificates of deposit and
commercial papers and excluding instruments of payment;

8. Professional

client means a client who possesses

the
experience, knowledge and expertise to make its own
investment decisions and properly assess the risks that it
incurs, in accordance with the criteria and procedures laid
down in Annex II;

9. Market operator means a person or persons who effectively

direct the business of a regulated market;

17. Home Member State means:

(a)

in the case of investment firms:

(i) if the investment firm is a natural person, the
Member State in which its head office is situated;

brings

operator, which

10. Regulated market means a multilateral system, operated by a
together multiple
market
third-party buying and selling interests
in financial
instruments — in the system and in accordance with
non-discretionary rules — in a way that results in a
contract, in respect of the financial instruments admitted
to trading under its rules and systems, and which is auth-
orised and functions regularly and in accordance with the
provisions of Title III;

11. Multilateral

trading facility

(MTF) means a multilateral
system which brings together multiple third-party buying
and selling interests in financial
instruments — in the
system and in accordance with non-discretionary rules
— in a way that results in a contract;

(ii) if

the investment

firm is a legal person,

the
Member State in which its registered office is
situated.
the competent authority
shall also ensure that the head office of the firm
is located in this Member State;

In this case,

(iii) if the investment firm has, under its national law,
no registered office, the Member State in which its
head office is situated;

(b) in the case of a regulated market, the Member State in
which the regulated market is registered or, if under
the law of that Member State it has no registered
office, the Member State in which the head office of
the regulated market is situated;

12. Market order means an order to buy or sell a financial

instrument at the best available price;

18. Host Member State means the Member State in which an

investment firm has a branch or provides services;

13. Limit order means an order to buy or sell a financial

instrument at its specified limit or better;

19. Competent authority means the authority, designated by the
home Member State in accordance with Article 45, unless
otherwise specified in this Directive;

14. Financial

instrument means those instruments specified in

Section C of Annex I;

20. Credit institutions means credit institutions as defined under

Directive 2000/12/EC;

15. Transferable

securities means

securities
which are negotiable on the capital market, with the
exception of instruments of payment, such as:

those classes of

(a) shares in companies and other securities equivalent to
shares in companies, partnership or other entities, and
depositary receipts in respect of shares;

(b) bonds or other forms of securitized debt;

(c) any other securities giving the right to acquire or sell
any such transferable securities or giving rise to a cash
settlement determined by reference to transferable
yields,
securities,
commodities or other indices or measures;

currencies,

interest

rates

or

16. Money-market

of
instruments which are normally dealt in on the money

instruments means

classes

those

21. UCITS Management

company means

a management

company as defined in Directive 85/611/EEC;

22. Tied agent means a natural or legal person who, without
being considered as an investment firm for the purposes of
this Directive, promotes the investment and ancillary
services of an investment firm to clients or prospective
clients, collects and transmits instructions or orders from
the client in respect of investment services or financial
instruments to that investment firm, and provides advice
to clients or prospective clients in respect of the financial
firm
instruments or services offered by the investment
under the full and unconditional responsibility of
the
investment firm on whose behalf it acts;

23. Branch means a place of business which is a part of an
investment firm, which has no legal personality and which
provides investment services for which the investment firm
has been authorised;

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24. Qualifying holding means any direct or indirect holding in
an investment firm which represents 10 % or more of the
capital or of the voting rights, as set out in Article 7 of
Council Directive 88/627/EEC (1), or which makes
it
the
possible to exercise a significant
management of
firm in which that
holding subsists;

influence over

investment

the

TITLE II

AUTHORISATION AND OPERATING CONDITIONS FOR
INVESTMENT FIRMS

CHAPTER I

CONDITIONS AND PROCEDURES FOR AUTHORISATION

25. Parent undertaking means a parent undertaking as defined in
Articles 1 and 2 of Council Directive 83/349/EEC (2);

Article 4

Requirement for authorisation

26. Subsidiary means a subsidiary undertaking as defined in
Articles 1 and 2 of Directive 83/349/EEC, including any
subsidiary of a subsidiary undertaking of an ultimate
parent undertaking;

27. Control means control as defined in Article 1 of Directive

83/349/EEC;

Each Member State

1.
the provision of
shall
investment services to investment firms. It shall ensure that
all investment firms for which it is the home Member State
operate only after authorisation in accordance with the
provisions of this Directive.

reserve

2.
By way of derogation from paragraph 1, Member States
shall allow any market operator to operate an MTF, subject to
compliance with Articles 13, 24, 27 and 28.

28. Close links means a situation in which two or more natural

or legal persons are linked by:

3.
By way of derogation from point 1 of Article 3(1),
Member States may authorise as investment firms undertakings
which are not legal persons, provided that:

(a) participation which means the ownership, direct or by
way of control, of 20 % or more of the voting rights or
capital of an undertaking,

(b) control which means the relationship between a parent
undertaking and a subsidiary, in all the cases referred
to in Article 1(1) and (2) of Directive 83/349/EEC, or a
similar
legal
relationship between any natural or
person and an undertaking, any subsidiary undertaking
of a subsidiary undertaking also being considered a
subsidiary of the parent undertaking which is at the
head of those undertakings.

A situation in which two or more natural or legal persons are
permanently linked to one and the same person by a control
relationship shall also be regarded as constituting a close link
between such persons.

In order to take account of developments on financial
2.
this
markets, and to ensure the uniform application of
Directive,
the Commission, acting in accordance with the
procedure referred to in Article 59(2), may clarify the defi-
nitions provided in paragraph 1 of this Article.

(a) their legal status ensures a level of protection for third
to that afforded by legal

interests equivalent

parties'
persons, and

(b) they are subject to equivalent prudential supervision appro-

priate to their legal form.

However, where a natural person provides services involving
the holding of third parties' funds or transferable securities, it
may be considered as an investment firm for the purposes of
this Directive only if, without prejudice
to the other
imposed in this Directive and in Directive
requirements
93/6/EEC, it complies with the following conditions:

(a) the ownership rights of third parties in instruments and
funds must be safeguarded, especially in the event of the
insolvency of the firm or of its proprietors, seizure, set-off
or any other action by creditors of the firm or of
its
proprietors;

(b) the firm must be subject to rules designed to monitor the

firm's solvency and that of its proprietors;

(1) OJ L 348, 17.12.1988, p. 62.
(2) OJ L 193, 18.7.1983, p. 1.

(c)

the firm's annual accounts must be audited by one or more
persons empowered, under national law, to audit accounts;

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(d) where the firm has only one proprietor, he must make
provision for the protection of investors in the event of
the firm's cessation of business following his death, his
incapacity or any other such event.

An applicant shall be informed, within six months of the
3.
submission of a complete application, whether or not author-
isation has been granted.

4. Member States shall establish a register of all investment
firms. This register shall be publicly accessible and shall contain
information on the services for which the investment firm is
authorised. It shall be updated on a regular basis.

Article 7

Withdrawal of authorisations

The competent authority may withdraw the authorisation
issued to an investment firm where such an investment firm:

investment

In the case of

firms which provide only
5.
investment advice, Member States may allow the competent
authority to delegate the function of granting authorisation
to a body which meets the conditions set out in Article 45(2).

(a) does not make use of the authorisation within 12 months,
expressly renounces the authorisation or has provided no
investment services for the preceding six months, unless
the Member State concerned has provided for authorisation
to lapse in such cases;

Article 5

Scope of authorisation

(b) has obtained the authorisation by making false statements

or by any other irregular means;

1.
The home Member State shall ensure that the author-
isation specifies the investment services which the investment
firm is authorised to provide. The authorisation may cover one
or more of the ancillary services set out in Section B of Annex
I. Authorisation may in no case be granted solely for the
provision of ancillary services.

An investment firm seeking authorisation to extend its
investment or ancillary services not
initial authorisation shall submit a

2.
business to additional
foreseen at the time of
request for extension of its authorisation.

3.
The authorisation shall be valid for the entire Community
and shall allow an investment firm to provide the services, for
the Community,
which it has been authorised,
either through the establishment of a branch or the free
provision of services.

throughout

Article 6

Procedures for granting and refusing requests for
authorisation

The competent authority shall not grant authorisation
1.
unless and until such time as it
the
applicant complies with all requirements under the provisions
adopted pursuant to this Directive.

is fully satisfied that

The

investment

firm shall provide all

2.
information,
including a programme of operations setting out inter alia the
types of business envisaged and the organisational structure,
necessary to enable the competent authority to satisfy itself
that the investment firm has established, at the time of initial
authorisation, all the necessary arrangements to meet its obli-
gations under the provisions of this Chapter.

(c) no longer meets the conditions under which authorisation
was granted, such as compliance with the conditions set
out in Directive 93/6/EEC;

(d) has seriously and systematically infringed the provisions
the

adopted pursuant
operating conditions for investment firms;

this Directive

governing

to

(e)

falls within any of the cases where national law, in respect
of matters outside the scope of this Directive, provides for
withdrawal.

Article 8

Persons who effectively direct the business

1. Member States shall require the persons who effectively
direct the business of an investment firm to be of sufficiently
good repute and sufficiently experienced as to ensure the sound
and prudent management of the investment firm.

2. Member States shall require the investment firm to notify
the competent authority of any changes to its management,
along with all information needed to assess whether the new
staff appointed to manage the firm are of sufficiently good
repute and sufficiently experienced.

3.
The competent authority shall refuse authorisation if it is
not satisfied that the persons who will effectively direct the
sufficiently good
business of
the investment
there are objective
repute or sufficiently experienced, or if
and demonstrable grounds
that proposed
changes to the management of the firm pose a threat to its
sound and prudent management.

for believing

firm are of

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4. Member States shall ensure that
investment
meeting the requirements laid down in paragraph 1.

is undertaken by at

the management of
two persons

firms

least

By way of derogation from the first subparagraph, Member
States may grant authorisation to investment firms which are
natural persons or to investment firms which are legal persons
managed by a single natural person in accordance with their
constitutive rules and national laws. Member States shall never-
theless ensure that alternative arrangements are in place which
ensure the sound and prudent management of such investment
firms.

satisfied as to the suitability of the persons referred to in the
first subparagraph. If the competent authority does not oppose
the plan, it may fix a deadline for its implementation.

firm, a credit

If the acquirer of any holding referred to in paragraph 3
4.
institution or an insurance
is an investment
undertaking authorised in another Member State, or
the
parent undertaking of an investment firm, credit institution
or
insurance undertaking authorised in another Member
State, or a person controlling an investment firm, credit insti-
tution or insurance undertaking authorised in another Member
State, and if, as a result of that acquisition, the undertaking
would become the acquirer's subsidiary or come under his
control, the assessment of the acquisition shall be subject to
the prior consultation provided for in Article 55.

Article 9

Persons exercising effective control and acquisitions of
qualifying holdings

1. Member States shall require any shareholder owning a
firm to be suitable,
qualifying holding in the investment
having regard to the need to ensure the sound and prudent
management of the investment firm.

5. Member States shall require that, if an investment firm
becomes aware of any acquisitions or disposals of holdings in
its capital that cause holdings to exceed or fall below any of
subparagraph of
referred to in the first
the thresholds
paragraph 3,
to inform the
firm is
that
competent authority without delay.

investment

Where close links exist between the investment firm and other
natural or legal persons, the competent authority shall grant
authorisation only if those links do not prevent the effective
competent
supervisory functions of
exercise of
authority.

the

the

2.
The competent authority shall refuse authorisation if the
laws, regulations or administrative provisions of a third country
governing one or more natural or legal persons with which the
undertaking has close links, or difficulties involved in their
enforcement, prevent the effective exercise of its supervisory
functions.

first

firm,

3. Member States shall require any natural or legal person
who proposes to acquire or sell, directly or indirectly, a qual-
to notify,
ifying holding in an investment
in
accordance with the second subparagraph,
the competent
authority of the size of the resulting holding. Such persons
shall likewise be required to notify the competent authority if
they propose to increase or reduce their qualifying holding, if
in consequence the proportion of the voting rights or of the
capital that they hold would reach or fall below or exceed
20 %, 33 % or 50 % or the investment firm would become
their subsidiary.

Without prejudice to the provisions of paragraph 4,
the
competent authority shall have up to three months from the
date of the notification provided for in the first subparagraph
to oppose such a plan if, in view of the need to ensure sound
it is not
and prudent management of the investment firm,

the names of

investment firms shall also inform the
At least once a year,
competent authority of
shareholders and
members possessing qualifying holdings and the sizes of such
holdings as shown, for example, by the information received at
annual general meetings of shareholders and members or as a
regulations applicable
result of compliance with the
to
companies whose
securities are admitted to
trading on a regulated market.

transferable

6. Member States shall require that, where the influence
exercised by the persons referred to in the first subparagraph
of paragraph 1 is likely to be prejudicial to the sound and
prudent management of an investment firm, the competent
authority takes appropriate measures to put an end to that
situation.

Such measures may consist in applications for judicial orders
and/or the imposition of sanctions against directors and those
responsible for management, or suspension of the exercise of
the voting rights attaching to the shares held by the share-
holders or members in question.

Similar measures shall be taken in respect of persons who fail
to comply with the obligation to provide prior information in
relation to the acquisition or increase of a qualifying holding. If
a holding is acquired despite the opposition of the competent
authorities, the Member States shall, regardless of any other
sanctions to be adopted, provide either for exercise of the
corresponding voting rights to be suspended, for the nullity
of the votes cast or for the possibility of their annulment.

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Article 10

Membership of an authorised Investor Compensation
Scheme

The competent authority shall verify that any entity seeking
authorisation as an investment
firm meets its obligations
under European Parliament and Council Directive 97/9/EC (1)
at the time of authorisation.

An investment firm shall be structured and organised in
3.
such a way as to minimise the risk of client interests being
prejudiced by conflicts of interest between the firm and its
clients or between one of its clients and another.

4.
An investment firm shall employ such systems, resources
and procedures as are necessary to ensure continuity and regu-
larity in the provision of the service.

Article 11

Initial capital endowment

1. Member States shall ensure that the competent authority
does not grant authorisation unless the investment firm has
in accordance with the requirements
sufficient initial capital
of Directive 93/6/EEC having regard to the nature of
the
investment service in question.

5.
An investment firm shall ensure that, when relying on a
third party for the performance of functions which are critical
for the provision of continuous and satisfactory service to
clients, that it takes reasonable steps to avoid undue additional
operational
important operational
functions may not be undertaken in such a way as to impair
the quality of
the
supervisor to monitor the firm's compliance with all obli-
gations.

its internal control and the ability of

risk. Outsourcing

of

that

shall

ensure

investment

2. Member States
firms
exempted from the scope of Directive 93/6/EEC, pursuant to
points (c) and (d) of Article 2(2) thereof, hold professional
indemnity insurance covering the whole territory of
the
some other comparable guarantee against
Community or
liability arising from professional negligence, representing at
least
to each claim and in
aggregate EUR 2 000 000 per year for all claims.

EUR 1 000 000 applying

3.
The amounts referred to in paragraph 2 of this Article
shall be periodically reviewed by the Commission in order to
take account of changes in the European Index of Consumer
Prices as published by Eurostat, in line with and at the same
time as the adjustments made under Article 4(7) of Directive
2002/. . ./EC [Insurance Mediation].

Article 12

Organisational requirements

1.
The home Member State shall ensure that investment
firms comply with the organisational requirements set out in
paragraphs 2 to 9.

2.
An investment firm shall establish adequate policies and
procedures to ensure compliance of the firm and its directors,
employees and tied-agents with its obligations under
this
Directive when conducting business with and on behalf of
clients and which require it to act in accordance with market
integrity. Those policies and procedures shall be such as to
enable the investment firm to demonstrate, at the request of
the competent authority, that it has acted in accordance with
those obligations.

(1) OJ L 84, 26.3.1997, p. 22.

6.
An investment firm shall have sound administrative and
accounting procedures, internal control mechanisms, effective
procedures
risk assessment, and effective control and
safeguard arrangements for information processing systems,
including, in particular, rules governing personal transactions
by employees.

for

7.
An investment firm shall arrange for records to be kept
of all services and transactions undertaken by it which shall be
sufficient
to enable the competent authority to monitor
compliance with the requirements under this Directive, and
in particular
firm has
complied with all obligations with respect to clients.

to ascertain that

the investment

An investment

8.
firm shall, when holding financial
instruments belonging to clients, make adequate arrangements
so as to safeguard clients' ownership rights, especially in the
event of the investment firm's insolvency, and to prevent the
use of a client's instruments on own account except with the
client's express consent.

9.
An investment firm shall, when holding funds belonging
to clients, make adequate arrangements to safeguard the clients'
rights and, except in the case of credit institutions, prevent the
use of client funds for its own account.

In the case of branches of

the
investment
10.
the Member State in which the
competent authority of
branch is located shall, without prejudice to the possibility of
the competent authority of the home Member State of the
investment
to those records,
enforce the obligation laid down in paragraph 7 with regard
to transactions undertaken by the branch.

firm to have direct access

firms,

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In order to take account of technical developments on
11.
financial markets and to ensure the uniform application of
paragraphs 2 to 10, the Commission shall adopt, in accordance
with the procedure referred to in Article 59(2), implementing
organisational
measures which
requirements to be imposed on investment firms providing
different
investment and ancillary services or combinations
thereof.

concrete

specify

the

Article 13

Trading process and finalisation of transactions in an MTF

shall

require

investment

firms
that
1. Member States
operating an MTF,
in addition to meeting the requirements
laid down in Article 12, establish transparent and non-discre-
tionary rules and procedures for fair and orderly trading and
establish objective criteria for the efficient execution of orders
so as to enable users to obtain the best price available on or
through the MTF, at any given moment for the size of trans-
action envisaged. Those rules and procedures shall be subject
to prior approval by the competent authority of the home
Member State.

shall

require

firms
2. Member States
that
to the facility in
operating an MTF provide for access
accordance with
commercial
conditions. Investment firms operating an MTF shall be able
to make the use of its facilities and access thereto available only
to eligible counterparties as referred to in Article 22(3).

transparent

investment

objective

and

that

shall

require

investment

3. Member States
firms
operating an MTF clearly inform their users of their respective
responsibilities for the settlement of the transactions executed
in that facility. If investment firms operating an MTF assume
part of the responsibility for the settlement of those trans-
actions, the competent authority shall ensure that they have
put in place the necessary arrangements to facilitate efficient
settlement.

4. Where a transferable security, which has been admitted to
is also traded on an MTF
trading on a regulated market,
the issuer shall not be
the issuer,
the consent of
without
subject to any obligation relating to initial, ongoing or ad hoc
financial disclosure with regard to that MTF.

5. Member States shall ensure that any investment
firm
operating an MTF complies immediately with any instruction
from its competent authority pursuant
to
suspend or remove a financial instrument from trading.

to Article 46(1)

6.
In order to take account of technical developments on
financial markets and to ensure uniform application of

paragraphs 1 and 2, the Commission shall adopt, in accordance
with the procedure referred to in Article 59(2), implementing
measures governing the content of trading rules to promote
fair and orderly trading through the MTF.

Article 14

Authorisation of third country firms and branches

1.
The Member States shall inform the Commission of any
general difficulties which their investment firms encounter in
establishing themselves or providing investment services in any
third country.

2. Whenever it appears to the Commission, on the basis of
information submitted to it under paragraph 1, that a third
country does not grant Community investment firms effective
market access comparable to that granted by the Community
to investment firms from that third country, the Commission
may submit proposals to the Council
for an appropriate
mandate for negotiation with a view to obtaining comparable
competitive opportunities for Community investment
firms.
The Council shall act by a qualified majority.

3. Whenever it appears to the Commission, on the basis of
information submitted to it under paragraph 1,
that
Community investment
firms in a third country are not
granted national
treatment affording the same competitive
opportunities as are available to domestic investment firms
the conditions of effective market access are not
and that
fulfilled, the Commission may initiate negotiations in order
to remedy the situation.

In the circumstances referred to in the first subparagraph, the
Commission may decide in accordance with the procedure
referred to in Article 59(2), at any time and in addition to
the initiation of negotiations, that the competent authorities
of the Member States must limit or suspend their decisions
regarding requests pending or future requests for authorization
and the acquisition of holdings by direct or indirect parent
undertakings governed by the law of the third country in
question. Such limitations or suspensions may not be applied
to the setting up of subsidiaries by investment firms duly auth-
orized in the Community or by their subsidiaries, or to the
acquisition of holdings in Community investment
firms by
such firms or subsidiaries. The duration of such measures
may not exceed three months.

Before the end of that three-month period referred to in the
preceding paragraph and in the light of the results of the
negotiations, the Commission may decide, in accordance with
the procedure referred to in Article 59(2), to extend these
measures.

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4. Whenever it appears to the Commission that one of the
situations referred to in paragraphs 2 and 3 obtains,
the
Member States shall inform it at its request:

obtain the information needed to assess the compliance of
investment firms with those obligations.

(a) of any application for the authorization of any firm which
is the direct or indirect subsidiary of a parent undertaking
governed by the law of the third country in question;

investment

In the case of

4.
firms which provide only
investment advice, the competent authority may delegate the
function of regular monitoring of operational and organisa-
tional requirements to a body meeting the requirements set
out in Article 45(2).

(b) whenever they are informed in accordance with Article 9(3)
that such a parent undertaking proposes to acquire a
holding in a Community investment firm, in consequence
of which the latter would become its subsidiary.

Article 16

Conflicts of interest

That obligation to provide information shall
agreement
when the measures
subparagraphs of paragraph 3 cease to apply.

lapse whenever
is reached with the third country concerned or
referred to in the second and third

1. Member States shall require investment firms to take all
reasonable steps to identify conflicts of interest between them-
selves,
including their managers and employees, and their
clients or between one client and another that arise in the
course of providing any investment and ancillary services, or
combinations thereof.

5. Measures taken under this Article shall comply with the
Community's obligations under any international agreements,
bilateral or multilateral, governing the taking up or pursuit of
the business of investment firms.

2. Member States shall require that investment firms whose
activities give rise to conflicts of interest maintain and operate
effective organisational and administrative arrangements to
prevent those conflicts from adversely affecting the interests
of clients, or otherwise manage them so as to achieve the
same result.

CHAPTER II

OPERATING CONDITIONS FOR INVESTMENT FIRMS

S e c t i o n 1

General provisions

Article 15

General obligation in respect of on-going supervision

1. Member States shall ensure that the competent authorities
keep under regular review the organisational arrangements
which investment firms have been required to put in place
as a condition for initial authorisation.

3. Where organisational or administrative arrangements
made by the investment firm to manage conflicts of interest
are not sufficient to ensure, with reasonable confidence, that
risks of damage to client interests will be effectively avoided,
the investment firm shall clearly disclose the general nature
and/or sources of conflicts of
to the client before
undertaking business on its behalf.

interest

4.
In order to take account of technical developments on
financial markets and to ensure uniform application of
paragraphs 1, 2 and 3,
in
accordance with the procedure referred to in Article 59(2),
implementing measures to:

the Commission shall adopt,

2. Member States shall require investment firms to notify
the competent authorities of any material changes to their
programme of operations and to provide the competent auth-
orities with all
information needed to verify that modified
organisational requirements are sufficient to ensure continued
compliance with the obligations under this Directive.

(a) define the steps that investment firms might reasonably be
expected to take to identify, prevent, manage and/or
disclose conflicts of
interest when providing various
investment and ancillary services and combinations thereof;

3. Member States shall ensure that the competent authorities
monitor the activities of
firms so as to assess
compliance with the operating conditions provided for in
this Chapter and other obligations under
this Directive.
the competent authorities
Member States shall ensure that

investment

(b) address conflicts that arise from any inducement that is
received or self-interest that arises in connection with the
performance of
service which may
compromise the quality or fairness of a related investment
service that is performed on behalf of or provided to a
client.

an investment

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Article 17

Ongoing capital endowment

Reports shall be provided to the client on the progress of
8.
and the costs associated with the transactions and services
undertaken on behalf of the client.

The Member States shall require that investment firms comply
at all times with the rules laid down in Directive 93/6/EEC,
having regard to the nature of
the investment service in
question.

S e c t i o n 2

Provisions to ensure investor protection

Article 18

Conduct

of

business

obligations when

providing

investment services to clients

shall

ensure

that, when providing
1. Member States
investment
firm acts
services
honestly, fairly and professionally in accordance with the best
interests of its clients and complies,
in particular, with the
principles set out in paragraphs 2 to 8.

an investment

to clients,

In order to ensure the necessary protection of investors
9.
the
and the uniform application of paragraphs 1 to 8,
Commission shall adopt,
in accordance with the procedure
referred to in Article 59(2), implementing measures to ensure
firms comply with the principles set out
that
therein when providing investment or ancillary services to
their clients. Those implementing measures shall
take into
account:

investment

(a) the nature of the service(s) offered or provided to the client
or potential client, including the particular procedures and
systems which investment firms use to execute orders on
behalf of clients;

(b) the nature of the financial

instruments being offered or

considered;

2. Marketing communications, or
information contained
therein, addressed to clients or potential clients, shall be
identified as such, and shall be fair, clear and not misleading.

(c)

the retail or professional nature of the client or potential
clients.

Timely information shall be provided in a compre-
the
form to clients or potential clients about
they are able to
the investment

3.
hensible
investment
understand the precise nature and risks of
service and financial instrument that is being offered.

firm and its services, so that

regarding
field,

The necessary information shall be obtained from the
4.
in the
client
and financial
investment
situation so as to enable the investment firm to determine
the investment services and financial instruments suitable for
that client.

its knowledge
its

investment objectives

and experience

Timely information shall be provided to the client
5.
regarding financial
instruments, proposed investments and
execution venues which is fair, clear and not misleading, so
as to enable the client to take investment decisions on an
informed basis.

guidance

Appropriate

risks
6.
associated with investments
instruments or
investment strategies shall be provided to the client, having
particular regard to the client's knowledge and experience.

and warnings on the
in particular

10. Member States shall allow an investment firm receiving
an instruction to perform investment or ancillary services on
behalf of a client through the medium of another investment
firm to rely on client information transmitted by the firm
which mediates the instructions.

The investment firm which receives an instruction to undertake
services on behalf of a client in this way shall also be able to
rely on any recommendations in respect of the service or trans-
action that have been provided to the client by another
investment firm.

instructions or
firm which receives client
The investment
orders through the medium of another investment firm shall
remain responsible for concluding the service or transaction,
based on any such information or
in
accordance with measures adopted pursuant to paragraph 9.

recommendations,

The competent authority of the home Member State
11.
the obligations of this provision and the
shall ensure that
adopted under paragraph 9 are
implementing measures
complied with by investment firms when providing services
in other Member States.

7.
A documentary record of an agreement between the firm
and the client shall be established which sets out the rights and
obligations of the parties, and the other terms on which the
firm will provide services to the client.

12.
The competent authority of the Member State in which
a branch is located shall enforce the obligations referred to in
paragraphs 1 to 8 and the implementation measures adopted
pursuant to paragraph 9 in respect of the services provided by
a branch to its clients.

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Article 19

Obligation to execute orders on terms most favourable to
the client

procedures and arrangements which provide for the fair and
expeditious execution of client orders, relative to other client
orders or the trading interests of the investment firm.

that

shall

require

investment

firms
1. Member States
providing services which entail the execution, whether by the
firm itself or another investment
firm, of client orders in
financial instruments ensure that those orders are executed in
such a way that the client obtains the best possible result in
terms of price, costs, speed and likelihood of execution, taking
into account the time, size and nature of customer orders, and
any specific instructions from the client.

or

arrangements

2. Member States shall ensure that investment firms operate
procedures
otherwise
comparable client orders in accordance with their time of
their reception by the investment firm, and for preventing
client interests from being adversely affected by any conflicts
of interest.

executing

for

The competent authority shall verify that

investment
2.
firms
implement effective and efficient procedures which
form a systematic, repeatable and demonstrable method for
facilitating execution of client orders on terms that are most
favourable to the client. In assessing these procedures, regard
shall be had to the extent to which the procedures enable the
firm to obtain the best possible result having regard to the
to which the
conditions prevailing in the marketplace
investment firm can reasonably be expected to have access.

3. Member States shall ensure that investment firms obtain
the express prior consent of clients before proceeding to
execute client orders outside the rules and systems operated
by a regulated market or MTF. Member States shall allow the
investment firm to obtain this consent either in the form of a
general agreement or in respect of individual transactions. If
the prior consent of clients is given in the form of a general
agreement, it should be contained in a separate document and
should be renewed annually.

3. Member States shall require investment firms to review,
on a regular basis, the procedures which they employ to obtain
the best possible result for their clients and, where necessary, to
adapt those procedures so as to obtain access to the execution
venues which, on a consistent basis, offer the most favourable
terms of execution available in the marketplace.

In order to ensure the protection necessary for investors,
4.
the fair and orderly functioning of markets, and to ensure the
uniform application of paragraphs 1, 2 and 3, the Commission
shall, in accordance with the procedure referred to in Article
59(2), adopt implementing measures concerning:

(a) the factors that may be taken into account for determining
the calculation of best net price
best execution or
prevailing in the marketplace for the size and type of
order and type of client;

(b) the procedures which,

taking into account the scale of
operations of different investment firms, may be considered
as
and effective methods of
obtaining access to the execution venues which offer the
most favourable terms of execution in the marketplace.

constituting reasonable

4. Member States shall require that, in the case of a client
limit order which cannot be immediately executed under
prevailing market conditions, investment firms are, unless the
client expressly instructs otherwise,
to
that order by
facilitate the earliest possible execution of
making public immediately the terms of
limit
order in a manner which is easily accessible to other market
participants. Member States shall provide that the competent
authorities are to be able to waive the obligation to make
public a limit order that
is large in scale compared with
normal market size as determined under Article 41(2).

to take measures

that client

5.
In order to ensure that measures for the protection of
investors and fair and orderly functioning of markets take
account of technical developments in financial markets, and
to ensure the uniform application of paragraphs 1 to 4, the
in accordance with the procedure
Commission shall adopt,
referred to in Article 59(2),
implementing measures which
define:

(a) the

conditions

and nature of

and
arrangements which result
and
expeditious execution of client orders and the situations
in which or types of
transaction for which investment
firms may reasonably deviate from prompt execution so
as obtain more favourable terms for clients;

the procedures
fair

in the prompt,

Article 20

Client order handling rules

1. Member States shall require that investment firms auth-
implement
orised to execute orders on behalf of clients

(b) the procedures for obtaining and renewing client consent
to executing those orders outside the rules and

prior
systems of a regulated market or MTF;

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(c) the different methods through which an investment firm
its obligation to disclose

can be deemed to have met
unexecuted client limit orders to the market.

6. Member States may allow the competent authority to
delegate the establishment and maintenance of
the public
register pursuant to paragraph 4 and the tasks of monitoring
compliance of tied agents with the requirements of paragraph
4 to a body meeting the conditions laid down in Article 45(2).

Article 21

Obligations of

investment firms when employing tied

agents

shall

require an investment

1. Member States
firm to
employ tied agents only for the purposes of promoting the
services of the investment firm, soliciting business or collecting
orders from clients or potential clients and transmitting these
to that investment firm, and providing advice in respect of
financial
instruments or services offered by that investment
firm.

shall

States

require

an investment

2. Member
firm
employing a tied agent to remain fully and unconditionally
responsible for any action or omission on the part of the
tied agent when acting on behalf of the firm. Member States
shall require the investment firm to ensure that a tied agent
discloses immediately to any client or potential client
the
capacity in which the agent is acting and the firm which he
is representing.

3. Member States shall ensure that investment firms monitor
the activities of
their tied agents and adopt measures and
procedures so as to ensure that they operate, on a continuous
basis, in compliance with this Directive.

4.
Each Member State shall ensure that tied agents which act
or wish to act on its territory are entered in a public register
which is established and maintained under the responsibility of
the competent authority.

The competent authority shall ensure that tied agents are only
admitted to the public register if it has been established that
they are of sufficiently good repute and that
they possess
appropriate general, commercial and professional knowledge
relevant
so as to be able to communicate accurately all
information regarding the proposed service to the client or
potential client.

The register shall be updated on a regular basis. It shall be
publicly available for consultation.

Article 22

Transactions executed with eligible counterparties

The Member States shall ensure that investment firms
1.
authorised to execute orders on behalf of clients and/or to
deal on own account, may enter
into transactions with
eligible counterparties without being obliged to comply with
the obligations under Articles 18, 19 and 20 in respect of
those transactions.

2.
In order to conclude transactions in accordance with
paragraph 1, the investment firm shall obtain confirmation
from the prospective counterparty that it agrees to be treated
as an eligible counterparty. This confirmation shall be obtained
either before or during the course of the transaction, or in the
form of a general agreement.

3. Member States shall recognise as eligible counterparties
this Article and Articles 13 and 39
for the purposes of
insurance companies or
investment firms, credit institutions,
any other authorised or
intermediary
considered as such by Community legislation, but excluding
UCITS and their management companies and pension funds
and their management companies.

regulated financial

Member States may also recognise as eligible counterparties
UCITS and their management companies, pension funds and
their management companies, and other companies meeting
including quanti-
pre-determined proportionate requirements,
tative thresholds. In the event of a transaction where the pros-
pective counterparties are located in different jurisdictions, the
investment firm shall defer to the status of the other company
as determined by the law or measures of the Member State in
which that company is established.

5. Member States shall ensure that investment firms employ
only tied agents entered in the public registers referred to in
paragraph 4.

Classification as an eligible counterparty under the second
subparagraph shall be without prejudice to the right of such
entities to request treatment as clients whose business with the
investment firm is subject to Articles 18, 19 and 20.

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4. Member States shall ensure that transactions undertaken
by users or participants of a regulated market or an MTF, on or
through the systems of the regulated market or MTFs, are
treated as transactions between eligible counterparties.

itself or by the regulated market or MTF through whose
systems the transaction was completed. In cases where trans-
actions on a regulated market or MTF are reported directly to
the competent authority by the regulated market or MTF, the
obligation on the investment firm laid down in paragraph 3
may be waived.

5.
In order to ensure the uniform application of paragraphs
1, 2 and 3 in the light of changing market practice and to
the
facilitate the effective operation of
Commission may adopt,
in accordance with the procedure
referred to in Article 59(2), implementing measures concerning
the classification of eligible counterparties.

the single market,

S e c t i o n 3

Market transparency and integrity

Article 23

Obligation to uphold integrity of markets, report trans-
actions, and maintain records

1. Without prejudice to the allocation of responsibilities for
enforcing the provisions of European Parliament and Council
Directive [. . .] [on Market Abuse], the competent authority
shall also monitor the activities of investment firms to ensure
fairly and professionally and in a
that
manner which promotes the integrity of the market.

they act honestly,

2. Member States shall require investment firms to keep at
the disposal of the competent authority, for at least five years,
the relevant data relating to all
in financial
instruments which they have carried out, whether on own
account or on behalf of a client. In the case of transactions
carried out on behalf of clients, the records shall contain all the
information and details of the identity of the client, and the
information required under Council Directive 91/308/EEC (1).

transactions

require investment

3. Member States shall
firms which
execute transactions in any financial instruments admitted to
trading on a regulated market to report details of such trans-
actions to the competent authority in the home Member State
of the investment firm. This obligation shall apply whether or
not such transactions were carried out on a regulated market.

4.
Those reports shall be transmitted as quickly as possible,
and no later than the close of the following working day. The
reports shall specify the instrument bought/sold, the quantity,
the date and time of execution, and transaction prices. They
shall identify the party executing the transaction and indicate
the market, trading system or other means through which the
transaction was concluded.

5. Member States shall provide that the reports are to be
made to the competent authority either by the investment firm

(1) OJ L 166, 28.6.1991, p. 77.

In order to ensure that measures for the protection of
6.
market
technical
integrity are modified to take account of
developments in financial markets, and to ensure the uniform
application of paragraphs 1 to 5, the Commission may adopt,
in accordance with the procedure referred to in Article 59(2),
implementing measures which stipulate the methods and
arrangements for reporting financial
the form
and content of
these reports, as well as arrangements for
communicating them to the competent authorities of other
Member States.

transactions,

Article 24

Monitoring of trading on or through an MTF

shall

ensure

1. Member States
firms
effective
an MTF
operating
arrangements to facilitate the effective and regular monitoring
of transactions undertaken on or through the facility in order
to identify disorderly trading conditions or behaviour that may
involve market abuse.

investment
and

that
adequate

establish

firms

supply

Member States shall ensure that under those arrangements,
information
investment
gathered pursuant to the first subparagraph to the competent
authority and provide full assistance to the latter in investi-
gating and prosecuting market abuse undertaken on or
through the MTF.

immediately

the

2.
In order to promote the orderly and effective monitoring
of trading on MTFs so as to sustain overall market integrity,
and to ensure the uniform application of paragraph 1, the
in accordance with the procedure
Commission shall adopt,
referred to in Article 59(2),
implementing measures which
define the arrangements referred to in paragraph 1.

Article 25

Obligation for investment firms to make public firm bid
and offers

1. Member States shall require any investment firm auth-
orised to deal on own account to make public a firm bid
and offer price
customarily
transactions of
undertaken by a retail investor in respect of shares in which
it is dealing, and where those shares are admitted to trading on
a regulated market and for which there is a liquid market.

size

for

a

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Member States shall require that the investment firms referred
to in the first sub-paragraph trade with other investment firms
the advertised prices, except
and eligible counterparties at
where
considerations
justified by
related to the final settlement of the transaction.

commercial

legitimate

to make public the volume and price of those transactions and
the time at which they were concluded. This information shall
be made public immediately, on a reasonable commercial basis,
and in a manner which is easily accessible to other market
participants.

2. Member States shall provide that the obligation set out in
paragraph 1 is waived in respect of investment firms which do
not represent an important provider of liquidity for the share(s)
in question on a regular or continuous basis.

3. Member States shall ensure that the bid and offer prices
required under paragraph 1 are made public in a manner
which is easily accessible to other market participants, free of
charge, on a regular and continuous basis during normal
trading hours.

The competent authority shall verify that published quotes
reflect prevailing market conditions for that share, and that
the investment firm regularly updates the bid and offer prices
that it makes public pursuant to paragraph 1.

4.
In order to ensure the uniform application of paragraphs
1, 2 and 3, in a manner which supports the efficient valuation
of shares and maximises the possibility of investment firms to
obtain the best deal for their clients, the Commission shall, in
accordance with the procedure referred to in Article 59(2),
adopt implementing measures which:

The

that

shall

ensure

authority

competent

the
2.
information which is made public
in accordance with
paragraph 1 and the time-limits within which it is published
comply with the requirements adopted pursuant to Article 42.
Where the measures adopted pursuant to Article 42 provide
for deferred reporting for certain categories of transaction in
shares, this possibility shall apply mutatis mutandis to those
transactions when undertaken outside the rules and systems
of regulated markets or MTFs.

3.
In order to ensure the transparent and orderly func-
tioning of markets and the uniform application of paragraph
in accordance with the
1,
procedure
implementing
measures which:

the Commission shall adopt,

in Article 59(2),

referred

to

(a) specify the means by which investment firms may comply
with their obligations under paragraph 1 including the
following possibilities:

(i) through the facilities of any regulated market which
has admitted the instrument in question to trading;

(a) specify the size of transactions customarily undertaken by a
retail investor in respect of which the investment firm shall
make public firm bid and offer prices;

(ii) through the offices of a third party;

(iii) through proprietary arrangements.

(b) define the shares or classes of share for which there is
sufficient liquidity to allow application of the obligation
under paragraph 1;

(c) determine which types of

shall be
exempted, pursuant to paragraph 2, from the obligation
under paragraph 1;

investment

firms

(d) specify the means by which investment firms may comply
with their obligations under paragraph 3, which shall
include the following possibilities:

(i) through the facilities of any regulated market which
has admitted the instrument in question to trading;

(ii) through the offices of a third party;

(iii) through proprietary arrangements.

Article 26

Post-trade disclosure by investment firms

(b) clarify the application of the obligation under paragraph 1
to transactions involving the use of shares for collateral,
lending or other purposes where the exchange of shares is
determined by factors other
than the current market
valuation of the share.

Article 27

Pre-trade transparency requirements for MTFs

that

shall

require

investment

1. Member States
firms
operating an MTF make public current bid and offer prices
which are advertised through their systems in respect of
shares admitted to trading on a regulated market. Member
this information is to be made
States shall provide that
available to the public on reasonable commercial terms and
on a continuous basis during normal trading hours.

The competent authority shall ensure that the content,
reporting by MTFs
to
transactions in those instruments

2.
timing and publication of pre-trade
comply with the same requirements as apply pursuant
Article 41 in respect of
when undertaken on a regulated market.

1. Member States shall require investment
firms which,
either on own account or on behalf of clients, conclude trans-
actions in shares admitted to trading on a regulated market
outside the rules and systems of a regulated market or MTF,

Competent authorities shall also waive the obligations referred
to in paragraph 1 in respect of trading methods operated by
MTFs when exemptions are provided, under Article 41, for the
same trading methods when operated by regulated markets.

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Article 28

Post-trade transparency for MTFs

that

shall

require

investment

1. Member States
firms
operating an MTF make public the price, volume and time of
the transactions executed under its rules and systems in respect
of shares which are admitted to trading on a regulated market.
Member States shall require that details of all such transactions
be made public, on a reasonable commercial basis, as close to
real-time as possible.

2.
The competent authority shall ensure that the content
and timing of the post-trade information, and the methods
for its publication comply with the same requirements as
apply pursuant
transactions in
to Article 42 in respect of
shares undertaken on a regulated market.

CHAPTER III

RIGHTS OF INVESTMENT FIRMS

Article 29

Freedom to provide services

firm
1. Member States shall ensure that any investment
authorised and supervised by the competent authorities of
another Member State in accordance with this Directive may
freely provide investment and ancillary services within their
territories, provided that such services are covered by its auth-
impose any additional
orisation. Member States shall not
requirements on such an investment firm in respect of the
matters covered by this Directive.

Any investment firm wishing to provide services within
2.
the territory of another Member State for the first time, or
which wishes to change the range of services so provided,
shall
the
the
competent authorities of its home Member State:

communicate

information

following

to

(a) the Member State in which it intends to operate;

(b) a programme of operations

the
investment or ancillary services which it
to
provide and whether it intends to employ the services of
tied agents in the territory of the Member States in which it
intends to provide services.

stating in particular
intends

3.
The competent authority of the home Member State shall,
within one month of receiving the information, forward it to
the host Member State. The
the competent authority of
investment
to provide the investment
service or services concerned in the host Member State.

firm may then start

In the event of a change in any of

4.
the particulars
communicated in accordance with paragraph 2, an investment
firm shall give written notice of that change to the competent
authority of the home Member State at least one month before
the
implementing the change. The competent authority of

home Member State shall inform the competent authority of
the host Member State of those changes.

5. Member States shall, without further legal or adminis-
trative requirement, allow MTFs from other Member States to
provide appropriate arrangements on their territory so as to
facilitate access to and use of their systems by remote users or
participants established in their territory.

Article 30

Establishment of a branch

1. Member States shall ensure that investment and ancillary
services may be provided within their territories through the
establishment of a branch of an investment firm provided that
those services are covered by the authorisation granted to the
investment firm in the home Member State.

Member States shall not impose any additional requirements,
with the exception of those allowed under paragraph 7, on the
organisation and operation of the branch in respect of the
matters covered by this Directive.

2. Member States shall require any investment firm wishing
to establish a branch within the territory of another Member
State first
its home
to notify the competent authority of
Member State and to provide it with the following information:

(a) the Member States within the territory of which it plans to

establish a branch;

(b) a programme of operations setting out inter alia the services
to be offered and the organisational structure of the branch
and indicating whether the branch intends to employ the
services of tied agents;

(c)

the address
documents may be obtained;

in the host Member State from which

(d) the names of those responsible for the management of the

branch.

3.
Unless the competent authority of the home Member
State has reason to doubt the adequacy of the administrative
firm,
structure or the financial situation of an investment
taking into account the activities envisaged,
it shall, within
three months of receiving all the information, communicate
that
the host
Member State and inform the investment
firm concerned
accordingly.

information to the competent authority of

In addition to the information referred to in paragraph 2,
4.
the competent authority of
the home Member State shall
communicate details of the accredited compensation scheme
firm is a member in accordance
of which the investment
with Directive 97/9/EC to the competent authority of
the
host Member State. In the event of a change in the particulars,
the competent authority of
the home Member State shall
inform the authority of the host Member State accordingly.

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refuses

5. Where the competent authority of the home Member
information to the
State
to communicate
it shall give
competent authority of the host Member State,
reasons for
firm concerned
within three months of receiving all the information.

to the investment

its refusal

the

6.
On receipt of a communication from the competent
authority of the host Member State, or failing such communi-
cation from the latter at the latest after two months from the
date of transmission of the communication by the competent
authority of the home Member State, the branch may be estab-
lished and commence business.

7.
The competent authority of the host Member State shall
assume responsibility for ensuring that the services provided by
the branch comply with the obligations laid down in Articles
12(7) and 18 and in measures adopted pursuant thereto.

The competent authority of the host Member State shall have
the right to examine branch arrangements and to request such
changes as are strictly needed to enable the competent
authority to enforce the obligations under Articles 12(7) and
18 and measures adopted pursuant thereto.

that, where

shall provide

Each Member State

8.
an
investment firm authorised in another Member State has estab-
lished a branch within its territory, the competent authority of
the home Member State of the investment firm, in the exercise
of
informing the competent
authority of the host Member State, may itself or through
the intermediary of persons instructed for that purpose, carry
out on-site inspections in that branch.

responsibilities and after

its

In the event of a change in any of

9.
the information
communicated in accordance with paragraph 2, an investment
firm shall give written notice of that change to the competent
authority of the home Member State at least one month before
implementing the change. The competent authority of the host
Member State shall also be informed of those changes by the
competent authority of the home Member State.

Article 31

Access to regulated markets

1. Member States shall ensure that investment firms from
other Member States which are authorised to execute client
orders or
to deal on own account have the right of
membership or have access to regulated markets established
in their territory by means of any or all of the following
arrangements:

(a) directly, by setting up branches in the host Member States;

(b) indirectly, by setting up subsidiaries in the host Member
States or by acquiring firms in the host Member States that

are already members of their regulated markets or already
have access thereto; and/or

(c) by becoming remote members of or having remote access
to the regulated market without having to be established in
the home Member State of the regulated market, where the
trading procedures and systems of the market in question
do not require a physical presence for conclusion of trans-
actions on the market.

2. Member States shall not impose any additional regulatory
or administrative requirements, in respect of matters covered
by this Directive, on investment
firms exercising the right
conferred by paragraph 1.

The right conferred by paragraph 1 shall be without
3.
prejudice to the obligation of the investment firm to comply
with any transparent and objective commercial criteria which
the regulated market imposes as a condition for membership
or access in accordance with Article 39.

Article 32

Access to clearing and settlement facilities and right to
designate settlement system

1. Member States shall ensure that investment firms from
other Member States have the possibility of direct or indirect
access to central counterparty, clearing and settlement systems
in their territory for the purposes of finalising transactions in
financial instruments.

Member States shall ensure that access of those investment
firms to such facilities is subject to the same transparent and
objective commercial criteria as apply to local participants.
Member States shall not restrict the use of those facilities to
in financial
the
instruments undertaken on a regulated market or MTF in
their territory.

clearing and settlement of

transactions

2. Member States shall ensure that regulated markets in their
territory offer direct,
and remote members or
participants the right to designate the system for the settlement
of transactions in financial
instruments undertaken on that
regulated market, subject to:

indirect

(a) such links and arrangements between the designated
settlement system and any other system or facility as are
necessary to ensure the efficient and economic settlement
of the transaction in question; and

(b) agreement by the competent authority responsible for the
regulated market that technical conditions for settlement of
transactions concluded on the regulated market through a
settlement
than that designated by the
regulated market are such as to allow the smooth and
orderly functioning of financial markets.

system other

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The rights of investment firms under paragraphs 1 and 2
3.
shall be without prejudice to the right of operators of central
counterparty, clearing or securities settlement systems to refuse
on legitimate commercial grounds to make the requested
services available.

4.
In order to ensure the uniform application of paragraphs
1, 2 and 3, the Commission shall adopt, in accordance with the
procedure referred to in Article 59(2), implementing measures
which clarify:

(a) the nature of

the technical

links between settlement
systems designated by investment firms and other systems
and facilities which are needed to ensure the efficient and
economic settlement of transactions, and the conditions
under which those links are to be considered adequate
for the purposes of this Article;

conditions under which authorisation was granted or to its
programme of operations.

The competent authority shall refuse to authorise the proposed
changes where the resulting programme of operations would
not fulfil the conditions laid down in this Title.

5. Member States shall provide that the competent authority
may withdraw the authorisation granted to a regulated market
where failure to comply with the provisions of this Title has
resulted or may result in demonstrable and significant prejudice
to the sound and prudent operation of the regulated market or
the smooth and orderly functioning of financial markets.

Article 34

Requirements for the market operator

(b) those considerations which a competent authority is
entitled to take into account when assessing whether the
settlement of transactions on a regulated market through a
securities settlement system other than that designated by
the regulated market might prove prejudicial to the smooth
and orderly functioning of financial markets.

1. Member States shall require the market operator to be of
sufficiently good repute and sufficiently experienced as to
ensure the sound and prudent management of the regulated
market. Member States shall also require the regulated market
to inform the competent authority of any changes to the
identity of the persons who effectively direct the business of
the regulated market.

TITLE III

REGULATED MARKETS

Article 33

The competent authority shall refuse to approve proposed
changes to the personnel of the market operator where there
are objective and demonstrable grounds for believing that they
pose a threat to the sound and prudent management of the
regulated market.

Authorisation and applicable law

1. Member States shall reserve authorisation as a regulated
market to those entities on their territory which comply with
the provisions of this Title.

Authorisation as a regulated market shall be granted only
where the competent authority is satisfied that both the
market operator and the rules and systems of the regulated
market comply with the requirements laid down in this Title.

to
2. Member States shall require the regulated market
relating to its organisation and operation
perform tasks
the competent
under the supervision and responsibility of
authority. Member States shall ensure that competent auth-
orities keep under regular review the compliance of regulated
markets with the provisions of this Title.

3. Without prejudice to any relevant provisions of Directive
2002/. . ./EC [Market Abuse],
the public law governing the
transactions conducted under the rules and systems of the
regulated market shall be that of the home Member State of
the regulated market.

4. Member States shall require the regulated market
to
notify the competent authority of any intended change to the

2. Member States shall ensure that the market operator is
responsible,
the regulated
market complies with all requirements under this Title.

for ensuring that

in particular,

the market operator
3. Member States shall require that
possess, at
the time of authorisation and on an ongoing
basis, sufficient financial resources to facilitate the orderly func-
tioning of the regulated market, having regard to the nature
the transactions concluded on the regulated
and extent of
market and the range and degree of the risks to which the
regulated market is exposed.

referred

the Commission shall adopt,

In order to ensure the uniform application of paragraph
4.
in accordance with the
3,
procedure
implementing
measures to determine the financial resources that a market
operator is to be required to hold, taking into account any
other arrangements
that may be used by the regulated
market to mitigate the risks to which it is exposed.

in Article 59(2),

to

5. Market operators which are recognised by the competent
authority of
their home Member State as complying with
paragraph 1 shall be deemed to comply with those
requirements when seeking authorisation to establish a
regulated market in another Member State.

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Article 35

Requirements relating to persons exercising effective
control of the regulated market

1. Member States shall require the persons who are in a
position to exercise, directly or indirectly, effective control of
the regulated market to be suitable.

2. Member States shall require the regulated market:

(a) to provide the competent authority with, and to make
public, information regarding its ownership structure, and
in particular,
interests of any
parties in a position to exercise control over its operation;

the identity and scale of

(b) to inform the competent authority of and to make public
any transfer of ownership which gives rise to change in the
identity of the persons exercising effective control.

The

authority

competent

to approve
3.
proposed changes to the controlling interests of the regulated
market where there are objective and demonstrable grounds for
believing that they would pose a threat to the sound and
prudent management of the regulated market.

refuse

shall

Article 36

Organisational requirements

Member States shall require the regulated market:

(a) to have arrangements to identify clearly and manage the
potential adverse consequences, for the operation of the
regulated market or its participants, of any conflict of
interest between the interest of the regulated market,
its
owners or its operator and the sound functioning of the
regulated market, and in particular where such conflicts of
interest might prove prejudicial to accomplishment of any
functions delegated to the
regulated market by the
competent authority;

(b) to be adequately equipped to manage the risks to which it
is exposed,
implements appropriate arrangements and
systems to identify all significant risks to its operation,
and has put in place effective measures to mitigate those
risks;

(c) to have arrangements for the sound management of the
technical operations of the system,
including the estab-
lishment of effective contingency arrangements to cope
with risks of systems disruptions;

(d) to have

and non-discretionary rules and
transparent
the efficient execution of
procedures that provide for
in accordance with objective criteria so as to
orders
enable market participants
to obtain the best price
available on the market, at the time and for their size of

interest. Those rules and procedures shall be subject to
prior approval by the competent authority of the home
Member State;

(e)

to have effective arrangements to facilitate the efficient and
timely finalisation of the transactions executed under its
rules and systems.

Article 37

Admission of financial instruments to trading

1. Member States shall ensure that regulated markets have
clear and transparent rules regarding the admission of financial
instruments to trading. Member States shall require those rules
taking into
to be approved by the competent authority,
to
account all
paragraph 6.

implementing measures adopted pursuant

Those rules shall ensure that any financial instruments admitted
to trading in a regulated market have been issued in a manner
conducive to free negotiability and trading under conditions
which are fair, orderly and efficient.

In the case of derivatives,

2.
the rules shall ensure in
particular that the design of the derivative contract allows for
orderly pricing both in the derivative and in the underlying
market as well as for the existence of effective settlement
conditions.

3.
In addition to the obligations set out in paragraphs 1 and
2, Member States shall require the regulated market to establish
and maintain effective arrangements to verify that issuers of
transferable securities being considered for admission to trading
comply with their obligations under Community law in respect
of initial, ongoing or ad hoc financial disclosure.

The competent authority shall ensure that the regulated market
establishes arrangements which facilitate its members or
participants in obtaining access to information which has
been made public under Community law.

4. Member States shall ensure that regulated markets have
established the necessary arrangements to review regularly the
compliance with the admission requirements of the financial
instruments which they admit to trading.

5. Member States shall provide that once a transferable
security issued in their territory has been admitted to trading
on a regulated market,
it can subsequently be admitted to
trading on other regulated markets without the consent of
the issuer. The issuer shall be informed by the regulated
market of
its securities are traded on that
regulated market. The issuer shall not be subject to any obli-
gation to provide information required under paragraph 3
directly to any regulated market which has admitted the
issuer's securities to trading without its consent.

the fact

that

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In order to ensure the uniform application of paragraphs
in accordance with the
implementing

6.
1 to 5,
the Commission shall,
procedure referred to in Article 59(2) adopt
measures which:

(a) specify the characteristics of different classes of instruments
to be taken into account by the regulated market when
assessing whether an instrument is issued in a manner
consistent with the conditions laid down in the second
sub-paragraph of paragraph 1 for admission to trading
on the different market segments which it operates;

(b) clarify the arrangements that the regulated market is to
implement so as to be considered to have fulfilled its obli-
gation to verify that the issuer of a transferable security
complies with its obligations under Community law in
respect of initial, ongoing or ad hoc financial disclosure.

Article 38

Suspension and removal of instruments from trading

1. Without prejudice to the right of the competent authority
under Article 46(1)(j) and (k) to demand suspension or removal
the regulated market may
of an instrument
suspend or
instrument
remove from trading a financial
which no longer complies with its rules unless such a step
would be likely to prove detrimental to investors' interests or
the orderly functioning of the market.

from trading,

Member States shall ensure that a regulated market which
instrument
suspends or
removes from trading a financial
makes public
relevant
information to the
competent
authority shall be required to inform competent authorities
of other Member States accordingly.

this decision and communicates

competent authority. The

2.
A competent authority which demands the suspension or
removal of a financial instrument from trading on one or more
regulated markets shall immediately make public its decision
and inform the competent authorities of other Member States
accordingly.

Article 39

Access to the regulated market

1. Member States shall require the regulated market
to
establish and maintain transparent rules, based on objective
commercial criteria, governing access to or membership of
the regulated market. Those rules shall specify any obligations
for the members or participants arising from:

(a) the constitution and administration of the regulated market;

(b) rules relating to transactions on the market;

(c) professional standards imposed on staff operating on and

in conjunction with the market;

(d) the rules and procedures for the clearing and settlement of

transactions concluded on the regulated market.

Member States
establish effective arrangements
compliance of members and participants with those rules.

regulated markets
the continued

that
to monitor

shall also ensure

2. Member States shall ensure that regulated markets limit
membership or access to eligible counterparties as referred to
in Article 22(3).

3. Member States shall ensure that the rules on access to or
membership of the regulated market provide for the direct,
indirect or remote participation of investment firms.

requirement,

allow regulated markets

4. Member States shall, without further legal or adminis-
trative
from other
Member States to provide appropriate arrangements on their
territory so as to facilitate access to and trading on those
markets by remote members or participants established in
their territory.

5. Member States shall require the regulated market
to
communicate, on a regular basis, the list of its members and
participants to its competent authority.

Article 40

Monitoring of trading on regulated markets

that

shall ensure

1. Member States
regulated markets
establish and maintain effective arrangements and procedures
for the regular monitoring of transactions undertaken by their
members or participants under their rules and systems in order
to identify breaches of those rules, disorderly trading conditions
or conduct that may involve market abuse.

2. Member States shall require regulated markets to report
breaches of their rules or of legal obligations relating to market
integrity to the competent authority. Member States shall also
require the regulated market to supply the relevant information
immediately to the competent authority and to provide full
assistance to the latter
in investigating and prosecuting
market abuse undertaken on or through the systems of the
regulated market.

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Article 41

Pre-trade transparency requirements for regulated markets

1. Member States shall require regulated markets to make
public current bid and offer prices which are advertised
through their systems for shares admitted to trading. Member
States shall require this information to be made available to the
public on reasonable commercial terms and on a continuous
basis during normal trading hours.

Member States shall also require any regulated market to make
public, through the arrangements employed for making public
the information required under the first subparagraph, firm bid
and offer prices in shares which it has admitted to trading and
which are communicated to it by investment firms pursuant to
Article 25.

2. Member States shall provide that the competent auth-
orities are to be able to waive the obligation for regulated
markets
to make public the information referred to in
paragraph 1 in respect of transactions that are large in scale
compared with normal market size for the share or type of
share in question.

In order to ensure the uniform application of paragraphs
in accordance with the
implementing

3.
1 and 2,
the Commission shall,
procedure referred to in Article 59(2) adopt
measures as regards:

(a) the range of bid and offers or designated market-maker
quotes, and the depth of trading interest at those prices,
to be made public;

(b) the types of order or market-maker quote to be made

public;

under their rules and systems in respect of shares admitted to
trading. Member States shall require details of all such trans-
actions to be made public, on a reasonable commercial basis
and as close to real-time as possible.

Member States shall also require any regulated market to make
public, through the arrangements employed for making public
the information required under the first subparagraph, details
of transactions in shares which it has admitted to trading and
which have been reported to it by investment firms pursuant
to Article 26.

2. Member States shall provide that the competent authority
may authorise regulated markets to provide for deferred publi-
cation of the details of transactions that are large in scale
compared with the normal market size for that share or that
class of shares. The competent authority must give prior
approval to proposed arrangements for deferred trade-publi-
cation,
clearly
these
disclosed to market participants and the investing public.

arrangements

and ensure

that

are

In order to provide for the efficient and orderly func-
3.
tioning of
financial markets, and to ensure the uniform
application of paragraphs 1 and 2, the Commission shall, in
accordance with the procedure referred to in Article 59(2)
adopt implementing measures in respect of:

(a) the scope and content of
available to the public;

the information to be made

(b) the conditions under which a regulated market may
provide for deferred publication of trades and the sizes of
transaction or types of share for which deferred publication
is allowed;

(c) the size or

type of

transactions

for which pre-trade

disclosure may be waived under paragraph 2;

(c) appropriate arrangements

for making the information

public on a reasonable commercial basis.

(d) the applicability of paragraphs 1 and 2 to trading methods
operated by regulated markets which conclude transactions
under their rules by reference to prices established outside
the regulated market or by
the rules and systems of
periodic auction;

(e) appropriate arrangements

for making the information

public on a reasonable commercial basis.

Article 42

Article 43

Provisions regarding clearing arrangements

1. Member States shall provide that regulated markets have
the right to enter into appropriate arrangements with a central
counterparty or clearing house of another Member State with a
view to providing for the novation or netting of some or all
trades concluded by market participants under their rules and
systems.

Post-trade transparency requirements for regulated
markets

1. Member States shall require regulated markets to make
public the price, volume and time of the transactions executed

2.
The competent authority of a regulated market may not
oppose the use of central counterparty or clearing houses in
another Member State except where this is demonstrably
necessary in order to maintain the orderly functioning of
that regulated market.

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Article 44

List of regulated markets

this Directive and the competent authorities
purposes of
responsible in that Member State for the supervision of credit
and other financial institutions and insurance undertakings.

list

Each Member State shall draw up a list of
the regulated
markets for which it is the home Member State and shall
forward that
to the other Member States and the
Commission. A similar communication shall be effected in
respect of each change to that
list. The Commission shall
publish a list of all regulated markets in the Official Journal of
the European Communities and update it at least once a year.

TITLE IV

COMPETENT AUTHORITIES

CHAPTER I

DESIGNATION, POWERS, RESOURCES AND REDRESS
PROCEDURES

Article 45

Designation of competent authorities

1.
Each Member State shall designate a competent authority
to carry out each of the duties provided for under the different
provisions of this Directive. Member States shall
inform the
the competent authority
the identity of
Commission of
responsible for enforcement of each of those duties, and of
any division of those duties.

Member States shall ensure that those authorities exchange any
information which is essential or relevant for the exercise of
their duties.

Article 46

Powers to be made available to competent authorities

1. Member States shall ensure that the competent authorities
possess all supervisory, investigatory and enforcement powers
necessary for the exercise of their functions. They shall exercise
such powers in conformity with national law, either directly or,
where appropriate,
in cooperation with other authorities,
including judicial authorities.

In particular, Member States shall ensure that competent auth-
orities have at least the powers to:

(a) have access to any document in any form whatsoever;

(b)

additional

person,
information
request
investment firm or regulated market, and if needed to
summon and question a person with a view to obtaining
information;

from any

The Commission shall publish a list of competent authorities in
the Official Journal of the European Communities and update it at
least once a year.

(c)

carry out on-site inspections;

The competent authorities referred to in paragraph 1
2.
shall be public authorities, without prejudice to the possibility
of delegating functions to other entities where that is expressly
provided for.

Such delegation may take place only if a clearly defined and
documented framework for
the exercise of any delegated
functions has been established. Prior to delegation, competent
authorities shall ensure that the body to which functions are to
be delegated has the capacity and resources to effectively
execute all responsibilities and that
it has established the
necessary arrangements
to clearly identify and avoid the
potential negative effects of any conflict of interest between
the
the delegated functions and any other
proprietary or commercial interest.

exercise of

Competent authorities
tiveness of
responsibility
pursuant to this Directive are applied.

shall periodically review the effec-
these arrangements. They shall retain ultimate
adopted

the provisions

ensuring

that

for

If a Member State designates more than one competent
their
shall be clearly defined and they shall

3.
authority to enforce a provision of
respective
cooperate closely.

this Directive,

roles

Each Member State shall ensure that such cooperation also
the
takes place between the

competent

authorities

for

(d)

require existing telephone and data traffic records;

(e)

require cessation of a practice that
provisions laid down pursuant to this Directive;

is contrary to the

(f)

request the freezing and/or the sequestration of assets;

(g)

request temporary prohibition of professional activity;

(h)

require
information;

authorised

entities'

auditors

to

provide

(i)

(j)

adopt any type of measure to ensure that authorised
entities continue to comply with the legal requirements;

demand the
instrument;

suspension of

trading

in a

financial

(k) demand the removal of a financial

from
trading, whether on a regulated market or under other
trading arrangements;

instrument

(l)

seek judicial orders and take other action to ensure
compliance with these regulatory, administrative and
investigation powers;

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(m) impose administrative sanctions;

(c) professional organisations having a legitimate interest in

(n)

initiate or refer matters for criminal prosecution.

2. Member States shall ensure that competent authorities
have the adequate resources for the exercise of their functions,
and that
the staff of such authorities observe professional
standards and are subject to appropriate internal procedures
or rules of conduct which ensure, in particular, the protection
of personal data, procedural fairness and the proper observance
of confidentiality and secrecy provisions.

acting to protect their members.

Article 49

Extra-judicial mechanism for investors' complaints

set up efficient

shall
and redress procedures

and effective
1. Member States
the out-of-court
complaints
settlement of consumer disputes concerning the provision of
investment and ancillary services provided by investment firms,
using existing bodies where appropriate.

for

Article 47

Sanctions

2. Member States shall ensure that those bodies are not
prevented by legal or regulatory provisions from co-operating
effectively in the resolution of cross-border disputes.

1. Without prejudice to the procedures for the withdrawal
of authorisation or to the right of Member States to impose
criminal penalties, Member States shall ensure, in conformity
with their national
law, that the competent authorities take
appropriate administrative measures or impose administrative
sanctions in respect of
the persons responsible where the
provisions adopted pursuant to this Directive have not been
complied with. Member States shall ensure that these measures
are effective, proportionate and dissuasive.

2. Member States shall determine the sanctions to be applied
for failure to co-operate in an investigation.

3. Member States shall provide that the competent authority
may disclose to the public any measure or sanction that will be
imposed for infringement of the provisions adopted pursuant
to this Directive, unless the disclosure would jeopardise the
financial markets or cause disproportionate damage to the
parties involved.

Article 48

Right of appeal

1. Member States shall ensure that any decision taken under
regulations or administrative provisions adopted in
laws,
accordance with this Directive is properly reasoned and is
open to appeal or review by the courts. The same shall
apply where,
in respect of an application for authorisation
which provides all the information required, no decision is
taken within six months of its submission.

2. With regard to the right of appeal
referred to in
paragraph 1, Member States shall provide that one or more
of the following bodies, as determined by national law, may, in
the interests of consumers and in accordance with national law,
take action before the competent authority or the courts:

(a) public bodies or their representatives;

Article 50

Professional secrecy

1. Member States shall ensure that all persons who work or
who have worked for the competent authorities or bodies to
whom functions are delegated pursuant to Article 45(2), as
well as auditors and experts instructed by the competent auth-
orities, are bound by the obligation of professional secrecy. No
confidential information which they may receive in the course
of their duties may be divulged to any person or authority
whatsoever, save in summary or aggregate form such that
individual
firms cannot be identified, without
prejudice to cases covered by criminal law.

investment

2. Where an investment firm has been declared bankrupt or
information
is being compulsorily wound up, confidential
which does not concern third parties involved in attempts to
rescue that
firm may be divulged in civil or
investment
commercial proceedings.

Article 51

Relations with auditors

1. Member States shall provide at least that any person auth-
orised within the meaning of Council Directive 84/253/EEC (1),
performing in an investment firm the task described in Article
51 of Council Directive 78/660/EEC (2), Article 37 of Directive
83/349/EEC or Article 31 of Directive 85/611/EEC or any
other task prescribed by law, shall have a duty to report
promptly to the competent authorities any fact or decision
concerning that undertaking of which that person has
become aware while carrying out
task and which is
liable to:

that

(a) constitute a material breach of the laws, regulations or
administrative provisions which lay down the conditions
governing authorisation or which specifically govern
pursuit of the activities of investment firms;

(b) consumer organisations having a legitimate interest

in

protecting consumers;

(1) OJ L 126, 12.5.1985, p. 20.
(2) OJ L 222, 14.8.1978, p. 11.

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(b) affect the continuous functioning of the investment firm;

Article 53

(c)

lead to refusal to certify the accounts or to the expression
of reservations.

That person shall also have a duty to report any facts and
decisions of which the person becomes aware in the course
the tasks referred to in the first
of carrying out one of
subparagraph in an undertaking having close links resulting
from a control relationship with the investment firm within
which he is carrying out that task.

2.
The disclosure in good faith to the competent authorities,
by persons authorised within the meaning of Directive
84/253/EEC, of any fact or decision referred to in paragraph
1 shall not constitute a breach of any contractual or legal
restriction on disclosure of information and shall not involve
such persons in liability of any kind.

CHAPTER II

Cooperation in investigations

1.
A competent authority of one Member State may request
the competent authority of another
the co-operation of
Member State for an on-the-spot verification or in an investi-
gation.

Competent authorities which receive such requests shall, within
the framework of their powers, act upon them by:

(a) carrying out the verifications themselves;

(b) allowing the authorities who have requested them to carry

them out; or

(c) allowing auditors or experts to carry out the verification.

2.
A competent authority may refuse to act on a request for
cooperation in carrying out an investigation as provided for in
paragraph 1 only where:

COOPERATION BETWEEN COMPETENT AUTHORITIES OF
DIFFERENT MEMBER STATES

(a) such an investigation might adversely affect

the sover-

eignty, security or public policy of the State addressed;

Article 52

Obligation to cooperate

Competent authorities of different Member States shall
1.
the
co-operate with each other whenever necessary for
purpose of carrying out their duties under this Directive,
in
the exercise of their powers under this Directive or national
law.

Competent authorities shall render assistance to competent
authorities of other Member States. In particular, they shall
exchange information and co-operate in any investigation
activities.

2. Member States shall take the necessary administrative and
organisational measures to facilitate the assistance provided for
in paragraph 1.

Competent authorities shall be able to use their powers for the
purpose of cooperation, even in cases where the conduct under
investigation does not constitute an infringement of any regu-
lation in force in that Member State.

3. Where a competent authority is convinced that acts
contrary to the provisions of this Directive, carried out by
entities not subject to its supervision, are being or have been
carried out on the territory of another Member State, it shall
notify this in as specific a manner as possible to the competent
authority of the other Member State. The latter authority shall
take appropriate action. It shall inform the notifying competent
authority of the outcome of the action and, to the extent
possible, of significant interim developments.

(b) judicial proceedings have already been initiated in respect
of the same actions and the same persons before the auth-
orities of the Member State addressed;

(c)

final judgement has already been given in the Member State
addressed in respect of the same persons and the same
actions.

In the case of such a refusal, the competent authority shall
notify
accordingly,
competent
providing as detailed information as possible.

requesting

authority

the

Article 54

Exchange of information

authorities

Competent

shall
1.
immediately
information
required for the purposes of carrying out their duties set out
in the provisions adopted pursuant to this Directive.

of Member
another with the

supply one

States

Article 50 shall not prevent the competent authorities from
exchanging information in accordance with this Directive.

authorities

Competent
information shall
indicate what information, or part of it, thus supplied shall
be
by
considered
professional secrecy.

communicating

confidential

therefore

covered

and

The Commission may adopt, in accordance with the procedure
referred to in Article 59(2), implementing measures concerning
procedures for the exchange of information.

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Competent authorities receiving confidential information
2.
under paragraph 1 of this Article or under Articles 51 and 58
may use it only in the course of their duties:

(a) to check that the conditions governing the taking up of the
business of investment firms are met and to facilitate the
monitoring, on a non-consolidated or consolidated basis, of
the conduct of that business, especially with regard to the
imposed by Directive
capital
93/6/EEC, administrative and accounting procedures and
internal-control mechanisms;

requirements

adequacy

(b) to monitor the proper functioning of trading venues;

(c) to impose sanctions;

(b) the authorities responsible for overseeing persons charged
the accounts of
investment

with carrying out statutory audits of
insurance undertakings,
firms and other financial institutions.

institutions,

credit

Member States which have recourse to the option provided for
in the first
the
following conditions are met:

subparagraph shall

require at

least

that

(a) the information must be for the purpose of performing the
task of overseeing referred to in the first subparagraph;

(b) information received in that context must be subject to the
conditions of professional secrecy laid down in Article 50;

(d) in administrative

appeals

against

decisions

by

the

competent authorities; or

(e)

in court proceedings initiated under Article 48.

(c) where the information originates in another Member State,
it must not be disclosed without the express agreement of
the competent authorities which have transmitted it and,
where appropriate, solely for the purposes for which those
authorities gave their agreement.

However, where the competent authority communicating
information consents
the authority receiving the
information may use it for other purposes.

thereto,

Member States shall communicate to the Commission and to
the other Member States the names of the authorities which
may receive information pursuant to this paragraph.

3.
Paragraphs 1 and 2 of this Article and Article 50 shall
neither preclude the disclosure of information to bodies which
administer compensation schemes where this is necessary for
the exchange of
the performance of
information needed for
supervisory
functions:

the performance of

functions nor

their

(a) within a Member State or between Member States, between

competent authorities and

(i) bodies responsible for the liquidation and bankruptcy
of investment firms and other similar procedures;

(ii) and persons responsible for carrying out statutory
audits of the accounts of investment firms and other
financial institutions and insurance undertakings,

(b) between competent authorities and the authorities or
bodies of other Member States responsible for the super-
vision of credit institutions, other financial institutions and
insurance undertakings.

Such information shall be subject
professional secrecy laid down in Article 50.

to the conditions of

4.
Notwithstanding paragraphs 1 and 2 of this Article and
Articles 50 and 58, Member States may authorise exchanges of
information between, the competent authorities and:

(a) the authorities

responsible for overseeing the bodies
involved in the liquidation and bankruptcy of investment
firms and other similar procedures;

5.
Notwithstanding paragraphs 1 and 2 of this Article and
Articles 50 and 58, Member States shall, with the aim of
the financial
strengthening the stability and integrity of
system, authorise the exchange of information between the
competent authorities and the authorities or bodies with legal
responsibility for the detection and investigation of breaches of
company law.

Member States which have recourse to the option provided for
in the first
the
following conditions are met:

subparagraph shall

require at

least

that

(a) the information shall be for the purpose of performing the

task referred to in the first subparagraph;

(b) information received in this context shall be subject to the
conditions of professional secrecy imposed in Article 50;

(c) where the information originates in another Member State,
it must not be disclosed without the express agreement of
the competent authorities which have transmitted it and,
where appropriate, solely for the purposes for which those
authorities gave their agreement.

Where, in a Member State, the authorities or bodies referred to
in the first subparagraph perform their task of detection or
investigation with the aid, in view of their specific competence,
of persons appointed for that purpose and not employed in the
public
exchanging information
provided for in the first subparagraph may be extended to
such persons under the conditions stipulated in the second
subparagraph.

the possibility of

sector,

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In cases referred to in point (c) of the second subparagraph, the
authorities or bodies referred to in the first subparagraph shall
communicate to the competent authorities which have trans-
mitted the information the names and precise responsibilities
of the persons to whom it is to be sent.

States shall, however, ensure that information received under
paragraph 1 of this Article from the competent authorities of
other Member States may not be disclosed in the circumstances
referred to in this paragraph without the express consent of the
competent authorities which transmitted it.

Member States shall communicate to the Commission and to
the other Member States the names of the authorities or bodies
which may receive information pursuant to this paragraph.

6.
This Article and Articles 50 and 58 shall not prevent a
competent authority from transmitting to central banks, the
European System of Central Banks and the European Central
in their capacity as monetary authorities, and, where
Bank,
appropriate, to other public authorities responsible for over-
seeing payment
the
systems,
performance of their tasks.

information intended for

Likewise such authorities or bodies shall not be prevented from
communicating to the competent authorities such information
as they may need for the purposes of paragraph 3. Information
received in this context shall be subject to the conditions of
professional secrecy laid down in Article 50.

Article 55

Inter-authority consultation prior to supplementary
authorisation

1.
The competent authorities of the other Member State
involved shall be consulted prior to granting authorisation to
any investment firm which is:

(a) a subsidiary of an investment firm or credit

institution

authorised in another Member State;

(b) a subsidiary of the parent undertaking of an investment
firm or credit institution authorised in another Member
State;

law for

7.
This Article and Articles 50 and 58 shall not prevent the
competent authorities from communicating the information to
a clearing house or other similar body recognized under
national
settlement
services for the markets of one of the Member States, if the
competent
to
communicate that information in order to ensure the proper
functioning of those bodies in relation to defaults or potential
defaults by market participants.

the provision of clearing or

is necessary

authorities

consider

that

it

The information received shall be subject to the conditions of
professional secrecy laid down in Article 50. The Member
States shall, however, ensure that information received under
paragraph 1 of this Article may not be disclosed in the circum-
stances referred to in this paragraph without
the express
consent of the competent authorities which transmitted it.

8.
In addition to and notwithstanding the provisions
referred to in paragraphs 1 and 2 and in Articles 50 and 58,
Member States may, by virtue of provisions laid down by law,
authorise the disclosure of certain information to other
departments of
administrations
responsible for legislation on the supervision of credit insti-
tutions, financial institutions, investment firms and insurance
those
inspectors
undertakings
departments.

central government

instructed

their

and

by

to

Such disclosures may, however, be made only where necessary
for reasons of prudential supervision.

9.
the
This Article and Article 50 shall not prevent
competent authorities from communicating information to
any body or bodies to whom they have delegated their
functions if they consider it necessary in order to ensure the
proper exercise of those functions.

(c) controlled by the same natural or legal persons as control
institution authorised in

firm or credit

an investment
another Member State

2.
The competent authority of the Member State responsible
for the supervision of credit institutions or insurance under-
takings shall be consulted prior to granting an authorisation to
an investment firm which is:

(a) a subsidiary of a credit institution or insurance undertaking

authorised in the Community; or

(b) a subsidiary of the parent undertaking of a credit institution
or insurance undertaking authorised in the Community;

(c) controlled by the same person, whether natural or legal,
who controls a credit institution or insurance undertaking
authorised in the Community.

The

relevant

authorities

competent

referred to in
3.
paragraphs 1 and 2 shall
in particular consult each other
when assessing the suitability of the shareholders and the repu-
tation and experience of directors involved in the management
of another entity of the same group. They shall exchange all
information regarding the suitability of shareholders and the
reputation and experience of directors that is of relevance to
the other competent authorities involved, for the granting of an
the ongoing assessment of
authorisation as well as
compliance with operating conditions.

for

Article 56

Powers for host Member States

The information received shall be subject to the conditions of
professional secrecy laid down in Article 50. The Member

1.
Host Member States may, for statistical purposes, require
all investment firms with branches within their territories to
report to them periodically on the activities of those branches.

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In discharging their responsibilities under this Directive,
2.
host Member States may require branches of investment firms
to provide the information necessary for the monitoring of
their compliance with the standards set by the host Member
State that apply to them. Those requirements may not be more
stringent than those which the same Member State imposes on
established firms for the monitoring of their compliance with
the same standards.

Article 57

Precautionary powers for host Member States

1. Where the competent authority of the host Member State
has clear and demonstrable grounds for believing that an
investment firm acting within its territory under the freedom
to provide services is in breach of the obligations arising from
the provisions adopted pursuant to this Directive, it shall refer
those findings to the competent authority of the home Member
State.

the orderly

is clearly prejudicial

2.
If, despite the measures taken by the competent authority
of the home Member State or because such measures prove
inadequate, the investment firm persists in acting in a manner
to the interests of host country
that
the
investors or
functioning of markets,
State,
competent
after
authority of
informing the competent authority of
the home Member
State, shall take all the appropriate measures needed in order
to protect investors and the proper functioning of the markets.
The Commission shall be informed of such measures without
delay.

the host Member

Article 58

Exchange of information with third countries

exchange of

1. Member States may conclude cooperation agreements
information with the
for
the
providing
third countries or with third
competent
authorities of
country authorities or bodies whose
are
analogous to those of the bodies referred to in points (i) and
the first
(ii) of Article 54(3)(a) and points (a) and (b) of
subparagraph of Article 54(4) only if
information
disclosed is subject to guarantees of professional secrecy at
least equivalent
to those required under Article 50. Such
exchange of information must be intended for the performance
of the supervisory task of those authorities or bodies.

responsibilities

the

2. Where the information originates in another Member
State, it may not be disclosed without the express agreement
of the competent authorities which have transmitted it and,
where appropriate, solely for the purposes for which those
authorities gave their agreement.

TITLE V

FINAL PROVISIONS

Article 59

The Commission shall be assisted by the European
instituted by Commission Decision

1.
Securities Committee
2001/528/EC (1) (hereinafter referred to as ‘the Committee’).

2. Where reference is made to this paragraph, Articles 5 and
7 of Decision 1999/468/EC shall apply, having regard to the
provisions of Article 8 thereof, provided that the implementing
measures adopted in accordance with this procedure do not
modify the essential provisions of this Directive.

The period laid down in Article 5(6) of Decision 1999/468/EC
shall be three months.

the application of

requiring the adoption of

3. Without prejudice to the implementing measures already
adopted, on the expiry of a four-year period following the
its
entry into force of
this Directive,
provisions
rules and
decisions in accordance with paragraph 2 shall be suspended.
On a proposal from the Commission, the European Parliament
and the Council may renew the provisions concerned in
accordance with the procedure laid down in Article 251 of
the Treaty and, to that end, they shall review them prior to
the expiry of that period.

technical

Article 60

Reports and review

1.
No later than [31 December 2008, 4 years after the entry
into force of this Directive], the Commission shall, on the basis
of public consultation and in the light of discussions with
competent authorities, report to the European Parliament and
Council on the possible extension of
the
provisions of the Directive concerning pre and post-trade trans-
parency obligations to transactions in classes of
financial
instrument other than shares.

the scope of

On the basis of
that report,
proposals for related amendments to this Directive.

the Commission may submit

2.
No later than [31.12.2006, 2 years after the entry into
force of this Directive], the Commission shall, on the basis of
public consultations and in the light of discussions with
competent authorities, report to the European Parliament and
Council on:

(a) the continued appropriateness of

the exemption under
point (i) of Article 2(1) of this Directive for undertakings
whose main business
in
commodities derivatives;

is dealing on own account

(b) the content and form of proportionate requirements for the
authorisation and supervision of such undertakings as
investment firms within the meaning of this Directive.

(1) OJ L 191, 13.7.2001, p. 45.

On the basis of
that report,
proposals for related amendments to this Directive.

the Commission may submit

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Article 61

(a)

In point 7 the following point is added:

Amendment of Directive 85/611/EEC

‘(f) commodity derivatives’.

In Article 5 of Directive 85/611/EEC, paragraph 4 is replaced
by the following:

(b) The following point is added:

‘4.
Articles 2(2), 11, 12, 17 and 18 of European
Parliament and Council Directive . . . (*) shall apply to
the provision of the services referred to in paragraph 3
of this Article by management companies.

___________
(*) OJ L [. . .]’

Article 62

Amendment of Directive 93/6/EEC

In Directive 93/6/EEC, point (2) of Article 2 is replaced by the
following:

Investment

‘2.
institutions that
firms shall mean all
provide investment services in accordance with European
Parliament and Council Directive . . . (*) with the exception
of:

(a) credit institutions;

(b) local firms;

(c)

firms which only receive and transmit orders from
investors without
securities
belonging to their clients and which for that reason
may not at any time place themselves in debit with
their clients;

holding money

or

(d) investment firms which are authorised to provide only

the service of investment advice.

___________
(*) OJ L [. . .]’

‘15. Operation of a multilateral trading facility’.

Article 64

Repeal of Directive 93/22/EEC

Directive 93/22/EEC is repealed with effect from the date of
application set out in Article 64.

References
references to this Directive.

to Directive 93/22/EEC shall be construed as

Article 65

Transposition

Member States shall bring into force the laws, regulations and
administrative provisions necessary to comply with this
Directive by 30 June 2006 [18 months of
its entry into
force]
forthwith inform the
latest. They
Commission thereof.

shall

the

at

They shall apply those provisions as from 1 July 2006.

When Member States adopt those provisions, they shall contain
a reference to this Directive or be accompanied by such a
reference on the occasion of
their official publication.
Member States shall determine how such reference is to be
made.

Article 66

Entry into force

This Directive shall enter into force on the day following that
of
the European
Communities.

its publication in the Official

Journal of

Article 63

Amendment of Directive 2000/12/EC

Article 67

Addressees

Annex I of Directive 2000/12/EC is amended as follows:

This Directive is addressed to the Member States.

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ANNEX I

LIST OF SERVICES AND FINANCIAL INSTRUMENTS

SECTION A

Investment services

1. Reception and transmission of orders in relation to one or more financial instruments.

2. Execution of orders on behalf of clients.

3. Dealing on own account.

4. Managing portfolios in accordance with mandates given by clients on a discretionary client-by-client basis where

such portfolios include one or more financial instruments.

5. Investment advice

6. (a) underwriting and placing of financial instruments on a firm commitment basis;

(b) placing without a firm commitment or other activities undertaken in agreement with the issuer of the instrument

to assist the distribution of or subscription to public or private offers of financial instruments.

7. Operation of Multilateral Trading Facilities.

SECTION B

Ancillary services

1. Safekeeping and administration of financial

instruments for the account of clients,

including custodianship and

related services such as cash/collateral management;

2. Granting credits or loans to an investor to allow him to carry out a transaction in one or more financial instruments,

where the firm granting the credit or loan is involved in the transaction;

3. Advice to undertakings on capital structure, industrial strategy and related matters and advice and services relating to

mergers and the purchase of undertakings;

4. Foreign exchange services where these are connected to the provision of investment services;

5. Investment research and financial analysis or other forms of general recommendation relating to transactions in

financial instruments.

SECTION C

Financial Instruments

1. Transferable securities;

2. Money-market instruments;

3. Units in collective investment undertakings;

4. Options and futures contracts in respect of securities, currencies,

interest rates or yields, commodities or other

derivatives instruments, indices or measures;

5. Interest-rate, currency and equity swaps;

6. Forward-rate agreements and any other derivative contract for a cash settlement determined by reference to prices of

securities, interest rates or yields, foreign exchange rates, commodities or other indices or measures;

7. Contracts for differences or other derivative instruments for transfer of credit risk.

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PROFESSIONAL CLIENTS FOR THE PURPOSE OF THIS DIRECTIVE

ANNEX II

I. Categories of client who are considered to be professionals

The following should all be regarded as professionals in all investment services and instruments for the purposes of
the Directive.

1. Entities which are required to be authorised or regulated to operate in the financial markets. The list below should
the entities
be understood as including all authorised entities carrying out
mentioned: entities authorised by a Member State under a European Directive, entities authorised or regulated
by a Member State without reference to a European Directive, and entities authorised or regulated by a
non-Member State:

the characteristic activities of

(a) Credit institutions

(b) Investment firms

(c) Other authorised or regulated financial institutions

(d) Insurance companies

(e) Collective investment schemes and management companies of such schemes

(f) Pension funds and management companies of such funds

(g) Commodity dealers.

2. Large companies and other institutional investors:

(a)

large companies and partnerships meeting two of the following size requirements on a company basis:

— balance sheet total: EUR 20 000 000,

— net turnover: EUR 40 000 000,

— own funds: EUR 2 000 000.

(b) Other institutional investors whose corporate purpose is to invest in financial instruments.

3. National and regional governments, Central Banks, international and supranational institutions such as the World

Bank, the IMF, the ECB, the EIB and other similar international organisations.

The entities mentioned above are considered to be professionals. They must however be allowed to request
non-professional treatment and investment firms may agree to provide a higher level of protection. Where the
client of an investment firm is a company or a partnership referred to above, the investment firm must inform it
prior to any provision of services that, on the basis of the information available to the firm, the client is deemed to
be a professional client, and will be treated as such unless the firm and the client agree otherwise. The firm must also
inform the customer that he can request a variation of the terms of the agreement in order to secure a higher degree
of protection.

It is the responsibility of the client, considered to be a professional client, to ask for a higher level of protection when
it deems it is unable to properly assess or manage the risks involved.

This higher level of protection will be provided when a client who is considered to be a professional enters into a
written agreement with the investment firm to the effect 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, or to one or more types of product or transaction.

II. Clients who may be treated as professionals on request

1. Identification criteria

Clients other than those mentioned in section I, including public sector bodies and private individual investors,
may also be allowed to waive some of the protections afforded by the conduct of business rules.

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Investment firms should therefore be allowed to treat any of the above clients as professionals provided the
relevant criteria and procedure mentioned below are fulfilled. These clients should not, however, be presumed to
possess market knowledge and experience comparable to that of the categories listed in section I.

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 firm, 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 fitness test applied to managers and directors of entities licensed under European Directives in the financial
field could be regarded as an example of the assessment of expertise and knowledge.

In the case of small entities, the person subject to the above assessment should be the person authorised to carry
out transactions on behalf of the entity.

In the course of the above assessment, as a minimum, two of the following criteria should be satisfied:

— The client has carried out transactions, in significant size, on the relevant market at an average frequency of

10 per quarter over the previous four quarters;

— The size of the client's financial

instrument portfolio, defined as including cash deposits and financial

instruments exceeds 0,5 million Euro;

— The client works or has worked in the financial sector for at least one year in a professional position, which

requires knowledge of the transactions or services envisaged.

2. Procedure

The clients defined above may waive the benefit of the detailed rules of conduct only where the following
procedure is followed:

— they must state in writing to the investment firm that they wish to be treated as a professional client, either
generally or in respect of a particular investment service or transaction, or type of transaction or product;

— the investment firm must give them a clear written warning of the protections and investor compensation

rights they may lose;

— they must state in writing, in a separate document from the contract, that they are aware of the consequences

of losing such protections.

Before deciding to accept any request for waiver, investment firms must be required to take all reasonable steps to
ensure that the client requesting to be treated as a professional client meets the relevant requirements stated in
Section II.1 above.

However, if clients have already been categorised as professionals under parameters and procedures similar to
those above, it is not intended that their relationships with investment firms should be affected by any new rules
adopted pursuant to this paper.

Firms must implement appropriate written internal policies and procedures to categorise clients.

Professional clients are responsible for keeping the firm informed about any change, which could affect their
current categorisation. Should the investment firm become aware however that the client no longer fulfils the
initial conditions, which made him eligible for a professional treatment, the investment firm must take appro-
priate action.