LIBA
L O N D O N I N V E S TM E N T B AN K I N G A S S O C I A T I O N
6 Frederick's Place, London, EC2R 8BT
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e-mail: liba@liba.org.uk website: www.liba.org.uk
CESR final consultation on harmonisation of conduct of business standards
(CESR/01-014) and investor categorisation (CESR/01-015)
A response by the London Investment Banking Association (LIBA)
Introduction
Key issues
Detailed comments
Standards and Rules for Harmonising Core
Conduct of Business Rules for Investor Protection
Implementation of Article 11 of the ISD: Categorisation
of Investors for the Purposes of Conduct of Business Rules
Paragraphs 1 – 3
Paragraphs 4 – 9
Paragraphs 10 – 46
Paragraphs 47 – 53
_____________________________________________________________________
1. LIBA represents the major European and international investment banks and
securities houses which base their European operations in London. A list of our
Members is attached.
2. LIBA welcomes the opportunity to comment on CESR’s revised proposals for
conduct of business standards and the categorisation of investors. We particularly
welcome CESR’s preparedness to amend its proposals to take account of
consultees’ comments, and also to continue to seek a framework which addresses
in the most appropriate way the public policy needs of the users of European
capital markets. We found CESR’s hearing in Paris on 8th November very helpful
in understanding the approach which CESR is proposing. We have suggested a
number of amendments below which we believe achieve CESR’s policy
objectives in a way which causes less impediment to the efficiency of Europe’s
capital markets.
3. It is unfortunate that the consultation period has been so limited. We have
endeavoured to analyse all the main points which continue to give rise to concern,
and to propose constructive solutions. However, it may be that further issues will
be raised by our Members on which we will need to make further submissions to
CESR in the coming weeks.
Key issues
4. We welcome CESR’s recognition that the professional investors category should
include large and sophisticated corporates. However, the category should be
expanded further, in particular to include:

members of groups which contain corporate professionals - so that specialist
financing subsidiaries are not excluded - and

non-EU companies - so that the EU regime is not internationally
uncompetitive.
5. We welcome CESR’s recognition that it is appropriate to exclude counterparty
relationships from the conduct of business standards. However, it is important
that entities which wish to deal as counterparties are not prevented from doing so
by over-rigid boundaries or criteria for the counterparty regime. It is also
important that the market is not restricted by an over-formal requirement for
counterparties to agree the status with each other.
6. We are concerned about the application to the full range of professional investors
of certain of the proposed standards. In particular, a best execution obligation or a
suitability obligation would be quite inappropriate for large or sophisticated
professional investors. Any such obligations need apply at most only to entities
which have opted for professional status.
7. There is a need for very great caution to ensure that any duty to care for
execution-only customers does not impede firms’ ability to respond to customers’
demand for such services. Suitability obligations should not apply unless the firm
makes a personal recommendation.
8. In relation to both conduct of business standards and customer categorisation, it
will be important to maintain appropriate consistency between the CESR
standards and the relevant provisions in the proposed revision of the ISD.
9. It would be very helpful if CESR could make clear that the standards are to be
applied by the regulator in the country of origin of the service. The country of
origin approach is implicit in the discussion in paragraphs 2 and 5 of the
Introduction about reducing barriers to the internal market. The Commission’s
consultation on the revision of the ISD envisages country of origin control in the
context of converged conduct of business rules. The wording of Article 11.2 of
the ISD, together with the Commission’s interpretation of similar provisions in the
Consolidated Banking Directive, provides a foundation for the application of the
country of origin approach in the context of the existing ISD. CESR should take
advantage of this opportunity to endorse it.
Detailed comments
Standards and Rules for Harmonising Core Conduct of Business Rules for Investor
Protection
10. Definitions: ‘Cold calling’: The footnote states that potential customers include
existing customers who are cold-called ‘for investments services or products
different from those they have already purchased’. We suggest the addition of ‘or
agreed to purchase’, to cover the situation where a list of services, not all of which
may have been provided, is provided in the customer agreement.
11. Articles 3, 151: The requirement to ensure that ‘persons or entities with which it is
undertaking authorisable investment business are authorised to conduct that
business’ should make clear that it refers to the use of agents or intermediaries,
and that it applies also to entities which are authorised outside the EEA. It should
also be recognised that in certain circumstances, because of differences in
licensing requirements around the world, or delays in notification of withdrawal of
authorisation, it may be difficult for firms to ‘ensure’ that an entity is authorised.
12. Articles 4, 6, 152: We welcome the recognition that conflicts of interest can be
managed if they are not avoidable, and the focus of the principles and rules on
management and disclosure of conflicts. However, the wording should be
amended to reflect the fact that an internal independence policy should be aimed
at preventing or (not and) managing conflicts, and that the function of Chinese
walls is to manage or minimise conflicts, not prevent them.
13. Articles 10, 11, 19, 155, 156, 164, Annex: Articles 11 and 156 require a firm to
demonstrate that it has complied with its internal code of conduct. While 19 and
164 specify some of the contents of the code of conduct, such a code may also
include other matters, which may not be covered by the conduct of business
standards. CESR should make clear that firms are not subject to regulatory
sanctions in relation to breaches of codes of conduct which do not relate to
regulatory requirements. Any provisions relating to the code of conduct should be
flexible enough also to take account of the broader context of the associated
policies and procedures which firms have established.
14. Articles 13, 158: It should be explicitly stated that only the most important
‘results of monitoring’ are required to be reported. In addition, firms should not
be required to report the results of monitoring routinely to internal or external
auditors: such a requirement could impair the effectiveness of the compliance
function and thus the ability of managers to manage the business effectively. We
suggest that Articles 13 and 158 be amended to say ‘…and, as appropriate, to the
internal or external auditors…’
15. Article 14: The guidance on how to assess the seriousness of regulatory breaches
is helpful.
16. Articles 17, 101, 162, 176: ‘Relevant records’ should be defined, in particular
taking into account that a requirement to keep records of telephone orders for five
years would give rise to huge storage and retrieval problems: the primary purpose
of telephone records is to resolve transmission errors, which should become
apparent much sooner.
17. Article 20: Given that the firm retains responsibility for outsourced activities, the
requirements relating to such activities which 'might affect the provision of
investment services' are unduly broad. In particular, any requirement to act ‘in the
best interests of customers’ should apply to the firm, and not to the service
provider.
18. Articles 30-33, 42-56, 57-60: We welcome the more flexible approach to
information provision and risk warnings.
19. Article 41: Article 41(g) should include a presumption that the customer can
communicate in the language of the written agreement.
20. Article 59: ‘Financial instruments not traded on a regulated market’ would include
instruments traded on non-EEA exchanges, as well as certain government and
corporate bonds for which specific risk warnings would not be appropriate. We
suggest the addition of ‘or equivalent non-EEA exchange’.
21. ‘Financial instruments subject to high volatility’ would include all equities, which
from time to time may be subject to high volatility because of general market
conditions. It should be made clear that what is referred to is high volatility in
normal market conditions.
22. Article 64: For OTC derivatives it is likely to be difficult to provide the required
information within one day following execution.
23. Trade confirmations typically focus (via an automated process) on the settlement
of the transaction, rather than the market on which the transaction was carried out.
Furthermore, it would be difficult to automate the provision of information on the
market where the trade was carried out, so costs would be likely to increase.
24. Articles 79, 83: CESR has explained the provisions on the duty to care where the
transaction is ‘execution only’ as requiring firms to consider whether an execution
only order falls outside the range of types of transaction which would be expected
given the information which the firm knows about its customer. It is essential that
any standards in this area do not impose disclosure standards which would prevent
firms from providing the low-cost execution-only dealing services which
customers demand. No restrictions should apply where the means by which the
customer has accessed the service (e.g. a website) automatically provides the
customer with information about the nature of the service offered. Furthermore,
no restrictions should apply when it is the customer who has made the investment
firm aware that the service to be provided is the pure transmission or execution of
orders.
25. Articles 80, 82: The proposed approach to credit risk assessment is overprescriptive. These should be matters of commercial judgement, not regulatory
requirement.
26. Article 86: We welcome CESR’s approach requiring disclosure to customers of
trading venues which the firm has access to. We have suggested this approach as
preferable to disclosure to regulators in the context of the Commission’s
consultation on the ISD. Changes to this information should be notified
periodically, and not necessarily immediately the change occurs.
27. Article 106: The requirement for aggregation to be in the ‘best interest’ of the
customer is excessive. Firms should be permitted to aggregate provided that the
customer’s interest is not disadvantaged.
28. Article 107: In order to ensure that non-professional investors can participate in
the grey market, the standard should make clear that it would be sufficient to
inform the investor that a prospectus will be forthcoming when the security is
issued.
29. Articles 108, 177: The listed criteria (including also counterparty
creditworthiness) are all factors which firms take into account when they assess
how best to serve customers’ interests. However, it will be vital to ensure that the
standard does not lead regulators to adopt an over-mechanistic application of the
multiple criteria when assessing whether or not best execution has been achieved.
Any best execution requirement should focus on the price for the size. In
addition, it is important that the obligations on firms to take account of the
conditions and prices on ‘relevant markets’ apply only to markets to which the
firm has access.
30. There should be no best execution requirement for professionals, with the possible
exception of ‘opted-up’ professionals. Market forces are sufficient to ensure that
firms provide professional customers with the quality of execution that is required.
31. Articles 109, 178: The new requirement for case by case prior disclosure of the
fact that a firm is acting as principal, and of relative prices in other markets, is
likely to be burdensome and time-consuming, and could result in customers losing
out if (as may be very likely) the market moves before the firm is able to complete
the transaction. The provision of such information in advance is not necessary,
and may be impractical, particularly where automatic execution systems are
concerned. Any best execution obligations should focus on the transaction itself,
and not on impractical prior disclosure. Rather than disclosure transaction by
transaction, any prior disclosure should merely state that the firm may from time
to time act as principal.
32. Article 112: It should be made clear that time priority applies only to market
orders, and not to limit orders.
33. Article 113: If the best execution principle is respected, the best interests of
customers should automatically be served. The ‘best interest’ proviso is therefore
redundant.
34. Article 151: See paragraph 11 above.
35. Article 152: See paragraph 12 above.
36. Articles 155, 156, 164: See paragraph 13 above.
37. Article 158: See paragraph 14 above.
38. Articles 162, 176: See paragraph 16 above.
39. Article 169: It is normal practice in the professional OTC swaps market to provide
mark to market in response to customer requests, but not to provide regular
statements. We suggest the addition of ‘or provide statements on request,
according to normal market practice’.
40. Article 171: We are concerned at the continuation of the proposal to apply a ‘duty
to care’ or suitability obligation in relation to all professional customers. In
particular, it will generally not be possible for a firm to assess the suitability of
transactions for large corporates or other sophisticated professionals, particularly
if the investor is operating in the market through more than one intermediary.
Any suitability requirements for professionals should at most be limited to ‘opted
up’ professionals. For other professionals, any duty of care should be a matter for
agreement between the parties. If CESR does decide to retain a suitability
requirement for any part of the professional category, exemptions for execution
only and unsolicited orders should be included on the lines of Article 83, as
modified in our comments above on that article.
41. Article 172: The standards should not require firms to obtain a signed agreement
in all circumstances before a firm can provide any investment services to
professionals. We agree, of course, that customers should be identified before
services are provided in accordance with money laundering rules – which Article
170 should refer to explicitly. However a prior customer agreement requirement
could impede the prompt provision of services. For professional customers, with
the possible exception of ‘opted up’ professionals, the most that should be
required is that a customer agreement is entered into as soon as possible.
42. Articles 173, 177: The application of a best execution obligation for professional
customers should be a matter for agreement between the parties, even if the firm is
acting as agent, and control over the quality of execution should be a commercial
and not a regulatory matter for professional customers.
43. Article 178: See paragraph 31 above.
44. Annex – Core principles for ‘Counterparty Relationships’: We welcome CESR’s
recognition that counterparty relationships, which are characterised by the absence
of a customer relationship, should not be subject to the conduct of business
regime. However, the definition of ‘counterparty relationships’, as set out in
Footnote 14, should be modified in two important respects to ensure that the
counterparty regime is appropriately applied:

Footnote 14 implies that the three listed criteria are exclusive, and that other
entities should not be able to enter into a counterparty relationship. However,
the criteria would not include certain entities which are not authorised or
members of regulated markets and whose size is not measured by volume of
sales, but which nevertheless currently operate as counterparties in the markets
– for example, hedge funds. The criteria should therefore be inclusive, not
exclusive, and any professional customer should have the ability to enter into a
counterparty relationship (this approach is implied in the explicative note
attached to the consultation paper).

Footnote 14 states that counterparties must reciprocally confirm in the contract
that the transaction is executed under a counterparty relationship. Such a
requirement would be burdensome for entities which regularly transact with
each other as counterparties, and should apply only when the absence of a
customer relationship is an exception to the normal course of business.
45. Furthermore, it should be made clear that authorised entities and members of
regulated markets can trade as counterparties even if they are acting on behalf of
underlying customers (the relationship with the customers would of course be
governed by the conduct of business standards).
46. Counterparty principles 3, 5, and 6 are largely duplicative, and could usefully be
combined.
Implementation of Article 11 of the ISD: Categorisation of Investors for the Purposes
of Conduct of Business Rules
47. Article 7: The Professional regime is still inappropriately being described as
'exceptional'. The counterparty, professional, and non-professional regimes
should all be appropriate to the relevant type of investor, and none should be an
‘exception’ to any of the others.
48. Article 10: We welcome the inclusion of large corporates in the professional
investors category. In order to ensure appropriate treatment of all professional
entities, CESR should however expand the definition to include the following:
 non-EU listed corporates – to avoid competitive disadvantage to EU firms
dealing with non-EU professional investors;
 members of groups which include large or listed companies – to allow
specialist financing subsidiaries of professional corporates to gain the benefits
of the professional regime;
 local and public authorities – so that they are able to enjoy the same benefits
as national and regional governments and central banks;
 sophisticated small corporate and individual investors whom the firm has
assessed as expert, and who have agreed to be treated as professionals – so
that the firm can take the initiative to propose professional status to investors
who meet the criteria in II.1, who would then follow the procedure in II.2.
49. Article 11: It should be made clear that the provisions for professionals to opt for
greater protection do not imply that the only option is the full range of retail
protections. For most professionals, in particular authorised entities, national
governments, and very large corporates, the ability to choose non-professional
status would be inappropriate to their level of expertise. The ability to opt down is
most likely to be appropriate for entities which have opted into professional status.
Entities which automatically fall into the professional category should have the
ability to agree targeted application of particular protections as a matter of
contract, but not to change their categorisation. We agree that the onus should be
on a professional investor to seek additional protections if it wants them.
50. Article 12: CESR has retained the statement that non-professionals who opt to be
treated as professionals 'should not be presumed to possess market knowledge and
experience comparable to' investors who are automatically professionals. There is
no indication of how this would determine which non-professional conduct of
business standards would continue to apply, and how the regime would differ
from the standard professional regime. At the 8th November hearing, CESR
indicated that Article 12 referred to the assessments which are required under
Articles 13 and 14: if this is the intention, the paper should make it clear.
51. We have described in our comments on Articles 171, 172, and 177 of CESR’s
Conduct of Business Standards paper how the distinction between ‘automatic’
professionals and ‘opted up’ professionals could be used to target investor
protections within the professionals category at those entities which actually need
them.
52. Article 13: When a firm has judged an entity to be professional, and the entity has
provided the firm with a list of employees who are authorised to act on its behalf,
there should be no requirement for the firm also to assess the expertise,
experience, or knowledge of the people acting on behalf of the customer.
53. Article 16: The recognition that customers whom the firm has already categorised
as professionals are not affected by the new framework is helpful.
London Investment Banking Association
30th November 2001
COM77A
MEMBERS OF THE LONDON INVESTMENT BANKING ASSOCIATION
Ansbacher & Co Limited
ABN AMRO Bank N.V.
Arbuthnot Latham & Co., Limited
BNP Paribas
Barclays Capital
Bear, Stearns International Limited
Beeson Gregory Limited
CIBC World Markets Plc
Cazenove & Co.
The Chase Manhattan Bank
Close Brothers Corporate Finance Ltd
Collins Stewart Limited
Commerzbank AG
Credit Suisse First Boston International
Daiwa Securities SMBC Europe Limited
Dawnay, Day & Co., Limited
Deutsche Bank AG London
Dresdner Kleinwort Wasserstein
Goldman Sachs International
Granville Baird Ltd.
Hawkpoint Partners Limited
HSBC Investment Bank plc
ING Barings
Insinger English Trust
Instinet UK Ltd
Investec Bank (UK) Limited
Knight Securities International Ltd
Lazard
Lehman Brothers
Merrill Lynch Europe PLC
Mizuho International plc
Morgan Stanley International Ltd
Nomura International plc
Peel Hunt plc
N M Rothschild & Sons Limited
Schroder Salomon Smith Barney
Singer & Friedlander Holdings Limited
Société Générale
3i Group plc
The Toronto Dominion Bank
UBS Warburg
Westdeutsche Landesbank Girozentrale
sd E/memnam
30th November 2001