'Execution of orders on behalf of clients' means acting to conclude agreements to buy or sell one or more financial instruments on behalf of clients and includes the conclusion of agreements to sell financial instruments issued by an investment firm or a credit institution at the moment of their issuance (Article 4(1)(5) of MiFID II Directive).
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Execution of orders on behalf of clients is included in the Section A (Investment services and activities) of the MiFID II Annex I point 2.
The execution of an order on behalf of a client can be opposed to simply arranging the relevant deal (like, for example, a name passing broker does).
The execution of orders on behalf of clients can take place either when dealing in investments as agent (by entering into an agreement in the name of your client or in your own name, but on behalf of your client) or, in some cases, by dealing in investments as principal (for example by back-to-back or riskless principal trading).
A specific form of execution of orders on behalf of client is a matched principal trading.
It has been underlined by the the UK Financial Conduct Authority (Markets in Financial Instruments Directive II Implementation – Consultation Paper I (CP15/43), December 2015, CP15/43, p. 262) "If a firm executes client orders by standing between clients on a matched principal basis (back-to-back trading), it is both dealing on own account and executing orders on behalf of clients".
Another important observation on the regulatory scope of the "execution of orders on behalf of clients" has been made by the European Banking Authority (EBA) in the Report on Investment Firms, Response to the Commission's Call for Advice of December 2014 (EBA/Op/2015/20, p. 18).
EBA noted that "the combination of MiFID investment services for which an authorisation is necessary and which is required in order to carry out certain activities differs between Member States. In most Members States, an authorisation to exercise reception and transmission of orders (MiFID A1) is mandatory for the execution of orders (MiFID A2), but there are exceptions.
Another example is that order execution on behalf of clients may be assumed in those cases where the investment firm acts on behalf of the client but places the order on the market in its own name. Being the only contractual partner of its client, the firm has an obligation against the client to deliver the financial instruments purchased on their behalf. Whereas this situation leaves the firm without any market risk, since the parties agree that the client would bear the economic risk of the transaction, the firm may remain in principle exposed to credit risk towards both the market counterparts and its client, leading to concerns about whether such a service would fall under the execution of orders (MiFID A2) or would be seen as a market 'risk free' form of principal trading. When execution on behalf of clients has been implemented as referred to above, the distinction between such firms and those that may be authorised to undertake deals on own account (MiFID A3)—but only for the purposes of executing client orders in accordance with the conditions set out in point (a) of Article 96(1) of the CRR—appears blurred. In such a context, stricter initial capital and own funds requirements could be necessary."
Executing orders
Q15.When might we be executing orders on behalf of clients (A2, article 4.1(5) and recital 45)?
When you are acting to conclude agreements to buy or sell one or more MiFID financial instruments on behalf of clients. You will be providing this investment service if you participate in the execution of an order on behalf of a client, as opposed simply to arranging the relevant deal. In our view, you can execute orders on behalf of clients either when dealing in investments as agent (by entering into an agreement in the name of your client or in your own name, but on behalf of your client) or, in some cases, by dealing in investments as principal (for example by back-to-back or riskless principal trading).
This activity includes the issue of their own financial instruments by an investment firm or a credit institution.
Q15A. Is every issue of financial instruments a MiFID investment service?
No. Although the answer to Q15 says that executing client orders includes issuing your own financial instruments, not every issue of financial instruments amounts to the MiFID investment service of execution of orders on behalf of clients. This is explained in more detail in the rest of this answer.
One difficult question is whether the extension of the executing orders service only applies to firms that are already investment firms because of other services and activities they provide or whether this part of the definition is also relevant to someone who is deciding whether they are an investment firm in the first place.
In the FCA’s view, this part of the definition is not limited to someone that is already an investment firm because of its other activities and services. This is because the risks at which recital 45 of MiFID says this part of the definition is aimed apply whether or not the issuer is already an investment firm for another reason. For example, there is no reason why a firm that issues its own complicated securities to the retail market should not need authorisation if a firm that distributes ones issued by another firm requires authorisation.
On the other hand, it cannot be the case that raising capital by issuing its own capital causes an ordinary commercial company to become an investment firm. The reasons why this should not be the case include the following:
• If you do not issue financial instruments on a professional basis and do not otherwise execute orders on behalf of clients, you will generally not need permission or authorisation to do this. See Q8 for more information.
• The investor may not be your client. For example, an ordinary commercial company issuing debt securities to financial investors is unlikely to be providing a service; it is more likely to be receiving one.
• Recital 45 of MiFID confirms that the definition is intended to catch issuers when distributing their own financial instruments. Thus if you get another investment firm or credit institution to distribute your financial instruments, you will not be executing client orders."
Perimeter Guidance Manual, FCA, Release 50, May 2020 www.handbook.fca.org.uk, p. 9 - 11
Regulatory chronicle
24 September 2021
Consultation on Review of the MiFID II framework on best execution reports, ESMA, ESMA35-43-2836
Documentation
MiFID II, Article 4(1)(5), Annex I Section A2
Perimeter Guidance Manual, FCA, Release 50, May 2020 www.handbook.fca.org.uk, p. 9 - 11
Links
C6 energy derivatives contracts
Physically settled commodity derivatives in MiFID II
Contracts that must be physically settled