How does revised MiFIR address PFOF?

On 28 March 2024, amendments to the Markets in Financial Instruments Regulation (MiFIR) entered into force and became directly applicable in all Member States. The published text is available here.

The amendments include the newly introduced Article 39a that prohibits investment firms from acting on behalf of retail clients and “opt-in” professional clients from receiving any payment for or benefit from executing client orders on a particular execution venue or forwarding client orders to a third party for execution on a particular execution venue, known as payment for order flow or PFOF. Financial intermediaries should select the trading venue or counterparty solely on the basis of achieving best execution for their clients and collecting a payment for ensuring the execution of client transactions on a particular execution venue seems incompatible with the principle of best execution.

Who falls within the scope of the PFOF provision?

Addressees of the prohibition are investment firms acting on behalf of clients:

• for executing orders from those clients on a particular execution venue; or
• for forwarding orders of those clients to any third party for their execution on a particular execution venue.

Clients to whom the investment service is provided are not only retail clients within the meaning of Article 4 (1) (11) of the Markets in Financial Instruments Directive (MiFID II) (Directive 2014/65/EU), but also clients that have validly waived the level of protection applicable to retail clients and may thus be treated as professional clients in accordance with Section II of Annex II of MiFID II (referred to as “opt-in” professional clients). Third parties granting the payment are not in scope.

What kind of payments are covered by the PFOF prohibition?

The term “payment” comprises fees, commissions, or non-monetary benefits and corresponds to the inducement definition pursuant to Article 24 (9) MiFID II. It covers not only direct (re)payments, but also a waiver of fees and other benefits, such as better conditions for the execution of transactions. The payments must be provided for executing orders on a particular execution venue or for forwarding orders to any third party for the execution on a particular execution venue. Payments provided by third parties which are not in connection with the execution or forwarding are not in scope of the PFOF prohibition but the inducement regime under MiFID II will still apply to these payments. It is further questionable whether payments which are not linked to the execution on a "particular execution venue” are in scope of the PFOF prohibition. For example, in the case of a trade subsidy provided by the product manufacturer to the broker that exclusively benefits the client and there remains a choice for the client to select among several execution venues by giving an instruction on the execution.

What are the exemptions from the PFOF prohibition?

There is an exemption from the prohibition in subparagraph 2 of Article 39a (1) which stipulates that rebates or transaction fees (where permitted under the approved and public tariff structure of a trading venue in the Union or of a third-country trading venue) are permissible if they exclusively benefit the client.

What grandfathering rules are provided?

Until 30 June 2026, Member States may exempt investment firms under their jurisdiction from the prohibition where those investment firms:

• carried out such an activity before 28 March 2024; and
• where the investment firm provided investment services to clients domiciled or established in that Member State.

Investment firms operating in multiple jurisdictions will then only be able to receive payments in connection with transactions of clients domiciled or established in that Member State. It is in question whether investment firms can also receive payments in connection with transactions of clients domiciled in another Member State that has also made use of the grandfathering rule.

The German legislator published a draft bill for a new financial markets digitalisation act (Finanzmarktdigitalisierungsgesetz - FinmadiG) that amongst other things foresees that investment firms in Germany may continue to receive payments from third parties when providing investment services to clients in Germany until 30 June 2026 by introducing a new Section 138a into the German Securities Trading Act (Wertpapierhandelsgesetz - WpHG). On 22 March 2024, BaFin published an announcement stating that it will not pursue any violations of the PFOF ban for orders from domestic clients until the legislative process has been completed.

Pursuant to Article 39a (2) MIFIR, Member States must notify ESMA by 29 September 2024 if they intend to follow the German example and make use of the grandfathering rule. Germany submitted the corresponding notification to ESMA on 21 March 2024 and so far is the only country appearing on the list of Member States using the temporary exemption published by ESMA.

As regards Ireland, Italy, Spain, the Netherlands, France, Luxembourg and Sweden there are currently no intentions to make use of the grandfathering rule and thus, the prohibition of PFOF is being applied immediately. In Austria, there were considerations to issue a corresponding exemption from PFOF following the German example but so far no public announcement has been made.

What’s next?

Even if the implementation of grandfathering rules in Member States other than Germany is currently unlikely, it cannot be ruled out, as they can still be reported to ESMA until 29 September 2024. Also, it will be interesting to see how the rules are applied in a cross-border context as many brokers make use of the European passport and potentially may not differentiate between clients domiciled in different Member States. We are closely following developments in relation to PFOF and the revised MiFIR and MiFID requirements, please get in touch with the contacts mentioned on the right if you would like to discuss further.

With thanks to Dr. Peter Knobel - Partner at Cerha Hempel Rechtsanwälte GmbH and Joel Montin - Counsel at Hannes Snellman Advokatbyrå AB who collaborated with the Hogan Lovells authors on this article.