CESR Looks for 'Super ECP'

A new consulting paper by the Committee of European Securities Regulators (CESR) on client classification for the Markets in Financial Instruments Directive (Mifid) is sure to throw investment banks for a loop when it comes to their know-your-customer (KYC) programs.

Written in response to specific queries from the European Commission (EC) on this topic, the paper’s authors do not come out and state specific suggestions, but rather put forward a number of ideas to solicit comments from the various stakeholders within the industry.

One of the observations made by CESR in the paper is that the entire client classification system paints everyone with a broad brush and that a client's size or type of institution does not necessarily equate with expertise when it come to understanding the risks involved when they make their own investment decisions. For example, an eligible counterparty (ECP) may not have the necessary expertise that befits its classification.

As the authors note, "[T]here is no specific test of their ability to make their own investment decisions and understand the risks involved."

This raises a number of interesting questions on how CESR, and presumably the EC, expect to test an ECP's worthiness to invest as an ECP. Which benchmark should be used and who would select it? How would the testing be implemented and by whom?

One thing is for sure: It would destroy the time-to-market for new bespoke over-the-counter (OTC) offerings to the buy side.

Yet CESR has some interesting ideas for highly complex instruments like asset-backed securities (ABSs) and non-listed OTC products. The body floats the idea of doing away with the ECP classification in favor of a "super ECP" status that would be subject to even stricter requirements, which would further limit the potential customer pool for these instruments.

Parties wishing to respond to CESR's concepts can submit comments to CESR until Aug. 9. We suggest you do.