Written evidence submitted by HSBC (FCR0045)

In general, EU countries prescribe criminal penalties under their local law for firms which conduct business in their territory or with their nationals without local authorisation. The effect of such criminalisation is generally to render the transaction concerned unenforceable. However, most countries recognise that where non-retail investors wish to use the services of overseas financial services providers, they should not necessarily be prohibited from doing so. This means that most countries have a "reverse solicitation" rule whereby foreign financial firms are permitted to deal with persons in their territory provided that the dealing is at the "exclusive initiative" of the customer and has not been solicited by the foreign firm.

Policy basis for reverse solicitation exemptions

The circumstances for which rules of this kind are envisaged involve investors in one country who wish to make investments in another. Thus, for example, an investor in Germany should be able to invest in Peru through a Peruvian stockbroker without that stockbroker being required to be authorised in Germany. However, in order to avoid this becoming a blanket permission for all foreign firms to do business in Germany, the permission is restricted to circumstances in which the transaction is initiated by the German firm without having been solicited by the Peruvian firm.

Reversing reverse solicitation?

It is suggested by some that these rules can be used in reverse by financial firms seeking to market investments and securities. The argument is that a financial firm should be able to market to an investor without restriction, provided that the ultimate actual decision to invest is taken by the investor, since this act has the effect of bringing the transaction within the reverse solicitation exemption.

However, this would not be regarded in any of the countries that we have considered (and we have considered most of the EU 27) as falling within their "reverse solicitation" exemptions. The essence of reverse solicitation is the lack of solicitation, and in general any such solicitation will displace the exemption.

What is solicitation?

There is, of course, some scope for discussion as to what constitutes "solicitation" in this regard. Preliminary contacts such as handing over business cards, placing information on public websites and responding to queries generally do not constitute "solicitation", although the position varies from country to country. Thus the rule is not that there must have been no contact at all between the firm and the customer prior to the order. However, in general any explicit discussion of the product or the service involved will constitute "solicitation" for this purpose. A relatively few countries extend this exemption to relationships arising from reverse enquiry – thus once a client has initiated a relationship with a foreign firm, the foreign firm is permitted to engage in solicitation of the client for individual transactions in the context of the relationship (although not beyond it). This approach, however, is rare – most countries test solicitation on a transaction by transaction basis. 

Reverse solicitation and relationship banking

The irrelevance of this exemption for modern banking and financial business derives from the fact that the vast majority of that business is relationship based. Modern banks do not do business on a deal by deal basis, but on a relationship basis, seeking to build a broad and lasting relationship with customers, seeking to develop a track-record with each customer for the efficient and effective delivery of value-added service. 

Current Legal Position

Reverse solicitation is a feature of a limited number of Single Market Directives[1].   Where the Directives themselves do not provide for firms to have access on the basis of reverse solicitation, the question of whether reverse solicitation is permitted is a matter of domestic law in the individual Member State. 

The approach in Member States is mixed. Some Member States allow firms to do business on the basis of reverse solicitation, some take a restrictive approach to reverse solicitation whereas others have no formal exemption or guidance relating to reverse solicitation.  The approach may also differ depending upon the activity in question.

Practical compliance problems with reverse solicitation

Even where transactions are genuinely one-off relationships, the reverse solicitation exemption is extremely difficult to use in practice.

• Except in limited circumstances it is impractical to examine the facts surrounding each and every transaction and relationship to determine whether the firm has remained on the right side of the line.  
• ‎Most firms' business model envisages that their client coverage teams will seek to engage in dialogue with clients and potential clients about their requirements and so it is very difficult to control client coverage behaviour in a way that treats foreign clients differently.  
• There are also concerns in some areas where the firm may have ongoing duties to the client (either legally or merely as a matter of client expectation) e.g. to inform the client of a change of circumstance that makes an investment no longer attractive (such that this approach to the client may be seen as solicitation).

Reverse solicitation post-Brexit

Today these rules are largely self enforced by non EU firms as there is little focus by local regulators on the treatment of cross border wholesale business. However one consequence of the UK leaving the EU is that (in the absence of a deal on cross border business) it is likely that cross border business by UK and other non EU firms will be subjected to greater scrutiny (and competitor complaint) - there will be more ‘police on the border’. Firms' awareness of this risk will reinforce and even increase their risk aversion.

Reverse solicitation under MiFID 2

It is sometimes suggested that the existing, restrictive reverse solicitation rules will be broadened under MiFID 2. This refers to the provisions of MiFIR Art 46(5) (similar language is contained in recital 111 and Art. 42 of MiFID 2), which provides, in part, that

"Member States shall ensure that where an eligible counterparty or professional client … established or situated in the Union initiates at its own exclusive initiative the provision of an investment service or activity by a third-country firm, this Article does not apply to the provision of that service or activity by the third-country firm to that person including a relationship specifically related to the provision of that service or activity."

It should be clear that the effect of this provision is not to mandate the disapplication either of MiFID or of local regulations in respect of reverse solicitation, but only the provisions of Art 46. Art 46, without this provision, would require all non-EU firms providing investment services or performing investment activities within the EU to be registered in the register of third-country firms kept by ESMA. Thus the effect of the language quoted above is to ensure that firms acting under existing reverse solicitation regimes are not caught by the Art 46 registration regime. Otherwise it leaves existing laws intact.

Reverse solicitation and compliance risk appetite

For the reasons set out above, conducting regulated business other than one-off, idiosyncratic business with clients in the EU in reliance on a reverse solicitation analysis is relatively high-risk. Not only are the rules themselves extremely vague, but the critical determinant of applicability - who said what to whom when – is extremely difficult to identify, and even harder to record in a fashion which would definitively satisfy investigating authorities.  

We should note in this regard that the threat to a firm conducting business in this way would come from its domestic regulator as well as overseas regulators – in our view there is a significant risk that the UK regulator would be prepared to take regulatory action against a UK firm which appeared to be conducting its business in breach of the criminal laws of its clients' home jurisdictions, and could not demonstrate that its activities were legal.

Consequently, for a firm to organise its business in this way would require that firm's board to be prepared to accept a high level of compliance and regulatory enforcement risk. Categorically this is not the stance of the larger London-based institutions.

February 2017