Cost and charges requirements under Mifid II could "corrupt" investment strategies as consumers place too much focus on transaction costs outside of the wider investment context, the Investment Association has warned.
Mifid II requires financial services firms to disclose a breakdown of all costs and charges associated with a client’s investments, on both a forecast and actual basis.
The rules took effect in January 2018, with the intention to increase transparency of costs charged to clients and to strengthen investor protection.
But speaking at a Tax Incentivised Savings Association event in London yesterday (February 7) Mark Sherwin, senior adviser at the Investment Association, said there was a danger transaction costs under Mifid II were being interpreted out of context by consumers, as they focused too much on the cost figure.
Mr Sherwin warned transaction costs of funds were not comparable and it would be a "mistake" to attempt to do so, with some funds already having been shunned by investors because of the headline cost.
The policy could effectively place a "soft cap" on trading activity by managers looking to keep overall costs down, he said.
This was because the only way a fund manager could limit the cost would be to cut the number of trades they make, with the other components of the cost consisting of largely non-negotiable elements such as tax and commission.
In turn this meant a focus on the level of transactions costs may constrain investment decisions.
Mr Sherwin said: "The key thing driving transaction costs is the amount you trade, this is totally at the manager’s discretion as he decides whether he’s going to trade or not.
"If a fund has twice the transaction costs of another fund, the most likely explanation is it traded twice as much.
"So the manager can only make a meaningful change to the level of transaction costs by changing the amount they trade, but the effect of putting pressure on the volume traded means transactions might not take place that otherwise would have."
Mr Sherwin warned this outlook could "constrain investment decisions" and "corrupt investment strategy".
It would "effectively be a soft cap on the trading activity potential", he added.
Mr Sherwin also pointed to the problem that consumers could not see which funds were more expensive beneath the headline figure aggregated under the Mifid rules.
Alistair Cunningham, head of financial planning at Wingate Financial Planning, said: "Since it’s introduction last year it has been evident that the way the charges, particularly ex-ante costs, are calculated is problematic.
"That there is room for discretion in the assumptions and basis for the calculation pretty much invalidates the concept of having a more transparent assessment of cost.
"The solution would seem to me to mandate the way that charges are disclosed, and how we have a situation that different firms can produce Mifid II disclosures in a non-comparable way is beyond me."