PERG 13.5 Exemptions from the definition of investment firm

Introduction

Q35. Where do we find a list of exemptions from the definition of investment firm?

The exemptions can be found in Part 1 of Schedule 3 to the  Regulated Activities Order and Regulation 8 of the MiFI Regulations. They broadly correspond to the exemptions in articles 2 and 3 of MiFID.

Q35A. Can you give me a complete list of exemptions?

Q35B. How are the Schedule 3 exemptions relevant?
A person is not an investment firm as defined in the Regulated Activities Order or the Act and is not a MiFID investment firm or a MIFIDPRU investment firm if it has an exemption in Part 1 of Schedule 3 to the Regulated Activities Order. However, a person with such an exemption can still be an investment firm as defined in the Glossary. Please see the table in the answer to Q-1 (Are all the different types of investment firm mentioned at the start of this chapter basically the same?) for more details.
Q35C. Broadly speaking, who do the Schedule 3 exemptions cover?
They are likely to be relevant to insurers, group treasurers, professional firms to which Part XX of the Act applies, many authorised professional firms, professional investors who invest only for themselves, pension schemes, depositaries and operators of collective investment schemes or other collective investment undertakings (such as investment trusts), journalists, and commodity producers and traders. 
Insurance

Q36. We are an insurer. Are we exempt?

• Yes. More specifically, you are exempted from the definition of investment firm if you fall into one of the following categories:
  ● The Society.
  ● A firm with permission for:
  o effecting contracts of insurance or carrying out contracts of insurance);
  o insurance risk transformation; or
  o managing the underwriting capacity of a Lloyd’s syndicate as a managing agent at Lloyd’s.
  The exemption is available when carrying on those activities and any other activities permitted by rules made by the FCA or the PRA.

Intra-group activities

Q37. We are a non-financial services group company providing investment services to other companies in the same group. Are we exempt under the group exemption?

Yes, you are exempted from the definition of investment firm if you provide these services exclusively for your parent company, your subsidiaries and those of your parent company. The exemption is narrower than the corresponding exclusion in article 69 of the Regulated Activities Order (groups and joint enterprises) insofar, for example, as it does not apply to investment services supplied to a joint venture participant (see PERG 2.9.10 G).

Q38. We also buy and sell financial instruments for ourselves. Are we still able to use the group exemption?

Yes. As long as your own account dealing does not involve you providing an investment service to non-group entities, you can still rely on the group exemption in respect of the services you provide solely to other group companies.

So far as your own account dealing is concerned, you may be able to rely upon the own account exemption (see Q40) or the commodities exemption (see Q44 to Q45) if you meet the relevant conditions. The ability to combine reliance on the group exemption and the own account and commodities exemptions could be relevant to companies performing group treasury functions.

The answer to Q46 (Is it possible to combine Schedule 3 exemptions?) explains why it is possible to combine exemptions.

Incidental services as part of a professional activity

Q39. We provide investment services as a complement to our main professional activity. Are we exempt?

Yes, you are exempted from the definition of investment firm under paragraph 1(d) in Part 1 of Schedule 3 to the Regulated Activities Order. The exemption is further defined in Part 2 of that Schedule. The exemption is only available if:

• • you provide these services in the course of your professional activity;
• • a close and factual connection exists between your professional activity and the provision of the investment service to the same client, such that the investment service can be regarded as accessory to your main professional activity;
• • the provision of investment services to the clients of your main professional activity does not aim to provide a systematic source of income to you;
• • you do not market or otherwise promote your ability to provide investment services, except where these are disclosed to clients as being accessory to your main professional activity; and
• • your professional activity is regulated by legal or regulatory provisions or a code of ethics that do not exclude the provision of investment services.

The exemption is relevant, for example, to firms belonging to designated professional bodies, such as accountants, actuaries and solicitors, to whom Part XX of the Act applies. It could also apply to authorised professional firms which provide investment services in an incidental manner in the course of their professional activity. In our view, the criteria set out in PROF 2.1.14 G in relation to section 327(4) of the Act are also relevant to considering whether a firm can rely on the this Schedule 3 exemption (see further guidance in PROF 2.1.16G).

If an authorised professional firm has the standard requirement on its permission that it “...must not carry on the specified regulated activities otherwise than in an incidental manner in the course of the provision by it of professional services (that is, services which do not consist of regulated activities)”, our assumption is that it is exempt if it complies with this requirement.

If you are an authorised professional firm that does not benefit from the exemption, you may also wish to consider whether you are eligible to be treated as a MiFID optional exemption firm (see Q48 and Q49).

The exemption may also apply to journalists, broadcasters and publishers (where they are subject to regulation or a code of ethics), although in most cases the FCA would not expect these persons to fall within the definition of investment firm (see Q4).
The exemption corresponds to the exemption in article 2.1(c) of MiFID as supplemented by article 4 of the EU MiFID Org Regulation. 

Own account

Q40. We regularly buy and sell financial instruments ourselves but never as a service to third parties. Are there any exemptions which might apply to us?

Yes, you could be exempted from the definition of investment firm under paragraph 1(e) of Part 1 of Schedule 3 to the Regulated Activities Order. However, the exemption does not apply if you:

• • are a market maker (please see Q41 below);
• • are a member of, or a participant in, a UK regulated market or MTF (except that non-financial entities can be members or participants as described in the answer to Q40A);
• • have direct electronic access to a UK trading venue; and in relation to this condition, please note that:  
  o non-financial entities can however have such access, as described in the answer to Q40A; and
  o direct electronic access is defined in paragraph 7 of Schedule 3 to the Regulated Activities Order;
• • apply a high-frequency algorithmic trading technique (see Q41A); or
• • deal on own account when executing client orders.

This exemption does not apply to dealing on own account in commodity derivatives, emission allowances or derivatives thereof (the exemption discussed in the answer to Q44 (Activities in relation to commodity derivatives) is relevant instead).

Article 2(1)(d) of MiFID says that persons exempt under the commodities exemption described in the answer to Q44 are not required to meet the conditions laid down in the MiFID own account exemption corresponding to the own account exemption described in this answer in order to be exempt. In the FCA’s view, that does not mean that you can do business of the type covered by the article 2.1(d) exemption without meeting the exemption conditions described in this answer just because you qualify for the commodities exemption. Recital 22 to MiFID confirms that the two exemptions apply cumulatively. Another reason for this conclusion is that articles 2.1(d) and (j) apply to different asset classes and there does not seem to be any reason apparent from MiFID why exemption under article 2.1(j) should be relevant to the asset classes in article 2.1(d).
This is also the position for the Regulated Activities Order provisions discussed in this chapter: a person may rely on the commodities exemption even if they do not meet the conditions of the own account exemption but qualification for the commodities exemption does not mean that the person is exempt as respects the activities covered by the own account exemption.

See the answer to Q46 for more information about combining this exemption with other exemptions, particularly the exemption for commodity derivatives business.
The exemption corresponds to the exemption in article 2.1(d) of MiFID. 

Q40A. When can a non-financial entity have direct electronic access to or be a participant in a trading venue without losing the benefit of the own account exemption described in the answer to Q40?

The paragraph 1(e) own account exemption can still be available if you are a member of, or a participant in, a regulated market or an MTF or you have direct electronic access to a UK regulated market, MTF or OTF, as long as:

• • you are a non-financial entity; and
• • your transactions are objectively measurable as reducing risks directly relating to your commercial or treasury financing activity, or the commercial or treasury financing activity of your group.

Q40B. What does direct reduction of risk mean in the answer to Q40A?

The second condition described in the answer to Q40A (objectively measurable reduction of risks) is designed to allow a non-financial business to hedge without losing the exemption. The following points are relevant to whether hedging meets this second condition:

• • The exception covers hedging for commercial activities as well as treasury activities. It can therefore cover risks to a change in value of your group’s assets, services, inputs, products, commodities or liabilities.
• • Hedging may cover potential indirect impacts on your business as well as direct ones.
• • A transaction may qualify as risk-reducing taken on its own or in combination with other hedging transactions.
• • A transaction may be treated as risk-reducing even though it is not a perfect hedge. Thus for example your group may use proxy hedging through a closely correlated instrument to cover an exposure, such as an instrument with a different but very close underlying in terms of economic behaviour.
• • If your group uses portfolio or macro hedging, it may not be able to establish a one-to-one link between a specific hedging transaction and a specific risk directly related to the commercial and treasury financing activities being hedged. The risks related to the commercial and treasury financing activities may be complex. For example, the risks may cover several geographic markets, products, time horizons or entities. Nevertheless, macro or portfolio hedging used to hedge a risk in relation to your group’s overall risks may be treated as risk-reducing.
• • Positions do not qualify as risk-reducing solely on the grounds that they form part of a risk-reducing portfolio on an overall basis. In such cases your group’s risk management systems should prevent such transactions from being categorised as risk-reducing.
• • A risk may evolve over time and, in order to adapt to the evolution of the risk, a hedging transaction initially executed for reducing risk may have to be offset through the use of additional hedging transactions. As a result, hedging of a risk may be achieved by a combination of hedging transactions and offsetting transactions that close out earlier hedging transactions that have become unrelated to the risk.
• • If a transaction originally qualifies as risk-reducing it does not stop being treated as risk-reducing just because the risk it hedges has since evolved.
• • A transaction may be treated as risk-reducing if it qualifies as a hedging contract pursuant to International Financial Reporting Standards as they have effect in the United Kingdom.

Q40C. What does non-financial entity mean in the answer to Q40A?

In the FCA’s view, non-financial entity means the same thing as it does in MiFID RTS 21.

Q41. What is a market maker?

It has the same meaning as it does in MiFIR. Therefore, a market maker is “a natural or legal person holding themselves out on the financial markets on a continuous basis as being willing to deal on own account by buying and selling financial instruments against that person’s proprietary capital at prices defined by that person”. In our view anyone who satisfies the definition will be a market maker for the purposes of the exemption, even if they have not entered into the agreement with the regulated market required by MAR 5A.5.3R (Market making agreements).
The definition corresponds to the definition of market maker in article 4.1(7) of MiFID.

Q41A. What is a high-frequency algorithmic trading technique?

This question is included here because it is relevant to the own account exemption described in the answer to Q40 and to the commodities exemption described in the answer to Q44.

The term is defined in paragraphs 8 and 9 of Schedule 3 to the Regulated Activities Order. It is a type of algorithmic trading technique characterised by:

• • infrastructure intended to minimise network and other types of latencies, including at least one of the following facilities for algorithmic order entry:
  • o co-location;
  • o proximity hosting; or
  • o high-speed direct electronic access;
• • system-determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and
• • high message intraday rates which constitute orders, quotes or cancellations.
  For the purposes of MIFID, the term is defined in article 4.1(40) of that Directive.

Employee share and company pension schemes

Q42. Is there an exemption relating to employee share schemes and company pension schemes?

Yes, there is an exemption from the definition of investment firm in paragraph 1(g) of Part 1 of Schedule 3 to the Regulated Activities Order for persons providing investment services consisting exclusively in the administration of employee-participation schemes, for example employee share schemes and company pension schemes. In our view, whilst administration for these purposes could extend to services comprising reception and transmission or execution of orders on behalf of clients or placing, it would not include personal recommendations in relation to, or managing, the assets of employee share schemes or company pension schemes.

This exemption can also be combined with the “group exemption” in paragraph 1(c) of Part 1 of Schedule 3 to the Regulated Activities Order, by virtue of paragraph 1(h) of Part 1 of Schedule 3 to the Regulated Activities Order. See the answer to Q46 for more about combining exemptions.
The corresponding MiFID exemption is in article 2(1)(f) of that Directive.

Collective investment undertakings

Q43. Are we right in thinking that there is an exemption for collective investment undertakings and their operators?

Yes, there is an exemption from the definition of investment firm under paragraph 1(j) of Part 1 of Schedule 3 to the Regulated Activities Order. Generally speaking, collective investment undertakings are specifically exempt, as are their depositaries and managers. For collective investment undertakings within the scope of the UCITS Directive or AIFMD the "manager" corresponds to the management company or AIFM of the undertaking. So far as collective investment schemes which are outside the scope of the UCITS Directive or AIFMD are concerned, the “manager” corresponds, in essence, to the operator of a scheme and not to a person who is managing the assets of the scheme (unless that person is also the operator). In our view, the manager of a collective investment undertaking only benefits from the exemption in respect of any investment services or activities it may carry on in that capacity. To the extent that it also provides investment services or performs investment activities in a different capacity, for example, if it provides investment advice to, or manages the assets of, an individual third party, these services and activities fall outside the scope of this exemption.

In the case of UCITS management companies, some requirements applying to investment firms will apply to those who provide portfolio management services (other than collective portfolio management), investment advice or safekeeping and administration services in relation to units to third parties (see Q6). UK AIFMs will also be subject to some requirements applying to investment firms if they provide investment services or activities for an undertaking other than a fund for which they are appointed as manager or operator. Full-scope UK AIFMs are only able to provide a limited range of such activities (see Q6A).

Exemption for commodity derivatives business

Q44. Who can rely on the exemption in article 2.1(j)?

You may be able to rely on the exemption if:

• • you deal on own account in commodity derivatives or emission allowances or derivatives thereof; or
• • provide other investment services in commodity derivatives or emission allowances or derivatives thereof to clients or suppliers of your main business (or if you are part of a group, the group’s main business); or
• • both.

This exemption can include someone dealing on own account as a market maker.

If you deal on own account when executing client orders you can only meet the exemption condition if the client is a client or supplier of your group’s main business.

The article 2.1(j) exemption does not apply to you if you apply a high frequency algorithmic trading technique.

The exemption will only apply if what you do is ancillary to your main business (see Q45 for more about this).

The exemption is not available if your group’s main business is any of the following (see the answer to Q44A for what main business means in this context):

• • the provision of investment services; or
• • the provision of banking services; or
• • acting as a market maker in relation to commodity derivatives.

Q44A. How do I know whether my main business is investment, banking or commodities?

When considering what is a group’s ‘main business’ for the purpose of the requirement described in the answer to Q44 that your main business should not be investment services, banking services or commodity derivatives market making, in our view various factors are likely to be relevant including turnover, profit, capital employed, numbers of employees and time spent by employees. These factors should then be considered in the round in deciding whether any one operation or business line amounts to your group’s main business.

The determination of your main business as described in this answer is not directly related to the test for deciding whether your commodities business is ancillary to your main business (the ancillary test is referred to in the answer to Q45). This is because the ancillary test compares the size of your commodity derivatives and emission allowance business (see guidance in PERG 13Q32 to 33C and 34A) with the rest of your business but does not specify how to identify what your main business is within your non-commodities business.

Q44B. Are there any formalities for using the commodities exemption?

It is a condition of the commodities exemption described in the answer to Q44 that you upon request, report to the competent authority the basis on which you consider that the requirement for the commodities business to be ancillary is met.

The FCA is the relevant competent authority for these purposes.

If you carry out some occasional commodity derivatives activities you may not need to rely on this exemption. See the answer to Q7 (We provide investment services to our clients. How do we know whether we are an investment firm for the purposes of article 4.1(1) MiFID?) for more on this.

Q44C. Can the commodities exemption be combined with other exemptions?

Yes.

There is no requirement that someone relying on this exemption must not carry on an activity covered by one of the other exemptions. In particular, this exemption can be combined with the exemption for own account transactions described in the answer to Q40 (see recital 22 to MiFID). For more on combining exemptions, please see the answer to Q46.

Q45. What is an ancillary activity for the purposes of the commodities exemption ?

You can find the meaning of ‘ancillary’ for the purposes of the commodities exemption described in the answer to Q44 in MiFID RTS 20 (regulatory technical standards for the criteria to establish when an activity is considered to be ancillary to the main business). You will need to consider whether your commodity derivatives business exceeds the main business threshold as stipulated in article 3 of MiFID RTS 20.

This answer does not give a full summary as the definition is too detailed for PERG.

The test as stipulated by article 3 of MiFID RTS 20 has two calculation methods. If the result of either calculation is that you fall below the specified threshold, you meet the test.

• • One method is based on the size of group trading activities in commodity derivatives and emission allowances.
• • The second measure compares the estimated capital employed for carrying out commodity derivative and emission allowance activities with group capital.

Both methods are based on commodities trading activities in the EEA, as if the UK were still part of the EU.

Q46. Is it possible to combine Schedule 3 exemptions ?

Various other answers to questions in this section deal with certain detailed combinations of exemptions:

• • Q42 deals with employee share schemes and company pension schemes.
• • It is possible to combine the exemption for own account dealing in paragraph 1(e) of Part 1 of Schedule 3 to the Regulated Activities Order and the exemption for commodity derivatives in paragraph 1(k) of Part 1 of that schedule. The answer to Q40 deals with the treatment of the commodity derivatives business of a firm relying on paragraph (1)(e). The answer to Q44C deals with the treatment of business within paragraph (1)(e) for a firm relying on the commodity derivatives exemption in paragraph (1)(k).

In certain cases, a firm will not need to combine exemptions. For example, an insurer relying on the exemption described in the answer to Q36 (We are an insurer. Are we exempt?) does not need to rely on any other exemption.

The answer to this question (Q46) is about whether there is a more general principle that exemptions in paragraph 1 of Part 1 of Schedule 3 to the Regulated Activities Order can be combined.

There is an argument that the drafting of some of the exemptions does not allow this approach. For example, the group exemption (see the answer to Q37) says that the exemption is available to persons providing investment services exclusively for their fellow group members. However, in the FCA’s view, it is generally possible to combine exemptions in paragraph 1 of Part 1 of Schedule 3 to the Regulated Activities Order. There is no clear prohibition in Schedule 3. There is no reason apparent from the Act, the Regulated Activities Order or UK law on markets in financial instrument why combining exemptions should not be allowed. This approach has support from recital 22 to MiFID, which says that exemptions apply cumulatively and that the ability to combine the exemptions in articles 2.1(d) (own account dealing) and 2.1(j) (commodity derivatives) is just an example of this principle.

Where an exemption is only available if the person only carries on a limited range of investment services or activities (as is the case for example with the group exemption) it can be argued that this restriction does not cover a service or activity which is covered by another exemption. This is on the basis that an exempt activity is not an investment service or activity for these purposes. The European Commission’s Q&A’s dealing with MiFID 1 take this approach.

Treating an exempt activity as not being an investment service or activity in this way only applies for the purpose of paragraph 1 of Part 1 of Schedule 3 to the Regulated Activities Order, meaning that it is only relevant for deciding whether a person comes within any of the types of investment firm listed at the start of this chapter.

Q46A. Is it possible to combine the Schedule 3 and the MiFID optional exemptions?

The FCA does not believe that it is generally possible to combine the Schedule 3 exemptions with the MiFID optional exemption. However, in the FCA’s view, a firm that relies on the paragraph 1(j) collective investment undertaking exemption (see Q43) can combine this with the MiFID optional exemption in relation to business falling outside the paragraph 1(j) exemption.

If, however, you are subject to the UCITS Directive or the AIFMD you may be restricted in your ability to carry out all the activities within the MiFID optional exemption.

Locals

Q47. We traded on an investment exchange as a local firm and were exempt from MiFID 1 . Are we exempt under MiFID?

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The MiFID optional exemption

Q48. What is this exemption?

It is an exemption provided for in regulations 6 to 8 of the MiFI Regulations. It applies to a firm whose permission permits it to carry on regulated activities as an exempt investment firm. The answers to Q49 to Q53 explain the exemption in more detail, including what the effect of the exemption is.
A firm with the benefit of this exemption is a MiFID optional exemption firm and the exemption is normally referred to as the MiFID optional exemption.
You will not benefit from this exemption unless you apply to the appropriate regulator for, and are granted, such permission. You will not be able receive such permission unless your business meets the conditions described in the answer to Q49.

The exemption corresponds to the optional exemption contained in article 3 of MiFID. Articles 3.1(d) and (e) of MiFID provided additional optional exemptions, but they were never implemented in the UK and are not reflected in any of the UK provisions discussed in this chapter.

Q49. Which firms might fall within this exemption?
The exemption is likely to be relevant to many financial advisers (see Q50) including some corporate finance advisers. It may also be relevant to some venture capital firms.

A firm with a permission described in the answer to Q48 is subject to a requirement under section 55L (Imposition of requirements by FCA) or 55M (Imposition of requirements by PRA) of the Act to comply with all the following:

• • they must not hold clients’ funds or securities and must not, for that reason, at any time, place themselves in debit with their clients;
• • they must not provide any investment service other than reception and transmission of orders or investment advice, or both, in relation to transferable securities and units in collective investment undertakings;
• • they may (in the course of providing the investment services mentioned in the previous bullet point) transmit orders only to one or more of the following:
  • o other investment firms authorised under the Act or authorised under MiFID;
  • o UK credit institutions authorised under the Act, excluding credit unions and friendly societies;
    o credit institutions authorised under the CRD;
  • o branches of third country investment firms or credit institutions which are subject to, and comply with, prudential rules considered by the appropriate regulator to be at least as stringent as those laid down in FCA rules made under Part 9C of the Act (Prudential regulation of FCA investment firms), PRA rules that are CRR rules as defined in section 144A of the Act (CRR rules), MiFID, the EU CRR or the Solvency 2 Directive;
  • o collective investment undertakings authorised under the law of the United Kingdom or of an EEA State to market units to the public, and managers of such undertakings;
    • o a company that meets the following conditions (such as an investment trust company): 
       - its exclusive object is to invest its funds in various stocks and shares, land or other assets with the sole aim of spreading investment risks and giving its shareholders the benefit of the results of the management of their assets; and
       - its securities are listed or dealt in on a United Kingdom regulated market or a regulated market in an EEA State.

Where you provide personal recommendations or receive and transmit orders in relation to derivatives which are financial instruments but not transferable securities, you will fall outside the scope of this exemption. In our view, this would be the case, for example, if you provided either or both of these investment services in relation to OTC derivatives concluded by a confirmation under an ISDA master agreement (see PERG 13 Annex 2 Table 2).

Q50. We are an IFA and have a permission which covers (i) arranging (bringing about) deals in investments; (ii) making arrangements with a view to transactions; and (iii) advising on investments, in each case in relation to securities but not derivatives. We are not permitted to hold client money or investments and do not have dealing or managing permissions in relation to financial instruments. Do we meet the eligibility conditions for the exemption?

The FCA expects so, assuming you do not:

• • carry on activities outside your permission; or
• • transmit orders to persons other than those listed in Q49 (for example, you will fall outside the exemption if you transmit orders directly to collective investment schemes whose units cannot be marketed to the public in the UK either because they are unregulated schemes or non- UK authorised collective investment schemes); or
• • place financial instruments without a firm commitment basis (see Q22 and Q23).

We would generally not expect IFAs to be placing financial instruments without a firm commitment basis as we associate placing of financial instruments with situations where a company or other business vehicle wishes to raise capital for commercial purposes, and in particular with primary market activity.

Q51. What happens if we breach any of the qualifying conditions (see Q49)? Do we then lose the exemption?

You are required to notify us of a breach (see SUP 15.3.11 R). We will then consider whether you should continue to benefit from the exemption and what, if any, supervisory or occasionally enforcement action is appropriate in the circumstances.

Q52. If we fall within the exemption does this prevent us from acquiring passporting rights under MiFID?

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Q53. What is the practical effect of exercising the optional exemption for those firms falling within its scope?

You are not a MiFID investment firm for the purposes of the Handbook. Nor are you a MIFIDPRU investment firm subject to the prudential requirements in MIFIDPRU. You are also not an investment firm as defined in the Act.
However, you are still an investment firm as defined in the Regulated Activities Order and an investment firm as defined in the Glossary.
Certain MiFID requirements of the UK law on markets in financial instruments apply to firms making use of the exemption but a firm with the benefit of the exemption is excluded from others.