MIFIDPRU 4.10 K-COH requirement

1The definition of COH includes orders that a firm handles when carrying on either of the following types of MiFID business:

1. (1)

   reception and transmission of client orders; and

2. (2)

   execution of orders on behalf of a client.

1MIFIDPRU 4.10.6G to MIFIDPRU 4.10.17G contain further guidance on whether particular arrangements are included within the measurement of COH.

1Where a firm executes an order in its own name (irrespective of whether the order is ultimately for the benefit of a client), the order is included within the firm’s measurement of its DTF under MIFIDPRU 4.15 (K-DTF requirement) and not within its measurement of COH under this section.

1Recital 44 of MiFID describes transactions that result from a firm bringing together 2 or more investors (such as introducing an issuer to a potential source of funding), but where the firm does not otherwise interpose itself within the chain of execution of any resulting order. In practice, this is most likely to be relevant in the context of corporate finance business or private equity business. A firm may exclude these transactions from its measurement of COH provided that its role does not go beyond this “extended” definition of reception and transmission. This is further described in the guidance in PERG 13.3 (Investment Services and Activities).

1A firm that trades in a matched principal capacity will be placing orders in its own name. These orders must therefore be included in the measurement of the firm’s DTF and are not included in the calculation of COH.

1. (1)

   1The FCA understands that activities that are described as involving “name give-up” may take different forms.

2. (2)

   In certain cases, a firm may distribute indications of interest that indicate a willingness to enter into a transaction, but do not have fixed terms. The firm may then pass the names of the counterparties to each other following a match to allow them to facilitate the trade. These indications of interest and name-passing are not included within the measurement of COH. However, this does not mean that every transaction which begins with an indication of interest is outside the scope of COH. Where a firm is subsequently instructed to transmit an order on firm terms, or to execute an order, that transaction will be within scope of COH, even if the order results from a process that began with an initial indication of interest.

3. (3)

   In some circumstances, a firm may disseminate orders on firm terms that result in a transaction as soon as they are confirmed by the recipient, following which the firm will disclose the name of the relevant counterparty. This activity is included within the measurement of COH because it involves reception and transmission of an order on firm terms.

1. (1)

   1A firm may facilitate trading by its clients on exchanges. Once a transaction has been executed, the relevant trade is then given up to the client’s clearing firm.

2. (2)

   A firm should consider the exact capacity in which it is acting, and whether it incurs any liability as principal, when determining whether orders resulting from exchange give-up activities are included within the measurement of COH.

3. (3)

   If the firm enters into the transaction in its own name and therefore incurs principal liability, even for a short period, in relation to the trade before it is given up, the order should be included within the firm’s measurement of DTF and not within its measurement of COH.

4. (4)

   If the firm does not incur liability as principal and merely acts as agent in the name of a third party in relation to the trade, the order should be included within the firm’s measurement of COH.

1. (1)

   1A firm may be involved in negotiating a bilateral trade in relation to an exchange-traded instrument between counterparties that takes place off-exchange because the size of the trade exceeds certain specified levels. In some cases, the exchange may provide communications functionality to facilitate the block trades, but the trades are not executed on the exchange’s public market.

2. (2)

   A firm must determine the capacity in which the firm is acting in relation to the block trade to determine if the value of the trade should be included in the firm’s measurement of COH.

3. (3)

   If the firm enters into the block trade in its own name and the trade is then given up to a client, the firm should include the value of that trade in its measurement of DTF.

4. (4)

   If the firm executes the block trade as agent by committing the client to the terms of the trade, the firm should include the value of that trade in its measurement of COH.

5. (5)

   If the firm receives firm terms of the block trade from the client and transmits the terms to the counterparty in order for the counterparty to confirm the terms to create a binding transaction, the firm should include the value of that trade in its measurement of COH.

1A firm may be a member of an exchange and may provide functionality whereby trades can be executed and booked directly into the account of the relevant client. In this case, the FCA considers that the trades should be included in the firm’s measurement of COH, as the firm is still being used to execute the relevant trade.

1. (1)

   1A firm which is operating a multilateral trading facility or operating an organised trading facility does not need to include any orders it handles solely in that capacity in its measurement of COH. However, it should consider as part of its ICARA process whether that activity gives rise to the risk of material potential harm which may require it to hold additional own funds or liquid assets under MIFIDPRU 7.

2. (2)

   However, if the operator of an organised trading facility is engaging in matched principal trading, as permitted by MAR 5A.3.5R, any matched principal trades are included in its measurement of DTF under MIFIDPRU 4.15 (K-DTF requirement).

1A firm that executes client orders on a multilateral trading facility or an organised trading facility when the firm is not acting in the capacity of the trading venue operator must include the orders in its measurement of COH (unless the firm executes the orders in its own name, in which case it must include the orders in its measurement of DTF).

1In certain circumstances, the same firm may both act as the operator of a multilateral trading facility or an organised trading facility and also submit an order on that trading venue on behalf of a client. In this case, although the firm is not required to measure COH in relation to its role as the operator of the trading venue, it must still measure COH (or DTF if it is possible to enter into transactions in its own name on the trading venue and it is executing in that capacity) in relation to the order that it executes for the client.

1. (1)

   1The effect of MIFIDPRU 4.10.4R(4) is that where a firm receives a client order but that order is not ultimately executed, it does not have to include the value of that order in its measurement of COH. However, as part of its ICARA process, a firm should consider whether the fact that an order has not been executed gives rise to any material risks to the firm or to its clients. This may depend on the reasons why the client order has not been executed.

2. (2)

   If, for example, the order was not executed because market conditions did not allow the firm (or another entity to whom the order was ultimately transmitted) to achieve an appropriate outcome for the client, this may be consistent with the firm’s contractual and regulatory duties. In that case, this may not give rise to any additional material risks.

3. (3)

   However, if the firm failed to transmit or execute an order because of an oversight or an internal systems failure, this may indicate that the firm has been failing in its duties to its client or in its regulatory obligations. Alternatively, the firm may have successfully transmitted an order, but failed to select an appropriate entity to receive and execute the order, and therefore may have failed to comply with its obligations to act in the best interests of the client when transmitting the order. In this case, the firm should consider as part of its ICARA process whether the failures may give rise to material risks and how these risks should be addressed.

1. (1)

   1Although failure to achieve the execution of an individual order does not necessarily indicate potential material harms, a series or pattern of failures may be evidence of potential material harms.

2. (2)

   A firm’s analysis under its ICARA process is separate from the application of any individual regulatory or other legal duties owed to an individual client. Therefore, while a firm may conclude that an isolated oversight in relation to a client order does not give rise to the risk of material harm under the ICARA process, this does not affect any obligations that the firm owes to the client.

1. (1)

   1Under the general approach in MIFIDPRU 4.10.20R(2), a firm determines the gross value of an order by multiplying the market price of the instrument by the quantity of the instrument being purchased or sold.

2. (2)

   However, MIFIDPRU 4.10.20R(5) permits (but does not require) a firm to calculate the value of an order by reference to the consideration paid or received by the client for the instruments (i.e. net of transaction costs), provided that the transaction costs are included in the gross value of the order and are not paid by the client to the firm separately.

3. (3)

   For example, Firm A executes an order for a client to buy 100 shares. The total cost of the order, including transaction costs, is £100. The client receives shares worth £88, after the firm uses £12 to cover transaction costs. Under the standard approach in MIFIDPRU 4.10.20R(2), the firm may record the value of the order in its COH as £100 (i.e. the gross cost of the order). The firm may, for example, choose this approach for reasons of simplicity and administrative convenience.

4. (4)

   Alternatively, in the example above, the firm may apply the approach under MIFIDPRU 4.10.20R(5) to record the value of the order in its COH as £88 (i.e. net of transaction costs paid by the client in relation to the transaction).

5. (5)

   However, a firm cannot rely on MIFIDPRU 4.10.20R(5) to reduce the value of an order by transaction costs that are paid separately by the client to the firm. For example, Firm B executes an order for a client to buy 100 shares. The total cost of the order is £100. The client additionally pays £12 to Firm B for transaction costs. In this case, the firm must record the net value of the order under MIFIDPRU 4.10.20R(5) in its COH as £100 (and not £88), as the transaction costs have been paid separately.

6. (6)

   The effect of MIFIDPRU 4.10.19R(2) is that when measuring the value of COH at the end of each business day, a firm must apply the relevant conversion rate on that date to any amounts in foreign currencies forming part of the COH attributable to that business day. The COH for each preceding business day should continue to be measured by reference to the conversion2 rate that was applicable on that preceding day.

7. (7)

   For the purposes of MIFIDPRU 4.10.19R(3), where a firm is carrying out a conversion that involves sterling, the FCA considers that an example of an appropriate market rate is the relevant daily spot exchange rate against sterling published by the Bank of England.

1For cash trades relating to exchange-traded options, the amount paid or received under MIFIDPRU 4.10.20R(2) is the premium paid for the option.

1. (1)

   1The effect of MIFIDPRU 4.10.23R is to permit a firm that receives and transmits orders that are cash trades to determine the COH attributable to the orders using an alternative approach. A firm may either:

   1. (a)

      apply the standard approach in MIFIDPRU 4.10.20R(2) and use the price at which the relevant order was ultimately executed, once this has been confirmed by the entity that executes the order; or

   2. (b)

      apply the alternative approach in MIFIDPRU 4.10.23R and use a deemed price that is determined by reference to the limit price of the order or, if there is no limit price, the end-of-day market price at the time at which the order is transmitted.

2. (2)

   However, a firm must not use the alternative approach in MIFIDPRU 4.10.23R for regulatory arbitrage to reduce its K-COH requirement. To prevent this, a firm may only apply the alternative approach either:

   1. (a)

      in relation to all cash trades that the firm receives and transmits; or

   2. (b)

      in relation to cash trades that the firm receives and transmits where the firm does not receive timely information from the broker about the terms on which the order was executed. In this case, the firm must apply the standard approach in MIFIDPRU 4.10.20R(2) in relation to all other cash trades. This is designed to ensure that the firm can record daily information for COH in circumstances where information about the ultimate execution of the order is otherwise missing or significantly delayed.

1MIFIDPRU 4.10.27G to MIFIDPRU 4.10.32G and MIFIDPRU 4 Annex 12G explain the circumstances in which a firm must include orders that arise in connection with portfolio management or investment advice in, or may exclude orders from, its measurement of COH.

1. (1)

   1The basic definition of COH includes:

   1. (a)

      orders that the firm executes when providing execution services for a client; and

   2. (b)

      orders that the firm has received from a client and transmitted to another entity for execution.

2. (2)

   The rules and guidance in MIFIDPRU 4.10.28R to 4.10.32G explain how this definition applies in particular scenarios and certain exclusions or modifications that may apply.

1The exclusions in MIFIDPRU 4.7.9R, MIFIDPRU 4.10.28R and MIFIDPRU 4.10.29R(3) may result in a firm that carries on delegated portfolio management having no K-AUM requirement or K-COH requirement in relation to all or part of a delegated portfolio. Where one or more exclusions apply, a firm should still assess as part of its ICARA process whether the activity of providing delegated portfolio management may give rise to potential material harms that may need to be covered by additional financial resources. Firms should refer to the rules and guidance in MIFIDPRU 7 for additional information on the ICARA process.

1. (1)

   1MIFIDPRU 4.10.29R does not apply where a financial entity (“A”) carries on portfolio management in relation to a portfolio and a MIFIDPRU investment firm (“B”) provides investment advice of an ongoing nature to A in relation to that portfolio. In this situation, A has not delegated portfolio management to B. Instead, A provides the service of portfolio management to A’s client, and B provides the separate service of investment advice to A. If A is a MIFIDPRU investment firm, A will include the value of the relevant portfolio when calculating its K-AUM requirement. B will calculate its own K-AUM requirement in relation to the same portfolio.

2. (2)

   Although MIFIDPRU 4.10.29R does not apply in this scenario, B may benefit from the separate exclusion in MIFIDPRU 4.10.28R(2) and therefore would not be required to include any orders that result from its ongoing investment advice within B’s calculation of COH, because B will calculate a K-AUM requirement in relation to the relevant portfolio.

1When measuring COH for the purposes of MIFIDPRU 4.10.19R, a firm must include:

1. (1)

   an order that the firm executes, or receives and transmits, as a result of providing investment advice (other than investment advice of an ongoing nature, if the firm calculates a K-AUM requirement in relation to the advice) to a client and subsequently receiving instructions from the client to transmit or execute the relevant order; and

2. (2)

   an order that a firm receives from another firm (“X”), where:

   1. (a)

      X provides investment advice (including investment advice of an ongoing nature) to a client;

   2. (b)

      as a result of the advice in (a), the client instructs X to place an order with the firm; and

   3. (c)

      the firm executes or receives and transmits the order received from X.