Planning to Open a Security Token Exchange in Europe?
Security token market is gaining more and more traction. In order to develop a functional security token industry in Europe, it’s vital to have liquidity and secondary trading platforms. Below, we’re going to give an overview of legal requirements if you’d like to open a trading platform for the security tokens. In order to build a trading platform for security tokens, you need to obtain the MTF license. MTF is a specific type of Investment Firm. Multilateral Trading Facility (MTF) is a multilateral system operated by an investment firm or a market operator, which brings together multiple third party buying and selling interests in financial instruments. These are basically alternative trading platforms to exchanges. The MTF concept is similar to the Alternative Trading Systems (ATS) widely developed in the United States.
Below, we’ll bring out some requirements on a high-level for such Investment Firms. The requirements are not comprehensive, and to apply for the MTF license please consult with a lawyer. The requirements are addressed to all Investment Firms under MiFID II. MiFID II is a legislative framework instituted by the European Union to regulate financial markets in the block. We’ve adjusted, simplified and updated a research carried out by the World Bank on Investment Firm requirements.
Please read our post on the licensing documents and process from here.
Let’s dig in and read about some of the requirements that MTF Investment Firms have to comply with.
Organizational requirements.
1. An investment firm shall establish adequate policies and procedures sufficient to ensure compliance of the firm including its managers, employees and tied agents.
2. An investment firm shall maintain and operate effective organizational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest from adversely affecting the interests of its clients.
3. An investment firm shall take reasonable steps to ensure continuity and regularity in the performance of investment services and activities. To this end the investment firm shall employ appropriate and proportionate systems, resources and procedures.
4. An investment firm shall ensure, when relying on a third party for the performance of operational functions which are critical for the provision of continuous and satisfactory service to clients and the performance of investment activities on a continuous and satisfactory basis, that it takes reasonable steps to avoid undue additional operational risk. Outsourcing of important operational functions may not be undertaken in such a way as to impair materially the quality of its internal control and the ability of the
supervisor to monitor the firm’s compliance with all obligations. An investment firm shall have sound administrative and accounting procedures, internal control mechanisms, effective procedures for risk assessment, and effective control and safeguard arrangements for information processing systems.
5. 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, and in particular to ascertain that the investment firm has complied with all obligations with respect to clients or potential clients.
6. An investment 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.
7. 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.
Implementing Measures
1.Member States require investment firms to comply with the following
requirements:
a) to establish, implement and maintain decision-making procedures and an organisational structure which clearly and in documented manner specifies reporting lines and allocates functions and responsibilities;
b) to ensure that their relevant persons are aware of the procedures which must be followed for the proper discharge of their responsibilities;
c) to establish, implement and maintain adequate internal control mechanisms designed to secure compliance with decisions and
procedures at all levels of the investment firm;
d) to employ personnel with the skills, knowledge and expertise necessary for the discharge of the responsibilities allocated to them;
e) to establish, implement and maintain effective internal reporting and communication of information at all relevant levels of the investment firm;
f) to maintain adequate and orderly records of their business and internal organization;
g) to ensure that the performance of multiple functions by their relevant persons does not and is not likely to prevent those persons from discharging any particular function soundly, honestly, and professionally.
Member States shall ensure that, for those purposes, investment firms take into account the nature, scale and complexity of the business of the firm, and the nature and range of investment services and activities undertaken in the course
of that business.
2. An investment firm shall establish, implement and maintain systems and procedures that are adequate to safeguard the security, integrity and confidentiality of information, taking into account the nature of the information in question.
3. An investment firm shall establish, implement and maintain an adequate business continuity policy aimed at ensuring, in the case of an interruption to their systems and procedures, the preservation of essential data and functions, and the maintenance of investment services and activities, or, where that is not possible, the timely recovery of such data and functions and the timely resumption of their investment services and activities.
4. An investment firm shall establish, implement and maintain accounting policies and procedures that enable them, at the request of the competent authority, to deliver in a timely manner to the competent authority financial reports which reflect a true and fair view of their financial position and which comply with all applicable accounting standards and rules.
5. An investment firm shall monitor and, on a regular basis, to evaluate the adequacy and effectiveness of their systems, internal control mechanisms and arrangements established.
Compliance
1. An investment firm shall establish, implement and maintain adequate policies and procedures designed to detect any risk of failure by the firm, as well as the associated risks, and put in place adequate measures and procedures designed to minimize such risk.
2. An investment firm shall establish and maintain a permanent and effective compliance function which operates independently and which has the following responsibilities:
h) to monitor and, on a regular basis, to assess the adequacy and effectiveness of the measures and procedures put in place, and the actions taken to address any deficiencies in the firm’s compliance with its obligations;
i) to advise and assist the relevant persons responsible for carrying out investment services and activities to comply with the firm’s obligations as required by the regulations.
3. In order to enable the compliance function to discharge its responsibilities properly and independently, an investment firm shall ensure that the following conditions are satisfied: the compliance function must have the necessary authority, resources, expertise and access to all relevant information;
a) a compliance officer must be appointed and must be responsible for the compliance function.
b) the relevant persons involved in the compliance function must not be involved in the performance of services or activities they monitor;
c) the method of determining the remuneration of the relevant persons involved in the compliance function must not compromise their objectivity and must not be likely to do so.
Risk management
1. An investment firm shall take the following actions:
a) to establish, implement and maintain adequate risk management policies and procedures which identify the risks relating to the firm’s activities, processes and systems, and where appropriate, set the level of risk tolerated by the firm;
b) to adopt effective arrangements, processes and mechanisms to manage the risks relating to the firm’s activities, processes and
systems, in light of that level of risk tolerance;
c) to monitor the following:
i) the adequacy and effectiveness of the investment firm’s risk management policies and procedures;
ii) the level of compliance by the investment firm and its relevant persons with the arrangements, processes and mechanisms adopted in accordance with point (b);
the adequacy and effectiveness of measures taken to address any deficiencies in those policies, procedures, arrangements, processes and mechanisms, including failures by the relevant persons to comply with such arrangements, processes and mechanisms or follow such policies and procedures.
2. An investment firm shall, where appropriate and proportionate in view of the nature, scale and complexity of their business and the nature and range of the investment services and activities undertaken in the course of that business, to establish and maintain a risk management function that operates independently and carries out the following tasks:
a) implementation of the policy and procedures referred to in paragraph 1;
b) provision of reports and advice to senior management in accordance with the regulations. Where an investment firm is not required under the first sub-paragraph to establish and maintain a risk management function that functions independently, it must
nevertheless be able to demonstrate that the policies and procedures which it is has adopted in accordance with paragraph 1 satisfy the requirements of that paragraph and are consistently effective.
Internal audit
An investment firm shall, where appropriate and proportionate in view of the nature, scale and complexity of their business and the nature and range of investment services and activities undertaken in the course of that business, to establish and maintain an internal audit function which is separate and independent from the other functions and activities of the investment firm and which has the following responsibilities:
a) to establish, implement and maintain an audit plan to examine and evaluate the adequacy and effectiveness of the investment firm’s systems, internal control mechanisms and arrangements;
b) to issue recommendations based on the result of work carried out in accordance with point (a);
c) to verify compliance with those recommendations;
d) to report in relation to internal audit matters in accordance with the law
Responsibility of senior management
1. An investment firm shall, when allocating functions internally, to ensure that senior management, and, where appropriate, the supervisory function, are responsible for ensuring that the firm complies with its obligations under MiFID II regulations. In particular, senior management and, where appropriate, the supervisory function shall be required to assess and periodically to review the effectiveness of the policies, arrangements and procedures put in place to comply with the obligations and to take appropriate measures to address any deficiencies.
2. An investment firm shall ensure that their senior management receive on a frequent basis, and at least annually, written reports on the matters covered in previous paragraphs and the appropriate remedial measures have been taken in the event of any deficiencies.
3. An investment firm shall ensure that the supervisory function, if any, receives on a regular basis written reports on the same matters.
4. For the purposes of this subpara, “supervisory function” means the function within an investment firm responsible for the supervision of its senior management.
Complaints handling
An investment firm shall establish, implement and maintain effective and transparent procedures for the reasonable and prompt handling of complaints received from retail clients or potential retail clients, and to keep a record of each complaint and the measures taken for its resolution.
Still reading? Impressive. Going forward…
Outsourcing
Meaning of critical and important operational functions
1. For the purposes of this paragraph, an operational function shall be regarded as critical or important if a defect or failure in its performance would materially impair the continuing compliance of an investment firm with the conditions and obligations of its authorization or its other obligations under the law, or its financial performance, or the soundness or the continuity of its investment services and activities.
2. Without prejudice to the status of any other function, the following functions shall not be considered as critical or important for the purposes of the previous point:
a) the provision to the firm of advisory services, and other services which do not form part of the investment business of the firm, including the provision of legal advice to the firm, the training of personnel of the firm, billing services and the security of the firm’s premises and personnel;
b) the purchase of standardised services, including market information services and the provision of price feeds.
Conditions for outsourcing critical or important operational functions or investment
services or activities
1. When investment firms outsource critical or important operational functions or any investment services or activities, the firms remain fully responsible for discharging all of their obligations under the law and comply, in particular, with the following conditions:
a) the outsourcing must not result in the delegation by senior management of its responsibility;
b) the relationship and obligations of the investment firm towards its clients must not be altered;
c) the conditions with which the investment firm must comply must not be undermined;
d) none of the other conditions subject to which the firm’s authorisation was granted must be removed or modified.
2. Investment firms shall exercise due skill, care and diligence when entering into, managing or terminating any arrangement for the outsourcing to a service provider of critical or important operational functions or of any investment services or activities. Investment firms shall in particular take the necessary steps to ensure that the following conditions are satisfied:
a) the service provider must have the ability, capacity, and any authorisation required by law to perform the outsourced functions, services or activities reliably and professionally;
b) the service provider must carry out the outsourced services effectively, and to this end the firm must establish methods for assessing the standard of performance of the service provider;
c) the service provider must properly supervise the carrying out of the outsourced functions, and adequately manage the risks associated with the outsourcing;
d) appropriate action must be taken if it appears that the service provider may not be carrying out the functions effectively and in compliance with applicable laws and regulatory requirements;
e) the investment firm must retain the necessary expertise to supervise the outsourced functions effectively and manage the risks associated with the outsourcing and must supervise those functions and manage those risks;
f) the service provider must disclose to the investment firm any development that may have a material impact on its ability to carry out the outsourced functions effectively and in compliance with applicable laws and regulatory requirements;
g) the investment firm must be able to terminate the arrangement for outsourcing where necessary without detriment to the continuity and quality of its provision of services to clients;
h) the service provider must cooperate with the competent authorities of the investment firm in connection with the outsourced activities; the investment firm, its auditors and the relevant competent authorities must have effective access to data related to the outsourced activities, as well as to the business premises of the service provider; and the competent authorities must be able to exercise those rights of access;
j) the service provider must protect any confidential information relating to the investment firm and its clients;
k) the investment firm and the service provider must establish, implement and maintain a contingency plan for disaster recovery and periodic testing of backup facilities, where that is necessary having regard to the function, service or activity that has been outsourced.
3. The respective rights and obligations of the investment firms and of the service provider to be clearly allocated and set out in a written agreement.
4.Where the investment firm and the service provider are members of the same group, the investment firm may, for the purposes of complying with the law, take into account the extent to which the firm controls the service provider or has the ability to influence its actions.
5.Investment firms shall make available on request to the competent authority all information necessary to enable the authority to supervise the compliance of the performance of the outsourced activities.
Safeguarding of client assets
Safeguarding of client financial instruments and funds
1. For the purposes of safeguarding clients’ rights in relation to financial instruments and funds belonging to them, investment firms comply with the following requirements:
a) they must keep such records and accounts as are necessary to enable them at any time and without delay to distinguish assets held for one client from assets held for any other client, and from their own assets;
b) they must maintain their records and accounts in a way that ensures their accuracy, and in particular their correspondence to the financial instruments and funds held for clients;
c) they must conduct, on a regular basis, reconciliations between their internal accounts and records and those of any third parties by whom those assets are held;
d) they must take the necessary steps to ensure that any client financial instruments deposited with a third party, are identifiable separately from the financial instruments belonging to the investment firm and from financial instruments belonging to that third party, by means of differently titled accounts on the books of the third party or other equivalent measures that achieve the same level of protection;
e) they must take the necessary steps to ensure that client funds deposited in a central bank, a credit
institution or a bank authorised in a third country or a qualifying money market fund are held in an account or accounts identified separately from any accounts used to hold funds belonging to the investment firm;
f) they must introduce adequate organisational arrangements to minimize the risk of the loss or diminution of client assets, or of rights in connection with those assets, as a result of misuse of the assets, fraud, poor administration, inadequate record-keeping or negligence.
2. If, for reasons of the applicable law, including in particular the law relating to property or insolvency, the arrangements made by investment firms in compliance with paragraph 1 to safeguard clients’ rights are not sufficient to satisfy the requirements set forth by applicable law, Member States shall prescribe the measures that investment firms must take in order to comply with those obligations.
3. If the applicable law of the jurisdiction in which the client funds or financial instruments are held prevents investment firms from complying with points (d) or (e) of paragraph 1, Member States shall prescribe requirements which have an equivalent effect in terms of safeguarding clients’ rights.
Depositing client financial instruments
1. Investment firms shall deposit financial instruments held by them on behalf of their clients into an account or accounts opened with a third party provided that the firms exercise all due skill, care and diligence in the selection, appointment and periodic review of the third party and of the arrangements for the holding and safekeeping of those financial instruments. In particular, investment firms shall take into account the expertise and market reputation of the third party as well as any legal requirements or market practices related to the holding of those financial instruments that could adversely affect clients’ rights.
2.Investment firms shall ensure that, if the safekeeping of financial instruments for the account of another person is subject to specific regulation and supervision in a jurisdiction where an investment firm proposes to deposit client financial instruments with a third party, the investment firm does not deposit those financial instruments in that jurisdiction with a third party which is not subject to such regulation and supervision.
Investment firms shall not deposit financial instruments held on behalf of clients with a third party in a third country that
does not regulate the holding and safekeeping of financial instruments for the account of another person unless one of the following conditions is met:
a) the nature of the financial instruments or of the investment services connected with those instruments requires them to be deposited with a third party in that third country;
b) where the financial instruments are held on behalf of a professional client, that client requests the firm in writing to deposit them with a third party in that third country.
Depositing client funds
1. Investment firms, on receiving any client funds, shall promptly place those funds into one or more accounts opened with any of
the following:
a) a central bank;
b) a credit institution authorised in accordance with Directive 2000/12/EC;
c) a bank authorised in a third country;
d) a qualifying money market fund.
3. Where investment firms do not deposit client funds with a central bank, they exercise all due skill, care and diligence in the
selection, appointment and periodic review of the credit institution, bank or money market fund where the funds are placed and the arrangements for the holding of those funds. Investment firms have take into account the expertise and market reputation of such institutions or money market funds with a view to ensuring the protection of clients’ rights, as well as any legal or regulatory requirements or market practices related to the holding of client funds that could adversely affect clients’ rights.
Clients have the right to oppose the placement of their funds in a qualifying money market fund.
Use of client financial instruments
1. Investment firms are not allowed to enter into arrangements for securities financing transactions in respect of financial instruments held by them on behalf of a client, or otherwise use such financial instruments for their own account or the account of another client of the firm, unless the following conditions are met:
a) the client must have given his prior express consent to the use of the
instruments on specified terms, as evidenced, in the case of a retail
client, by his signature or equivalent alternative mechanism;
b) the use of that client’s financial instruments must be restricted to the
specified terms to which the client consents.
Investment firms are not allowed to enter into arrangements for securities financing transactions in respect of financial instruments which are held on behalf of a client in an omnibus account maintained by a third party, or otherwise use financial instruments held in such an account for their own account or for the account of another client unless, in addition to the conditions set out in previous chapter, at least one of the following conditions is met:
a) each client whose financial instruments are held together in an omnibus account must have given prior express consent in accordance with point (a) of the previous paragraph;
b) the investment firm must have in place systems and controls which ensure that only financial instruments belonging to clients who have given prior express consent in accordance with point (a) of previous paragraph
are so used.
The records of the investment firm shall include details of the client on whose instructions the use of the financial instruments has been effected, as well as the number of financial instruments used belonging to each client who has given his consent, so as to enable the correct allocation of any loss.
Final notes
There are more requirements in regards of external auditors, conflict of interest, investment research and so forth. The idea of this blog post is to highlight what it takes in regards to regulations to operate a licensed investment firm (MTF) in Europe. That said, as the barrier of entry is high, there’s an enormous potential for companies who’re capable of obtaining the license and operating such company.
