MiFID II will impact advisers too

For many that will mean ignoring it until such time as the FCA starts making noises or it gets more prominence in the press. The first part effectively started with the issue of a discussion paper (DP15/3) published in March which seeks preliminary views on a limited range of subjects, including adviser independence, discretionary fund manager commissions, costs and charges disclosures, recording of telephone and electronic communications and structured deposits.

Technical guidance published by the European Securities and Markets Authority in December 2014 seeks to put flesh on the bones of the directive, and it is here that items of interest, concern and opportunity for advisers and wealth managers will be found. The ‘Investor Protection’ section covers a wide range of subjects from conflicts of interest, client reporting and extra costs disclosure to record-keeping and product governance.

There are a number of interesting snippets that are coming to light, some of which have received more publicity than others. For example, there will be a requirement for quarterly reporting for portfolio managers – this can be done electronically, but the twist is that you must confirm the client has accessed the report. Sticking with reporting, there is also a requirement to report losses greater than 10 per cent, and the same on an instrument basis if it is leveraged.

While it may seem like another set of rules for firms to contend with, there are also some significant bright spots. Work done by the FCA over the past few years on suitability, independence, record-keeping and inducements, to name a few, has gone a long way to limit the impact on UK-based firms.

Indeed, consumer-facing firms familiar with the sheer volume of work in the MiFID II will appreciate just how much the FCA has done and what can be ticked off before starting. Firms in many EU countries will be playing catch-up to a large extent. A ‘thank you’ to the FCA, however begrudging, probably would not go amiss.

Advice

Choosing a subject to focus on is difficult. The ESMA technical advice on investor protection runs to about 180 pages, and firms and their trade bodies have already spent hundreds of hours poring over the words and trying to work out what it means in practice.

The FCA will be doing the same. One particularly thorny area is information costs and charges. For example, it is clear that advisers and wealth managers alike will be required to give much more information about costs, including a comprehensive total expense ratio for any funds used, and the aggregated effect on the client portfolio. But this is one place where the detail needs much more work. Another area that is clearer and could well benefit advisers and wealth managers is ‘product governance’, so that is worth a more detailed look.

At first glance most advisers and wealth managers may think this is just about providers. Not so. The rules in this area cover ‘manufacturers’ and ‘distributors’. In fact a ‘manufacturer’ is defined as anyone involved in the creation, development, issue and/or design of an investment product, so this will almost certainly embrace advisers and wealth managers in a number of situations.

In addition, MiFID II defines investment product in a much wider sense than most firms would anticipate, and as well as including funds, exchange-traded funds, and the like, some may be surprised that it also seems to include shares and debt securities where these are intended for sale to clients.

The rules on product governance are detailed. Many, as expected, fall on the manufacturer, but these will have a knock-on effect and it is clear they are focused on the eventual impact on the end client. There is a requirement for the people involved to be properly trained and/or have the necessary expertise to understand the risks of the product to both the market and clients.

Not surprisingly, charging structures come under scrutiny

There must be a formal process in place for product development, and the firm’s management body is expected to oversee and control that process. This will include a number of areas with ‘scenario analysis’ – assessing the risk of poor investor outcomes and what might cause them, being one – and product design must be driven by features that benefit the client, not by a business model that depends on poor client outcomes.

Not surprisingly, charging structures come under scrutiny. In particular, tax-advantaged products should not have those advantages significantly depleted by charges and the charging structure should be appropriately transparent with respect to complexity and disguised charges.

Of particular interest to advisers and wealth managers is the requirement for the manufacturer to identify the target market for the product. This must be at a sufficiently granular level to avoid the inclusion of any groups of investors whose needs, characteristics and objectives are not compatible with the product. It will even require manufacturers to consider the channel for distribution, so some products may be listed as only appropriate for distribution with advice or through a discretionary manager. All this information will have to be shared with distributors, which will help advisers and wealth managers better understand how the product was intended, and how it should be used.

This is all well and good for manufacturers that are governed by MiFID II. However, for non-MiFID products, for example manufacturers/fund companies outside the EU, the above requirements and burden falls largely on the distributor who will have to assess target market. Manufacturers who want their products to be sold in the EU may well be encouraged to comply with these rules as a result.

The information flow from the manufacturer to the distributor is not just one way. In return, distributors are required to provide information that enables the manufacturer to assess the performance of its products and check this against what was expected, especially with regard to risks.

This is likely to include, at the least, information about the characteristics of the clients it ended up with – in anonymous form where appropriate. Where problems or issues are identified, the manufacturer is required to take appropriate action and examples given include withdrawing the product, changing it, terminating the relationship with the distributor and informing the regulator.

Work to do

This article only touches on the requirements of the new product governance rules, which in turn only form a relatively small part of MiFID II. It represents a huge piece of work. The FCA’s final rules around encapsulating MiFID II will not appear until the middle of 2016, but no firm should be waiting until then. The impact on any particular firm is likely to be limited by the activities it undertakes, and firms should be taking the time now to look at which areas affect them and get ahead of the game. They may be pleasantly surprised at how much they already do – thanks to the FCA’s previous work – and there will be opportunities for taking advantage of the changes before other firms do.

Mark de Ste Croix is head of compliance and legal of Raymond James Investment Services

Key points

Under Mifid II there will be a requirement for quarterly reporting for portfolio managers.

The rules in this area cover ‘manufacturers’ and ‘distributors’.

Of particular interest to advisers and wealth managers is the requirement for the manufacturer to identify the target market for the product.