Regulation  

Suitability and the advice process under Mifid II

This article is part of
Guide to Mifid II implementation

This means suitability needs to be at the heart of the entire investment process, from fund creation through to distribution, whether through a discretionary fund manager, investment adviser or electronic broker system, and these suitability checks must be conducted regularly.

According to Jennine Watts, regulatory solutions manager at SEI Wealth Platform, the impacts of suitability are “wider reaching”, meaning advisers must show not only whether the product was suitable, but also whether there were better alternatives. 

For example, advisers must be able to show a cost/benefit analysis that demonstrates whether another suitable product had lower entry or exit costs.

She says issues of suitability under Mifid II will also consider the increasing use of robo advice.

Ms Watts comments: “Inevitably, what all this means with regard to suitability of advised and portfolio management services is that the use of electronic processes does not diminish the firm’s responsibilities in any way.”

Moreover, advisers cannot just state to the regulator that they met the definitions of suitability, they “have to state how suitability is met”, Ms Watts adds. 

Application and scope

Who does the directive apply to? According to the FCA: 

•    interdealer brokers.
•    firms engaging in algorithmic and high-frequency trading.
•    trading venues including regulated markets, multilateral trading facilities, and prospective organised trading facilities.
•    prospective data reporting service providers.
•    investment managers.
•    stockbrokers.
•    investment advisers.
•    corporate finance firms and venture capital firms.

Jackie Beard, director of manager research services for Morningstar in EMEA, comments: “Advisers should start looking at their client base, the target market of the fund and who it is being aimed at. 

“I know it’s never directly comparable; for example, an institutional fund could be made available to retail investors and benefit certain retail investors. 

“However, the target audience of a fund is something that, under Mifid II, advisers should be considering and thankfully they will have information they did not have before.”

Yet Connor Sloman, head of products and client solutions for Morningstar’s EMEA division, points out: “Mifid II is not black and white for advisers when it comes to using target market information in their investment recommendations.

“There may be circumstances where it is appropriate for a product to be sold to an investor in a different target market, but advisers must justify their individual security decisions as enhancing the suitability or diversification of the investor’s portfolio.”

Regularity

Ms Gibson adds that regularity of suitability checking will be required from January onwards: assessing suitability is not a one-off exercise to be conducted at the point of recommendation only.

She explains: “The issues of due diligence and suitable advice are addressed through requirements of periodic suitability assessments and reports, which should also include advice on switching investments.”