MiFID II – Major reforms or a big whoop?
So what exactly is MiFID II and, more importantly for our purposes, what are its implications for advisers? These are the questions we will be exploring here.
Back to basics
The FCA website tells us that “The Markets in Financial Instruments Directive” is the EU legislation that regulates firms who provide services to clients linked to ‘financial instruments’ (shares, bonds, units in collective investment schemes and derivatives), and the venues where those instruments are traded.
The Markets in Financial Instruments Directive (MiFID) is the framework of European Union (EU) legislation for:
- investment intermediaries that provide services to clients around shares, bonds, units in collective investment schemes and derivatives (collectively known as ‘financial instruments’), and
- the organised trading of financial instruments
MiFID was applied in the UK from November 2007, but is now being revised to improve the functioning of financial markets in the light of the financial crisis and to strengthen investor protection.
The changes are currently set to take effect from 3 January 2018. The new legislation is known as MiFID II — this includes a revised MiFID and a new “Markets in Financial Instruments Regulation” (MiFIR)”.
Further analysis
If you’re looking for more details, then the paper from Morningstar entitled “Making the most of MiFID II – how to get ready for the requirements” – is quite enlightening. The paper reminds us that MiFID II is an EU directive and will have a similar effect throughout Europe that the RDR had on financial services in the UK. Indeed, financial advisers in the UK already meet many of the requirements of MiFID II because of the changes brought about as a result of the RDR process.
Where MiFID II is likely to have greater impact is with product providers. “A lot of MiFID II is focused around transparency, protecting the investor and putting the investor first. Firms will need to remove conflicts of interest and demonstrate how they are helping the investor.”
To be honest, I must confess to finding it somewhat disappointing that we have gone through the RDR in the UK and now MiFID II throughout Europe, in order for financial services providers and firms to treat customers fairly.
The main angles are:
- Firms need to look at their internal and external controls
- Defined target markets for investment products
- Monitored distribution of investment products
- Market structure
- Pre- and post-trade transparency
- Fee transparency
- Clearer costs and charges for investment products
- Forthright fees for advice
- Investor protection
- Delivery of suitable advice
- Suitable product line ups
- Unbundled research costs
- Ban on adviser commissions.
This last element here – the ban on adviser commissions – is quite interesting. MiFID II prohibits independent advisers from receiving commissions and rebate payments. It will be interesting to see how the European regulators deal with this. Of course, in the UK, the FCA seems to have ignored or somehow missed the concept that rather than operating on commission, advisers can now receive provider-facilitated advice fees. So, what was the standard 3% initial and 0.5%/1% ongoing commission has been re-badged as adviser fees at the same levels of payment. Whether this arrangement will continue in the UK in the future may depend on how the European regulators police this.
Impact on asset managers and providers
One of the major changes that will have some impact in the UK is that after January 2018, asset managers will be required to provide investors and advisers more transparency on the costs of their products. The asset managers will need to show clearly the levels of entry & exit fees, performance fees paid by the fund and transaction fees related to the investment product.
Another effect that may become apparent in the coming months is a greater emphasis on providers to ensure that their products are being marketed to the appropriate clients. Previously, this issue has rested with advisers, but now providers will need to be reporting this. This could lead to advisers needing to report to providers in this respect. This may also lead onto the FCA’s wish for client investments to be regularly reviewed to ensure continued suitability to the client objectives. An nth degree upshot of this could be that the providers will require advisers to prove that reviews have taken place before renewal/trail fee payments are made.
A large amount of the impact of MIFID II will be on investment product providers, including fund managers, platforms, insurance companies etc. The European Securities and Markets Authority (ESMA) has produced a paper with the rather snappy title of “Regulatory technical and implementing standards – Annex 1 MIFID/MIFIR dated 28/09/15”. This document runs to 553 pages and appears to cover everything that a regulated provider would need to know, but were afraid to ask. Interestingly, the first chapter – Chapter 2 – covers transparency. Perhaps chapter 1 was actually the table of contents as personally I cannot see it. However, the fact that it leads with transparency sets the tone of the expectations of ESMA.
Record keeping
One rather scary item for advice firms from MiFID II is that firms are required to record telephone conversations and electronic communications that relate to “the reception, transmission and execution of orders, or dealing on own account”. These recordings must be held for at least five years. After consultation, the FCA stated “Based on the responses received and following extensive industry engagement, we have concluded that additional flexibility for all Article 3 retail financial advisers is appropriate. This is because the business model of many of these firms is such that a full taping obligation may not always be proportionate.”
“As such, we will propose that these firms, irrespective of size, can comply with the ‘at least analogous’ requirement by either taping all relevant conversations or taking a written note of all relevant conversations. The decision to tape or take a note should be taken at the level of the firm rather than in relation to individual relevant conversations or the relevant conversations of different advisers. This flexibility will not be available to MiFID investment firms which can be characterised as retail financial advisers.”
Some advisers will still not be entirely happy about making written notes. I should have thought that was quite an easy minimum standard of compliance. Surely, every advisory firm makes notes from telephone calls? Otherwise, how do you remember instructions received, or comments made by clients?
So, for most advisers in the UK, MiFID II is unlikely to have a huge impact as the RDR has dealt with most issues. For investment managers, the watch word in the future will be transparency, in particular, the unbundling of costs and charges and the clarity of charges to clients. Whether the clients understand what they are paying for, we will probably never know.
About Tony Catt
Formerly an adviser himself, Tony Catt is a freelance compliance consultant, undertaking a whole range of compliance duties for professional advisers. info@tonycatt.co.uk
