Investments  

How to report virus-triggered 10% portfolio falls

  • Explain what the MiFIDII 10 per cent depreciation reporting rule is
  • Describe who it applies to
  • Describe what the client response to it is typically
CPD
Approx.30min
How to report virus-triggered 10% portfolio falls

What is the 10% Depreciation Regulation?

The 10 per cent depreciation regulation was introduced to the UK (and the entire EU community) on 3rd January 2018, and was primarily intended for the purpose of introducing retail investor protection and to standardise practices across the EU.

One of the regulations introduced within MiFID II is generally referred to as the 10 per cent Depreciation rule.

Under Article 62.1, the specific regulation is described (in part) as follows:

"Investment firms providing the service of portfolio management shall inform the client where the overall value of the portfolio, as evaluated at the beginning of each reporting period, depreciates by 10 per cent and thereafter multiples of 10 per cent, no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next day.

Subsequent guidance was also provided by the European Securities and Markets Authority (ESMA) around the method of calculation of the 10 per cent depreciation.

While the method of calculation espoused by ESMA within the guidance papers gives mathematicians cold sweats, it does clearly imply that the reporting must be based on a Money Weighted return calculation method.

Note that MiFID II regulation does not apply to all asset types (such as Insured funds) but many industry participants have applied the regulation across the entire range of retail investment vehicles with a view to embracing investor protection in a consistent and transparent manner.

Interpretation of the Regulation

The 10 per cent Depreciation regulation applies to retail discretionary portfolios.

Discretionary portfolios are those where the portfolio manager is empowered to make and execute investment decisions without referring to the end client for approval.

In the retail context, discretionary portfolios are generally those where an adviser has discretion over their client or where a discretionary investment manager is managing a model portfolio and an adviser has allocated a model to one of their clients.

The regulation clearly places the onus of reporting on the investment firm providing the portfolio management service to report.

The regulator has also made clear that firms should avoid any behaviour that might incentivise clients to add investments/cash that is invested for the purpose of avoiding the reporting on a portfolio depreciation.

Having the flexibility around calculation methods goes some way in trying to align different firms using different calculation approaches.

What Makes 10% Depreciation Complex

Onus of Reporting

The first and obvious complexity of complying with the 10 per cent depreciation reporting obligations is for discretionary managers who manage models on retail platforms.

These firms provide the portfolio management service but have neither any knowledge of the end investor nor any transaction history on which to make this calculation.

The solution has been that platforms, who are the source of truth for this information, run the calculations on a daily basis to detect where any reportable incidents have occurred and initiate the reporting process.

CPD
Approx.30min

Questions appear on the last page of this article.