The Committee of European Securities RegulatorsSecretary General
17 Place de la Boerse
75082 PARIS CEDEX 02
FRANCE

Att.: 

Date: 12.12.2001
Our ref.: 2001/000658 FJA/MSR
Your ref.: 

SECOND CESR CONSULTATION PAPER ON THE HARMONIZATION OF CONDUCT OF BUSINESS RULES FOR INVESTOR PROTECTION

1) Introduction

The Norwegian Financial Services Association (FNH) appreciates CESRs invitation to comment on the revised proposal for harmonization of core conduct of business rules presented 18 October 2001 (CESR/01-014). FNH also appreciates the opportunity to comment on the revised paper on the categorization of investors (ref. CESR/01-015), which to our knowledge has not been subject to previous public consultation.

Please find below our general remarks to the revised draft, followed by our specific comments to the proposed principles and rules. The contents in paragraph 3.2 are based in its entirety on comments received from one of our largest member banks, Den norske Bank ASA. These comments focus on the redrafted rules and the consequences these rules will have on the providing of investment services.

2) General remarks

FNH welcomes the proposed changes in the conduct of business rules. In particular we would like to express our satisfaction with the revision of the paper on categorization of investors, which in our opinion now contains a better and more appropriate definition of professional investors, in particular with respect to the inclusion of large corporations in the professional investors category.

However, we would like to express again some of the concerns in our letter of 27 April 2001 in response to the previous proposal. Our fundamental view is that, despite the revision of the standards, the rules are still elaborated at a far too detailed level. The content of the proposed principles and rules introduces extremely comprehensive information and advisory duties on the investment firms, which are new in relation to general investment services in Norway. We fear that such extensive requirements will imply significantly increased costs, in particular with regard to investment services to retail customers. By significantly increasing retail customer servicing costs, the proposed principles and rules will guarantee the customers more expensive, and in many cases unwanted, services. It will also make it more difficult to establish customer relationships, thus potentially reducing competition. In quickly moving markets there is a need for precise and well-defined rules that contribute to quick settlement of disputes. We fear that the extensive information and advisory duties prescribed in the draft will not contribute to a smooth functioning of the financial markets.

As pointed out in our previous letter, the responsibility for the investment decision should clearly remain with the customer, except when investment firms provide the service of discretionary portfolio management. Several of the proposed principles and rules should be rewritten in order to take this into account. We refer to the detailed comments in our previous letter, in particular to the provisions in Introduction; item 10 and Part III item 3, and to principle 68 below.

The proposed requirements concerning risk warnings, monitoring of the customers trading restrictions, investment advice according to the customers "needs" (as opposed to the customers "requirements") are still more extensive than the services which are presently being provided by investment firms acting as broker/dealer. We refer to the detailed comments in our letter of 27 April to items 21-26, 36, 38, 39, 50-56 and 71-81. (Corresponding to item 30-33, item 42, 45, 56-60 and 68-76 in the revised draft) These rules will represent a level of service provision, regulatory burden and legal risk, which cannot be covered by the present (modest) brokerage fee. Norwegian investment firms providing broker/dealer service do generally not take on extensive advisory responsibilities. Advisory duties may presently to some extent result from the obligation to respect "good business practice". More comprehensive and detailed, general, investment advisory duties on the investment firms do however need specific agreement with the customer.

The mass provision of investment services are today focused on low cost and discount pricing by use of the Internet in all relations with the clients, both for information, advice, routing of orders and execution. In this business environment, relations between the investment firm and its clients are no longer personal and individual, as seem to be the assumption in the Consultative paper. The proposed rules for investor protection will furthermore in our view, lead to an unnecessary detailed and rigid regime, allowing little room for the industry to develop business practices between the customer and the firm, and thereby hamper efficient development of the financial markets.

Notwithstanding the content of the code, we request CESR to use the necessary means to ensure that the proposed principles and rules are implemented in the same way in all member state. We therefore appreciate that CESR addresses these concerns in the introduction of the Explanation of changes document. It is important to avoid that the standards will be enacted legislation in some countries, while they in other countries are considered as supplemental rules or "soft-law". This is necessary in order to ensure that the standards are not enforced to a lesser degree in some countries than others and thus do not contribute to the presupposed harmonization of conduct of business rules. It is also necessary to clarify the legal status of the proposed standards, because in national legislation breaches on the principles and rules, to the extent that such rules are presented as following directly from an interpretation of the provisions in the ISD-directive implemented in national legislation,may be subject to criminal sanctions.

3) Specific comments to the proposed principles and rules

3.1 Paper on the categorization of investors

Item 10 b)
According to the categorization paper large companies and partnerships should be regarded as professional investors when meeting two of the described size requirements in 10 b). It should be clarified that it is sufficient to decide if these requirements are met at the establishment of the customer relationship. It should be the responsibility of the investor to ask for a higher level of protection if the investor does not longer meet the size requirements in 10 b), in accordance with the investors responsibility as set out in item 11 second paragraph. If the company should be treated as non-professional from the moment the requirements no longer are met, this would require a continuously monitoring of the company's accounts and contribute to unnecessary disputes with regard to the level of protection.

In our opinion the size requirements should be adjusted down, in order to apply also to investors normally considered as professional investors in smaller countries.

Item 10 c)
Among the entities considered to be professional investors according to 10 c) are national and regional governments. Norway has a high number of municipalities, ("kommuner"), many of them quite small. There have been cases where such municipalities as well as their pension funds, have been involved in investment programs without being able to properly assess and manage the risks involved and thus been exposed to loss. We therefore welcome the opportunity for professional investors to ask for a higher level of protection when it deems it is unable to properly assess or manage the risks involved. Measures should also be taken at a national level in order to secure that such entities are conscious of their status as professional investors according to the categorization paper, and the opportunity to request non-professional treatment when necessary.

3.2 Proposal for harmonization of conduct of business rules

Principle 4:
This principle makes reference to an obligation on the investment firms to establish an internal "independence policy". In our opinion this notion needs to be clearly defined, and the definition included in the paper's chapter II, Definitions. It appears unclear whether the notion is meant to refer only to internal policy rules regulating the handling of eventual conflicts of interests, or whether these internal rules should lay down broader principles concerning the investment firm's business practice, designed to ensure the maintenance of the firm's independence in the long run.

Principle 10, rule number 19:
Principle 10 and rule 19 lay down an obligation on the investment firm to establish an internal compliance function and internal code of conduct which will be applicable not only to the investment firm's supervisory board, directors, partners and employees, but also to the firm's "agents".

It is our opinion that the term "agents" needs to be defined and the definiton included in chapter II, Definitions. The term "agent" may be, and is, used with various meanings in different European national jurisdictions, and its interpretation is not harmonized. The use of the term "agent" will e.g. according to Norwegian law include independent financial agents, who may conduct business non-exclusively for several different principals. Their activities may be limited to passing on orders in financial instruments to various investment firms on behalf of which they are acting. These agents do not represent their principals in a way where they may actually contract obligations on their behalf.

If the term "agent" in Principle 10 and rule 19 is meant to be understood in this broad sense of the word, we object to the inclusion of the term "agents" under this principle and rule. An inclusion of the term would then imply a responsibility on the investment firm to establish codes of conduct applicable to all the different agents acting on their behalf. Not only will the investment firms not be in a legal position to impose such regulations on external legal entities such as agents, but seen from the perspective of the agents, who may well be representing several different investment firms, it may be impracticable, if not impossible, to comply with several different internal compliance policies and codes of conducts imposed by different investment firms. The codes of conduct of different firms may differ materially and/or be irreconcilable, and thus impossible for the agents to comply with. 

The implicit introduction of obligations on agents to comply with codes of conduct and compliance policies will in our opinion imply an indirect regulation of business carried out by agents, under the responsibility of private investment firms. Regulation of activities performed by agents is not harmonized at European level. Introduction of regulation or authorisation requirements related to agents, should eventually be considered by the different national regulatory authorities after a broader hearing, and in any event not be introduced indirectly, and implicitly, in the way proposed by the current draft CESR rules of conduct of business, with a responsibility for the agents' activity resting on the investment firms.

Rules 13 and 158:
These rules impose an obligation to report "the results of"monitoring in general. This obligation needs to be qualified. It appears meaningless to report allresults of the compliance functions' daily activities to auditors, competent authorities and senior management. The reporting should rather be limited to relevantresults, or a summaryof the results of the monitoring conducted by the compliance function, such as non-observance or violation of laws, general shortcomings etc.

Rule 24:
Ordinary business hours commence at 8:00 a.m. in Norway. Investment firms should be permitted to make cold calls during the ordinary business hours of the country in which they conduct business. Cold calling should therefore be allowed as from 8:00 a.m.

Rule 29:
This rule introduces a "frozen period" following the conclusion of a contract during a cold call, within which the contract shall not come into effect. A "frozen period" of 14 days, which may be reasonable if applied to traditional goods or services, is in our opinion inappropriate if applied to investment services. Market prices of financial instruments may fluctuate significantly within a period of 14 days. A "frozen period" of 14 days may exclude retail customers from participating in investments that otherwise would be interesting to them, such as subscriptions to new issues and IPOs. In connection with the privatisation of Norwegian stately owned companies, large scale marketing activities were as an example carried out in order to attract and ensure participation of a significant number of retail investors. A 14 days "frozen period" after the conclusion of a contract is in our opinion inappropriate and should not be applied to the area of investment services.

Rule 64, e):
The drafted rule 64, e) on customer reporting requires that investment firms unconditionally inform customers of the market on which the transaction was carried out. This seems unnecessary given the fact that the firm is under obligation of best execution and that it, according to rule 64, h), must inform the customer if itself, or a related party, was the customer's counterparty. Computer software is furthermore not developed to provide the required information on contract notes. This information does moreover make little sense with reference to a number of types of financial instruments, such as OTC foreign exchanges derivatives (e.g. FX forwards) and OTC interest rate derivatives (e.g. FRAs and SWAPs). Rule 64, e) should therefore in our opinion be altered and replaced by an obligation on the investment firm to provide the mentioned information "on request" by the customer, ref. the wording of rule 64, b), which would give the customer sufficient information and protection.

Rule 64, second paragraph:
This rule makes order confirmations mandatory as a matter of good conduct of business. We feel certain that many customers will not need, nor want to pay for, this service. Order confirmation should in our opinion be provided by investment firms upon the customer's request, by inclusion of such in the agreement between the customer and the investment firm (rule 86). This will allow for two service options to be chosen by the customer, e.g. (1) a low brokerage fee where no order confirmation is required and (2) a higher brokerage fee if the customer desires separate order confirmation. This more flexible attitude will in our view be beneficial both to competition and to customers' freedom of choice. According to the information we have received, retail customers rarely ask for, nor feel the need to receive, order confirmations. Retail customers trading online are moreover already today able to monitor their orders real-time online.

Given rule 64, b), it is furthermore our opinion that it should not be necessary and mandatory to state the time of reception of an order in the order confirmation, unless requested by the customer. It appears more relevant eventually to specify the typeof the order that has been placed, such as "best", "limit" etc.


Rule 67, first section:
The wording "send to its customer a monthly statement"should in our opinion be replaced by the wording "provide to its customer information". The current drafting makes the rules too detailed and rigid. Information (except from profit/loss reporting) mentioned under 67 a) and b) would e.g. need to be reported more frequently/earlier than monthly.

As to the obligation under b) to report on unrealised profit or loss, see comments on rule 67, c) below. Retail investors will typically trade options in connection with cash positions in securities. As different instruments may be registered on different securities accounts and with different investment firms, it may be impossible to provide the customer with the relevant combined profit and loss reporting. Reporting obligations of the proposed type is in our opinion more typically a task to be performed by a custodian, and should in any event not be a mandatory reporting obligation on the investment firms, but left to be agreed with the customer.

Rule 67 c):
This rule requires the investment firm to report to customers trading in derivatives the "resulting profit or loss". This will in practice rarely be possible if a customer puchases e.g. exchange traded derivatives through one investment firm and sells the same instruments through another investment firm. The proposed rule will implicitly imply an obligation on investors to sell financial instruments (such as exchange traded derivatives) through the investment firm where the instruments were purchased. This could distort competition and would in our opinion not be in the interest of the customers. Reporting duties on the investment firm related to profits and losses on derivatives trading should therefore in our opinion not be mandatory, but left to the choice of the customer, thus only provided upon the customer's request.

Principle 68, first section:
The interpretation of the notion of "legal capacity"is unclear and should be redrafted, or defined more precisely, in order to avoid doubt about whether reference by this notion is made to the customer's knowledge of legal matters, or rather to the legal structure of a corporate customer, or an employee's authorities and powers within a company.

Principle 68, second section:
It may be impossible in practice for an investment firm to comply with an obligation to know and more or less monitor the customers' internal trading restrictions. 

Non-professional corporate customers may often have internal restrictions on their interest rate risk exposure or foreign exchange exposure. Investment firms will rarely know the size of the customer's exposure, and accordingly not be aware of the customer's corresponding trading restrictions, since exposure may derive from other items (e.g. exported/imported goods and services) than from financial instruments.

If the customer does business with more than only one investment firm, only the customer himself will be in position to know his risk exposure, and thus his status with reference to trading restrictions. 

The drafted obligation may furthermore not be practiable to comply with even if the customer only is dealing with one investment firm if the customer's trading restrictions are related e.g. to interest rate risk. Interest rate risk may originate from products offered by different departments of an investment firm, such as fixed income securities, interest rate swaps, foreign exchange forwards etc. This may make it impossible for a large investment firm to monitor the customers' trading restrictions. The same applies for the cases where the customer is dealing with different branches of the firm, which may be placed in different time zones, and with different dealers.

The mentioned practical problems connected with the draft principles imposing a monitoring of the customers' trading restrictions by the investment firms, as well as the risk of litigation and abuse by some customers of the existence of such rules, may well be unacceptable to a prudent investment firm. It is therefore our opinion that monitoring of the customers' trading restrictions and "legal capacity"should not be mandatory obligations, but options eventually to be agreed with the customer in the customer agreement (rule 86).

Chapter 3 the "know your customer principle" and the duty to care:

The drafted requirements in rules 69-77 go far beyond present market practice in Norway. Investment firms with large existing customer bases will need significant resources and a long time in order to implement the proposed principles and rules with reference to existing customers. There is thus a need for "grand-fathering" the rules with respect to existing customers, or to allow for an adequate period of implementation.

Rule 81:
It should in our opinion not be necessary to make explicit reference to the risk warning if the customer confirms in a verifiable manner that he wants to proceed with a transaction despite the firm's advice that the transaction might not be suitable for him. References as the one drafted in rule 81 may also be difficult to implement, as confirmations are computer generated. There is also the risk that confirmations from the investment firm will become overloaded with information, given the complexity of the information that the new CESR conduct of business rules require the investment firm to provide in confirmations from the firm.

Rules 109 and 178:
The wording "and the corresponding price(s) and volume(s) in the relevant market(s)"should in our opinion be limited to exchange listed instruments, since the requirements make little sense related to other instruments traded in the OTC markets (e.g. FX forwards, interest rate swaps, FRAs etc). OTC derivatives moreover involve credit risk (and thus prices) which may vary with different customers, just like margins on loans may vary.

Core principles for "counterparty relationships":
The redrafting and proposal of a regime for "counterparty relationships" is warmly welcomed, and seems appropriate with regard to the large interbank market, particularly the market for OTC foreign exchange and interest rate derivatives.


A copy of this letter is also sent to The Norwegian Banking, Insurance and Securities Commission of Norway; Kredittilsynet.



Yours sincerely



Stein Sjølie
Director                                                                        Merethe S. Riddervold
                                                                                   Senior legal adviser


Enclosure