Tomorrow, a revamped version of the existing Markets in Financial Instruments Directive, or MiFID II, is set to come into force across Europe, after seven years in the making.
As if that weren’t enough to get a European financial industry executive’s attention, this will be followed later on this year with the so-called Insurance Distribution Directive, or IDD. This will replace the Insurance Mediation Directive – also throughout Europe – raising the bar significantly on its predecessor legislation.
Both MiFID II and the IDD were brought in with incontrovertibly well-intentioned aims, of ensuring the best possible outcome for the clients of investment products being sold to consumers across Europe. And, it is widely hoped, this is what they will do.
However, the realities of the existing marketplace, coupled with an apparent lack of understanding of the respective industries involved by those drafting the legislation, may see some significant teething problems as they bed in, some financial advisers, wealth managers and others familiar with the legislation and the market have been saying.
As reported here two weeks ago, the European Securities and Markets Authority – responding to such concerns – announced that it was granting the industry an extra six months to comply with a key MiFID rule, which has to do with a unique alphanumeric code known as a Legal Entity Identifier (LEI), required of all the market’s players.
Around the same time, the European Commission announced a proposed seven-month delay of the IDD, which would push the start date back to 1 October, from its original implementation date of 23 February.
Below, in an update of an earlier piece that appeared here in September, Bill Vasilieff, chief executive of the Bath, UK-based international platform provider Novia Global, considers what MiFID II – the first of the twin regulatory hurdles the industry faces this year – will mean for the industry.
After what seems like an eternity in the waiting, MiFID II is about to arrive. In the end, it all happened rather suddenly, with the new regulations being hurriedly finalised in late July 2017, for the scheduled 3rd of January, 2018 start.
For many industry practitioners, by the time it was clear what was expected of them, the timescale in which they were expected to implement all that is required by the legislation seemed impossibly short, and for the last several months, the European investment industry has been scrambling to get ready. According to one published report, preparing IT systems to meet the MiFID II requirements was expected to cost more than US$2bn in 2017 alone.
The objectives of MiFID II were, and remain, fairly simple: to give the customer a better deal while ushering in a new era of transparency, and at the same time preventing market abuse, and injecting more competition into the trading of all asset classes, including equities, fixed income, futures and commodities.
Rather unfortunately, though, a patchwork of uncoordinated regulation currently exists in Europe – with disclosure and sales rules differing, according to the legal format of the contract – which, some have pointed out, could lead to product arbitrage as MiFID II comes into force, and ultimately, prove to be bad rather than good news for the consumer, as advisers promote those products covered by the weaker regulation, rather than those from more strongly-regulated jurisdictions.
A good example of how this might occur lies in the existence of a direct regulatory rival to MiFID II, the Insurance Mediation Directive, which governs the sales/advice of the ubiquitous – in many advisory firms, anyway – life bond product, which still routinely pays very high initial commissions. As mentioned above, it is due to be replaced by the IDD next month, but questions about how the two regulations will co-exist remain to be answered.
Disclosure and reporting
Fundamentally, MiFID II is all about disclosure and reporting. In summary, the key new regulations the industry will need to take on board include:
• Measures to avoid market abuse – in practice, this will see all decision makers who are involved in any way in any transaction to be reported.
This means that all decision makers will need to have a “unique identifier number”, as without it, they will not be able to trade in such “reportable assets” as ETFs, shares and investment trusts. (The deadline for this, as noted above, has been pushed back by six months.)
• New pre- and post-sale reporting of charges. Our interpretation of the rules suggests that this disclosure also applies to fund switches.
• Rebates from product manufacturers (including commission) will not be allowed once MiFID II comes into force, unless they are passed on, in full, to the investor, which moves advisers into the world of fees or ‘adviser charging’. But note – this rule only applies if an adviser labels himself as “independent”. Those who don’t identify themselves as independent would not need to comply to this.
• Quarterly performance reporting for discretionary fund managers. Linked to this is a new requirement, also for DFMs, to report to clients, within 24 hours, if the portfolio has dropped by 10% during any reporting period.
• A definition of “independence” that does not require an adviser to look across the entire investment universe, but rather to consider a “sufficiently diverse range of options”.
• A requirement for advisers to record telephone conversations, or at least take comprehensive notes of their conversations with clients, and keep these for a minimum of five years, or for the duration of the client relationship.
• New requirements on assessing investment suitability, which will now be necessary on an annual basis at least.
• MiFID II introduces greater governance on product distributors, to ensure that manufacturers and distributors fully and properly define their target audience for a specific product, and ensure that it is only delivered to that market. If a distributor believes that a particular product sale does not meet the target market identified by the product manufacturer, then the distributor will be required to report this to the manufacturer.
• New rules concerning complex products and restrictions on selling these to retail customers with the introduction of a requirement to complete an appropriateness test.
• An enhanced complaints regime is also being introduced, bringing potential clients, professional clients and in some cases, eligible counter-parties into scope.
There are also new rules concerning packaged retail investments and insurance-based products (PRIIPS), and a requirement for enhanced disclosure, with the new insistence on the use of key information documents (KIDs).
However, these two sets of regulations are not aligned, and we anticipate that many advisers will continue to choose to be regulated under the IMD rather than MiFID II in this area, and continue to take high initial commissions.
Nevertheless, the general direction of travel is clear — and there are an increasing number of advisers who are already adopting the “new model” way of working, by offering the more transparent and fee-based approach.
Wealthy investors, too, prefer this model, indeed have done for some time, though they currently tend to be hoovered up by the private banks.
Most advisers, though, will discover that they are missing out if they don’t adopt this new way of working, at least for some of their more higher-net-worth clients.
Bill Vasilieff is chief executive of Novia Global, a Bath, England-based offshore platform which went live in October 2015, and which caters for an audience of international advisers, wealth managers and intermediaries. Prior to coming to Novia, Vasilieff had been a co-founder of Selestia, the UK platform.
According to Vasilieff, Novia Global is 100% prepared for the start of MiFID II tomorrow.