October 24, 2022
U.K. financial regulation includes a small and unusual provision, the so-called “MiFID override,” which prioritises the EU’s MiFID II regime over the U.K.’s own regulatory framework when determining questions of what is regulated. Perhaps surprisingly, the MiFID override remains in place post-Brexit, and the measures being taken by the U.K. Government to remove inherited EU law will potentially leave this highly consequential provision in place. This memorandum discusses the MiFID override in light of the aims of the Brexit Freedoms Bill. That Bill will (when and if enacted) provide for the supremacy of U.K. laws and remove the priority given to inherited EU law - a legacy from our membership of the EU. The MiFID override is at odds with the traditional U.K. legal methods of simplicity and clarity, and at odds with plain English drafting and understandability of legislation, since two contradictory and complex documents must be read alongside one another. We call for removal of the MiFID over-ride and the development of a new U.K. statutory instrument on the regulatory perimeter, which sets out all relevant provisions in one place and coherently.
The recently published Retained EU Law (Revocation and Reform) Bill (known as the Brexit Freedoms Bill), aims to revoke or assimilate retained direct EU law and EU-derived subordinate legislation into the U.K. legal system from the end of 2023. The sunset clause under the Brexit Freedoms Bill does not, however, apply to the financial services legislation in Schedule 1 of the Financial Services and Markets Bill (FSM Bill), which provides a mechanism for most EU-derived instruments and legislation to be reviewed, revoked, rewritten or restated, without any particular deadline. In particular, the FSM Bill contains detailed provisions to push down much of the EU’s “single rulebook” into the rulebooks of the U.K. regulators, so that they can remove or adjust those rules to make them suitable for the U.K. environment, again with no deadline for reform. This approach perhaps reflects the sheer volume of financial services law, which would prove challenging to re-work on the timetable of the end of 2023. The U.K.’s legacy primary or secondary legislation on financial services, such as the Financial Services and Markets Act 2000 (FSMA) and statutory instruments made under that Act would remain on the statute books.
This client note explores the complexities surrounding a core aspect of the inherited EU acquis, the so-called “MiFID override.” This is a provision which in part controls what activities are regulated. It is contained in a statutory instrument made under FSMA and requires the complete opposite of what is envisaged in the Brexit Freedoms Bill. It provides expressly for the supremacy of EU directives over the U.K.-originated text contained in the same statutory instrument, when considering the definitions of U.K.-regulated activities. The provision sits uneasily with government policy on Brexit, and as a result there may now be an opportunity to remove the unnecessary complexity that arises from this provision, to produce a more coherent single-source instrument to define the U.K.’s regulatory perimeter.
The activities and instruments which are regulated in the U.K. are set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). This specifies, for example, that deposit-taking, investment advice, insurance, brokerage and so on may only take place within FCA-regulated firms.
Subsequent to the RAO being introduced, the EU rolled out its Financial Services Action Plan, introducing multiple new directives and regulations seeking to harmonize financial regulation across different sectors. For investment business, the relevant directives were MiFID 1, effective 1 November 2007, which was then superseded by MiFID II and a related regulation MiFIR, effective 3 January 2018. These cover the activities of brokerage, dealing and investment advice, among others.
The so-called perimeter of MiFID and MiFID II differed from that under the RAO. For example, some of the exemptions for own-account dealing, especially in commodity derivatives, were less liberal under MiFID II. Also, MiFID II required the regulation (with fewer exceptions) of activities relating to “transferable securities,” narrowing the possible scope of some of the U.K.’s previously more generous exemptions.
The U.K. faced a choice when both MiFID and MiFID II came into force, of either (i) reforming and aligning the RAO with MiFID I and MiFID II; or (ii) a short-hand legislative fix. The U.K. opted for the latter, implementing the so-called “MiFID override.” This has been in force since 1 November 2007 and was expanded for MiFID II, effective on 3 January 2018.
The MiFID override is contained within Article 4(4) RAO. It states as follows:
“Where an investment firm or qualifying credit institution—
(a)provides or performs investment services and activities on a professional basis, and
(b)in doing so would be treated as carrying on an activity of a kind specified by a provision of this Part but for an exclusion in any of articles 15, 16, 18, 19, 22, 23, 29, 34, 38, 67, 68, 69, 70 and 72E,
that exclusion is to be disregarded and, accordingly, the investment firm or qualifying credit institution is to be treated as carrying on an activity of the kind specified by the provision in question.”
Essentially, the override disapplies numerous of the exemptions in the RAO, where such exemptions would not be allowed under MiFID II. The result of the MiFID override is that the RAO, the key U.K. legislation defining the scope of its financial services, is a non-comprehensive referential document. In any question of the so-called “regulatory perimeter,” it is necessary for U.K. firms, lawyers and regulators to look at two texts in parallel, the RAO itself and also MiFID II. This inelegant situation has then led to the Financial Conduct Authority (FCA) needing to carry out a sort of “mapping exercise,” in its Perimeter Guidance Manual (known as PERG), which seeks to explain how the various RAO and MiFID II activities and exemptions overlap and when.
The MiFID override has real consequences for both firms and investors.
Upon the introduction of the MiFID and MiFID II regimes, the MiFID override became the mechanism by which the expansion of the U.K. regulatory regime to various commodity and derivatives markets participants, proprietary traders, algorithmic traders and commodity trading firms became effective.
The MiFID override was also central to the recent High Court proceedings involving the London Capital & Finance plc (LCF) scandal, R v Financial Services Compensation Scheme Ltd  EWHC 760 (Admin). The legal issues in this judicial review centered on whether LCF’s bonds, which included a prohibition on assignment, were “transferable securities” for purposes of MiFID II. LCF was FCA-regulated and a registered ISA manager; their non-transfer clause was inserted as an arbitrage to deprive investors of regulatory protections. The court found the non-transfer clauses to be unfair and unenforceable under the Consumer Rights Act 2015, meaning that investors would have been able to transfer the bonds. This then raised the question of whether the bonds were not “transferable securities” under MiFID II—and if so, also in the U.K. under the MiFID override. If they were “transferable securities,” then LCF would have performed the MiFID II activity of “execution of orders on behalf of clients,” in issuing bonds to investors, invoking the Financial Services Compensation Scheme. This Scheme had initially been denied to most LCF investors.
The law underlying this situation is complex, and must verge on being unintelligible to ordinary investors. Moreover, from a policy perspective, it served no end: there was an exemption in the RAO to prevent ordinary companies which issue their own bonds from being caught by regulation. MiFID then made provision (confirmed in ECJ caselaw) for financial companies to be viewed as carrying on regulated activities when they issue products to investors, a sensible policy development. However, the relevant EU definition that this regulated activity attached to was “transferable securities.” This happens to be narrower than the traditional U.K. definition of “debentures,” which would have captured LCF’s bonds. Through no design, since no intention to create any loophole is evident from consultation papers at the time, FCA-regulated firms issuing “debentures which are not transferable securities” were not carrying on a regulated activity. LCF operated under the radar of the FCA, as a low-risk firm, when in fact it should have been a high-risk principal dealer with £237 million of deposits, which it then dissipated to its principals via an alleged fraud. It held £50,000 of regulatory capital against that book, when many tens of millions should have been required. Ultimately, the taxpayer ended up footing the cost of a bail-out, pursuant to a special statutory compensation scheme. HM Treasury is now proposing to close the LCF loophole, which is sensible. However, this will not address the underlying fundamental cause of regulatory arbitrage and unexpected bail-out costs for the exchequer, which derive from the quick fixes and lack of forethought in the design of the RAO and the MiFID override in particular.
The RAO has become cumbersome and complex to interpret, with its own definitions and exemptions then being subject to the MiFID override, which in turn requires the definitions and exemptions in MiFID II then also to be reviewed. Article 4 of MiFID II is a somewhat obscure and technically-drafted provision, which legal practitioners are aware of, but which does not allow for a plain English or lay understanding of its wide-reaching consequences. The text of the override is, in addition, difficult to comprehend and not transparent: for example, following the deletion of the definition of “investment services and activities” in Article 3 RAO upon Brexit, there is nothing to link the reader between the use of the term in the MiFID override and to Part 3, Schedule 2 of the RAO where the list is contained (with the exception of a new Part 5 to Schedule 2, which attempts to link the terms but does so by taking the reader to another, separate instrument).
In addition, while the title to Schedule 2 of the RAO was updated from its previously EU-derived one, its Part 3 (which contains the list of investment services and activities) has not been so updated: the title still uses the original EU source i.e., Section A, Annex 1 of MiFID II. Incorporating the EU requirements by reference, but under an overarching new non-EU heading, leaves the “overriding” of the U.K. exclusions listed in Article 4(4)(b) RAO entwined with and dependent upon EU legislation.
Further issues can be seen within the use of phrases in Article 4(4) RAO that are sourced from the EU definition of investment firm, such as “on a professional basis.” It is not clarified whether this should be read based upon the EU understanding of this phrase, or if it is equivalent to the domestic law test of “by way of business.”
The Brexit Freedoms Bill and the FSM Bill are currently progressing through Parliament. The Brexit Freedoms Bill will revoke or assimilate retained direct EU law and EU-derived subordinate legislation into the U.K. legal system from the end of 2023. It will also abolish from U.K. law the general principles of EU law, including the principle of EU supremacy (save for the power of HM Treasury, up until 23 June 2026, to make regulations to the contrary for specified instruments). The Brexit Freedoms Bill employs a “negative” approach to revoking retained EU law, i.e., that all direct retained EU law and EU-derived secondary legislation shall be revoked by the end of 2023 unless “saved” by HM Treasury producing a regulation to this effect.
In contrast, on a date to be appointed, the FSM Bill revokes only the laws it sets out in its Schedule 1. The intention is for each revoked instrument or item of legislation to be reviewed, revised (where applicable) and ultimately restated into U.K. law. The primary legislation listed in Schedule 1 features a few specified sections of FSMA to be revoked. However, none of these include the MiFID override or related provisions. Some subordinate EU-based financial services legislation may however be revoked, including the “MiFIR Regulations” and the “RAO Amendment Order.” Any amendments that such revoked legislation (prior to being revoked) made to other legislation, such as the RAO, will however remain valid and effective. In addition, the FSM Bill also makes targeted modifications to retained EU law during the “transitional period” (which refers to, in relation to any legislation, the period ending with the revocation of that legislation). The RAO, as an original U.K. statutory instrument, is not specifically listed in Schedule 1. However, it may fall within scope under the catch-all provision in Part 5 of Schedule 1. This creates some uncertainty. If the RAO is outside the ambit of the FSM Bill, then the MiFID override in the RAO may still be subject to revocation under the Brexit Freedoms Bill since it could be “EU-derived subordinate legislation.” Yet, regardless of the position under either Bill, the MiFID override in Article 4(4) RAO could potentially remain in place, as well as the RAO exclusions themselves and the MiFID exemptions (since the latter are onshored into U.K. law through Part 1, Schedule 3 of the RAO).
To ensure continuity and certainty, retained EU law subject to the FSM Bill will only be revoked once the regulators have drafted and consulted on the corresponding new rules. It is expected that the areas of financial services legislation to be prioritized for review will be communicated in due course. Following revocation and restatement, provisions such as the MiFID override will no longer be referred to as “retained EU law,” but instead “assimilated law” in which EU principles do not apply and, subject to HM Treasury making any contrary regulations, EU law will no longer have supremacy over the U.K. provisions. By this route, the whole of MiFID II could remain on the U.K. statute book, without the status of retained EU law, by the back door of the MiFID override.
The inherited legislation for the MiFID override is not set out all in one place. The override bakes in EU terminology and requires that two potentially conflicting documents—an inherited EU one, and a U.K. one—must be read together to understand critical U.K. legal provisions. The MiFID override represents a failure of plain English drafting, which failure can be directly linked to the LCF scandal and related taxpayer bail-out. The MiFID override also sits most uncomfortably with the principles of the Brexit Freedoms Bill. If the U.K. is to obtain any benefits of exiting the EU, then a “better regulation” agenda is one that clearly has potential. The U.K. has a one-off opportunity to enact clearer and more targeted laws, on U.K. methods, without lowering our standards, based on traditionally superior Parliamentary drafting conventions and applying common law interpretations.
It is now time for the MiFID override to be abolished and for a consolidated plain English RAO to be established, clearly setting out which financial activities are regulated, and which exemptions apply.
 The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, SI 544/2001.
 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC.
 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU.
 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012.
 LCF sold its mini-bonds to 11,600 investors, who invested a total value in excess of £237 million. LCF went into administration on 30 January 2019.
 These regulated investment activities are implemented into U.K. law by virtue of Article 14 RAO, “dealing in investments in principal,” and Article 64 RAO, “agreeing” to deal in investments as principal. The Claimants presented the argument that, inter alia, notwithstanding their supposed “non-transferable” label, the contended mini-bonds were in fact referable to classes of securities and therefore constituted dealing in transferable securities. The MiFID override would consequently be engaged, with the effect of disapplying the otherwise applicable exclusion under Article 18 RAO, which excludes from the scope of regulated activity “the issue by any person of his own debentures.” As a result, argued the Claimants, LCF should have been prevented from relying on the Article 18 exclusion and instead found to be engaging in the regulated activity of “dealing in investments as principal” with effect from the date that the MiFID override came into force, 3 January 2018. The court ultimately decided on the facts that these bonds were not transferable securities for regulatory purposes.
 Joined Cases C-688/15 and C-109/16 Agnieska EU:C:2018:209.
 Compensation (London Capital & Finance plc and Fraud Compensation Fund) Act 2021.
 HM Treasury, ‘Regulation of non-transferable debt securities (mini-bonds): Consultation response’ (March 2022).
 Regulation 2(1), Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017/701, as amended by Regulation 7(1)(r) of the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018, effective on IP completion day.
 The FCA’s view is that “professional basis” depends on the individual circumstances, including “the existence or otherwise of a commercial element and the scale of the relevant activity.” FCA Handbook, PERG 13.2, Question 7.
 The Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017, SI 2017/701.
 The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2017, SI 2017/488.
 Part 5 of Schedule 1 of the FSM Bill provides for EU-derived legislation not within Parts 1 to 3 relating to financial services or markets to be in scope of the Bill, including subordinate legislation that “contains provision for the purpose of implementing, or otherwise in relation to, an EU directive or any other obligation that was created or arose by or under the EU Treaties before IP completion day.”
 The revocation clause of the Brexit Freedoms Bill does not apply to legislation included in Schedule 1 of the FSM Bill (section 22(5)).
 Barnabas Reynolds, Rules for the Regulators – Regulating Financial Services After Brexit (Politeia, June 2022); Barnabas Reynolds, Restoring UK Law - Freeing the UK’s Global Financial Market (Politeia, February 2021).