Legal overview - MiFID in Bulgaria – three and a half years later


Legal overview - MiFID in Bulgaria – three and a half years later
Legal overview - MiFID in Bulgaria – three and a half years later



Like in the rest of the EU, maybe only on a somewhat smaller scale, MiFID was the hot topic for the financial community in late 2007. Banks and investment firms were focused on how to get compliant on day 1, and terrified by the wealth of new types of documentation that needed to be produced, adopted and exchanged with clients. With the passage of time after November 1, 2007, handling the newly required administration became routine, and then the important MiFID questions could have turned elsewhere: are there benefits in MiFID, how can these be increased and the regulation improved along the way, or at least how can the regulatory burden be decreased?
But, with the financial crisis, came the downsizing of the financial markets in Bulgaria: SOFIX, the key stock exchange index, fell between the end of February 2008 and the end of February 2011 roughly from 1430 to 450 points, and volumes fell for the same period roughly from EUR 3,450,000 to EUR 225,000! Many investment firms (or bank’s investment businesses) either disappeared or shrank manifold, and thus the focus was on surviving, or just giving the business up altogether, in order to reduce or avoid further costs. The details of the regulation did not seem to matter that much, in the end.
The outline below goes through the history of MiFID in Bulgaria, calling at several topics that indicate areas of possible regulatory improvements.

The local sources of MiFID regulation

MiFID (the level 1 and 2 directives) in Bulgaria is transposed in two major bodies of legislation: the Markets in Financial Instruments Act (“MiFIA”), and Ordinance No 38 of the Financial Supervision Commission on the Requirements to the Activities of Investment Firms (“Ordinance No 38”).
Regulation (EC) No 1287/2006 of the European Commission, obviously, has direct application in Bulgaria too. In real life, it was applied mostly with regard to the record-keeping obligations of investment firms.
On several occasions the regulatory and supervisory authority, the Financial Supervision Commission (the “FSC”), issued brief guidelines on matters related to MiFIA.
The European Securities Market Authority (previously CESR) has also produced a body of guidelines (as Lamfalussy “level 3” norms) which have had practical application in Bulgaria too, e.g. the formats for passporting applications.
MiFIA follows the basic structure and scope of MiFID’s level 1 and 2, but it is noteworthy that Bulgaria, as one of the several exception countries, does not regulate tied agents in MiFIA. Furthermore, MiFIA does not regulate smaller investment firms or other investment businesses as only national businesses not subject to MiFID and not eligible for passporting; all Bulgarian investment firms are regulated as MiFID investment firms.
In addition to MiFID matters, MiFIA and Ordinance No 38 regulate various topics “locally”, such as the need for investment firms to make their contracts only in FSC-registered offices (refer to “Review of Ordinance No 38 – initiative by the FSC” infra); as the requirement to enter into such contracts by the signing power of certain types of persons: corporate directors (general managers, or executive board members), prokurists, brokers,
and qualifying employees registered with the FSC (known as “persons under article 39, para 1, subpara 2” (of Ordinance No 38)); and such as the special function of investment firms as “registration agents” for certain non-market transfers of financial instruments.
Like MiFID’s level 1 and 2 directives, MiFIA is not providing extensive coverage of subjects such as OTC derivatives as a special species of financial instrument, or the possible conflicts between host and home member states conduct of business rules (e.g. where a branch of another EU-member state investment firm carries out investment services and activities in Bulgaria, being the host member state). Both these and other open issues have caused practical concerns in certain business quarters in Bulgaria.

Regulation and supervision

The key regulatory and supervisory authority of MiFID matters in Bulgaria is the FSC. However, concerning authorization, banks get a MiFID license in addition to, and as part of, their banking license from their own supervisory authority, the Bulgarian National Bank (the “BNB”). The BNB issues MiFID licenses after consultation with the FSC.
In accordance with its internal structure, a wide range of functions related to MiFID (but not licensing itself) are entrusted to one of the three Deputy-Chairpersons of the FSC, the one in charge of Capital Markets.
Rule making of statutory instruments is vested with the FSC.
The Bulgarian Stock Exchange – Sofia JSC (the “BSE”), the only regulated market in Bulgaria, also authors certain MiFID-related provisions, through its Rules. The BSE Rules, for example, provide for certain internal organization or operational requirements applicable to investment firms wishing to become its members, expanding on those contained in the MiFIA and Ordinance No 38.
There are two major business associations of MiFID firms in Bulgaria – the Association of Bulgarian Banks, and the Bulgarian Association of Licensed Investment Firms (having most of the non-banking investment firms as its members).
Both business associations have developed practices of proffering, debating and commenting on regulatory changes, however there is little selfregulation per se. The host of the MiFID-related regulation originates from the State.

Practices under the MiFIA and Ordinance No 38

Bulgarian practices have focused, it seems, on the client-investment firm relationship aspects of MiFID. Thus, early on, most investment firms and banks produced templates, and then put into daily use and thereafter mastered the handling of the voluminous paperwork that ought to be produced as part of this relationship. Everybody knows that client categorization comes about first; but then also, at least pro forma, clients have to be informed of various matters concerning the products offered and the risks associated, among others; a written contract is to be put in place, signed for the investment firm at least by a “person under article 39”, if not by a director, this contracting to be made under the watchful eyes of the internal control management unit of the firm;
with some exceptions a suitability or appropriateness test needs to be run (depending on the product), it is necessary to make sure the client is “aware” (and importantly state so in writing) of the firm’s policies on conflicts of interest handling and on best execution; and not least once a transaction is executed for the client, he or she needs to get promptly feedback in the form of a transaction report. These and other key procedures
or habits in place, based on suitable written templates, against the background of a well documented internal structure of the investment firm, the FSC is likely to be satisfied during an audit that the MiFIA and Ordinance No 38 are being complied with to a proper extent.
More recently, focus was put on internal organization (with investment firms trying wherever possible to have less employees cover all required MiFID internal functions), as well as on reporting of controlling interests in the equity of investment firms (and in other financial institutions generally) – an ad hoc reporting of such interests was mandated by the autumn 2010, following identical amendments concerning many financial services laws, including the MiFIA.
The passporting procedure in itself did not seem to cause particular problems for non-Bulgarian firms entering the market or for Bulgarian firms going elsewhere in Europe (Romania, but also on several occasion West-European countries). The gaps in conduct of business rules (especially those concerning relationship with clients) between a host and a home country regulation have rarely been addressed directly in guidelines by the FSC or in initiatives of the business associations, thus this most common concern, i.e. which rules are to be applied by the passported bank or investment firm (one or simultaneously more than one sets), remained largely unaddressed.
Other MiFID topics such as the rules on inducements or outsourcing, or (in view of their relative rarity in Bulgaria) those on non-exchange transactions transparency and reporting, have taken center stage much less commonly.
But if anything was the focus of MiFID related practices in Bulgaria in 2009 and 2010, this was, unfortunately, de-licensing or downsizing. The FSC’s statistical service reported that in the period June – December 2010 six out of sixty-one (or close to 10%) of the non-bank investment firms “returned” their licenses, with other firms applying for the same in the interim. In such procedures the FSC has scrupulously gone through most of or at least a representative selection of the client arrangements in order to make sure that these arrangements would be terminated, or as the case may be transferred to continuing investment firms, in a fair and equitable manner, protecting investors.

Review of Ordinance No 38 – initiative by the FSC

Almost ever since the enactment of MiFIA, but more vocally in the past year or so, Bulgarian investment firms and banks that intended to continue their investment business despite the crisis (especially those relying on a retail client base) insisted to the FSC that it eased the requirements on originating new business. E.g. by lifting the requirement that contracts be made only in registered offices of the investment firm, or by allowing the use of additional distribution channels (e.g. tied agents). About early February 2011 the FSC produced draft amendments to Ordinance No 38 which were circulated to the business associations for comments to be given prior to the FSC adopting them as a “final drafts” and then inviting a wider and final debate before adoption of final amendments.
In one of their more important aspects, these amendments finally make possible the distance marketing and contracting of investment services (and hopefully will put the lethargic Distance Marketing of Financial Instruments Act into some use for clients and the business alike). Three methods of distance contracting are envisaged: (i) by the use of “universal” (EU-issued “qualified” electronic signatures, after July 1, 2011), (ii) by way of contracting with clients having a bank account with a bank in the EEA or Switzerland (but not in any other FATF or OECD country, e.g. not in the USA, Canada, Japan, Australia, Hong Kong, Singapore, New Zealand,South Africa, etc.), subject to the arrangement that only such particular bank account will be used for the transfer of funds by the client to the investment firm and the payment back of proceeds by the firm to the client; or (iii) by having the client identification documents, MiFID document requested of the client (e.g. information concerning categorization), and the financial services written agreement itself, attested by a notary public (in the client’s location or elsewhere). Whilst one may come up with other, arguably even more flexible and less expensive, distance contracting methods, the current draft by the FSC does offer certain practical solutions to the now applicable burdensome restrictions on business origination of clients for brokerage, individual portfolio management and other standardized investment services. As a positive step forward, these changes will inevitably open the door to further relaxation of contracting and client-firm communication requirements (e.g. by offering further means of contracting and by relaxing further the requirements where the client is professional or an eligible counterparty).
Another set of draft changes focus on the organizational requirement for investment firms, easing them in several respects and allowing more flexible internal procedures of the internal control departments of investment firms. Enacting the amendments to Ordinance No 38 is expected before the end of H1 of 2011.
It will not be too much of an exaggeration to state that “MiFID II” (yet as a set of ideas indicated in the EC’s consultation document from December 2010) will cover a wide range of topics that are not too relevant for Bulgaria and its likes, at this stage. Dark pools, crossing systems, trading standardized OTC derivatives on exchanges, pre- and posttrade transparency, commodities trading, the mandatory consolidated tape, are also important in this country but certainly not as much as they are of practical relevance in the largest European capital markets.
Other aspect of MiFID II, however, are likely to be of significant relevance for MiFID in Bulgaria, especially the possibility to introduce (and regulate) non-MiFID smaller investment services providers, subjecting of structured deposits and other packaged-retail investment products (both already know in Bulgarian practices) to certain MiFID rules, the clarification of “execution only” services, the reinforcement of certain principles concerning internal organization, and not least the EU-wide introduction of tied agents (a new distribution channel in the case of Bulgaria).
But it will not be before May that the European Commission comes out with a proposal amending MiFID. At that time or shortly afterwards this overview will be followed by a particular memorandum on MiFID II.


Legal overview - MiFID in Bulgaria – three and a half years later