Legal Perspectives and Compliance with regard to Complexities of Portfolio Management under MiFID II

Josef Bergt
2023

Introduction

The realm of portfolio management, as defined under Art. 4 para. 1 no. 8 MiFID II, respectively Annex I Section A no. 4 MiFID II, encompasses a broad spectrum of activities involving the management of individual assets invested in financial instruments on behalf of others, with a degree of decision-making. This article delves into the legal intricacies of portfolio management, examining its statutory components, implications for financial service providers, and compliance requirements.

Management of Individual Assets

The concept of asset management inherently implies a duration and continuity, extending beyond singular investment decisions or isolated transactions. While a long-term mandate for the asset manager is typical, even a one-time management activity can fulfill the statutory requirement. The management activity must focus on individual client assets, which can be pooled in a portfolio without necessarily segregating each client's assets into separate portfolios.

The statutory definition of financial portfolio management emphasizes the management of individual client assets. While the law does not necessitate each client's assets to be managed in separate portfolios, it does require that the management activity be client specific.

Investment in Financial Instruments

Portfolio management means managing portfolios in accordance with mandates given by clients on a discretionary client-by-client basis where such portfolios include one or more financial instruments. Transferable securities respectively financial instruments, as defined in MiFID II, include equity- and non-equity-instruments.

Management on Behalf of Others

This criterion distinguishes financial portfolio management from managing one's own assets. It is fulfilled when acting on behalf of others, which includes situations where the client has provided the manager with signed blank order forms, making the management activity less transparent to the contractual partner.

Decision-Making Discretion

Portfolio management requires the manager to have discretion in managing the invested assets. This discretion is contrasted with a bound activity, where the provision of investment or brokerage services might be more applicable. The extent of the client's retained decision-making rights is crucial in determining whether the manager operates with the necessary discretion.

Exemption from Licensing in the Closest Family Circle

While the unpaid management of financial assets typically still falls under portfolio management, not every such activity within the family circle necessitates a license. Activities not oriented towards the market, such as those performed exclusively for immediate family members, may not require a license. The closest family circle generally includes spouses, parents, siblings, children, nieces, nephews, and grandchildren.

Delineation of Portfolio Management

• Custody and Commission Business
  • Portfolio managers are prohibited from simultaneously storing the managed securities. They must ensure these are kept in a client's securities account at a licensed depository institution. If the accounts are in the manager's name, they might be conducting custody and commission business with regard to financial instruments, which requires different licensing.
• Dealing on own Account
  • Proprietary trading or dealing on own account, involves trading financial instruments for one's own account as a service to others. This activity, conducted in one's own name and for one's own account, is distinct from portfolio management.
• Brokerage Services
  • Portfolio management is not an extended form of brokerage services. It involves managing investments in financial instruments in the client's name for their account, with decision-making discretion.
• Investment Advice
  • Portfolio management differs from investment advisory services, where the client retains the responsibility to implement investment recommendations. 

The legal framework of portfolio management under MiFID II presents a nuanced landscape requiring careful navigation by financial service providers. Understanding the distinctions between various financial services and adhering to compliance requirements is crucial for effective and lawful operation in the financial sector.

Source: BaFin Factsheet Information on the elements of financial portfolio management

Executive Summary:

• Definition and Scope: Portfolio management involves managing individual assets invested in financial instruments for others, with decision-making discretion.
• Client-Centric Management: The management activity must focus on individual client assets, which can be pooled in a portfolio.
• Legal Definition of Financial Instruments: A wide range of instruments falls under the legal definition, allowing for diverse portfolio compositions.
• Decision-Making Discretion: The manager must operate with discretion, differentiating financial portfolio management from bound activities like brokerage services.
• Exemption for Family Circle Management: Unpaid management of financial assets within the closest family circle may not require a license, provided it is not market-oriented.
• Client-Specific Asset Management: Financial portfolio management involves managing individual client assets, which can be pooled in a portfolio.
• Dealing on Own Account Distinction: Proprietary trading involves trading for one's own account, distinct from managing assets for others.
• Brokerage and Advisory Services: Portfolio management is distinct from brokerage and advisory services, with the latter involving client responsibility for implementing recommendations.