Late last year, the FCA announced it was consigning the Mifid II 10 per cent depreciation rule to the scrap heap of history.
The move to throw out the often maligned and controversial rule after years of criticism got me thinking; should we really be throwing away something that wealth management companies spent years developing and collectively millions of pounds to implement?
Surely in 2023 where reuse, recycle and repurpose are the mantras of the moment, we can do better and take key learnings away from it?
The 10 per cent depreciation rule was enforced under the Mifid II regime from January 2018 and certainly unified the industry, just not in the way it was intended.
Initial concerns focused on whether portfolios have ever or will ever drop 10 per cent or more over a specific period – something that has been well and truly debunked in recent years.
Other concerns centred on the impact this would have on client behaviours – would they be sparked into a frenzy of panic selling? Lastly, there was also the operational challenge of actually applying the rule to investors’ portfolios with minimal impact on resources.
Surely in 2023 where reuse, recycle and repurpose are the mantras of the moment, we can do better and take key learnings away from it?As a technology provider offering a solution in this space, I know first-hand the challenges involved and it is clear that as an industry we failed to adopt the correct approach.
That is not to say that wealth companies did a terrible job. Before they even started to build or integrate the technology, there were already some tough questions to answer: Which calculation method should we adopt? Should fees be excluded or included? Does the rule apply to me?
The last point being pertinent for platforms with clients invested in discretionary managed model portfolios on their platform, as the rule points to the discretionary manager as being responsible for monitoring and alerting.
But how can they do that when they do not have visibility of the underlying client’s transaction data required to calculate performance, not to mention the fact that they typically do not know who the customer is?
The European Securities and Markets Authority (ESMA) tried to help by offering industry guidelines by way of a suggested calculation method. The problem was, this calculation method produced some strange and inaccurate results when compared to the more comprehensive performance measurement calculations.
As a result, many wealth management firms and platforms adopted calculation methods that were consistent with other performance reporting based on traditional money and time-weighted return calculations.
Contrary to the accepted industry view, very few clients actually invoked a panic sell.We were really intrigued by these challenges so we examined a cohort of 25,000 discretionary managed portfolios during the fourth quarter of 2018 and found that just under 5 per cent were reported during the period and around 7 per cent of models had clients who were reported during the period.
Using the method espoused in the ESMA guidance, almost 20 per cent of cases that should have been reported were not reported (with around 450 individual notifications being generated during a peak day).
Additionally, contrary to the accepted industry view, very few clients actually invoked a panic sell and we found only two instances where clients switched out of their model and fled to safer grounds.
So, numerous concerns about the ruling’s effectiveness seem ill-founded. However, whether it was a lack of budget, underestimation of how much effort was involved, scepticism as to whether this piece of regulation was here to stay, or scepticism on how frequently they would need to report, many firms did not build or buy in automated, elegant and seamless reporting solutions.
This meant that when firms needed to report, which our research shows were regular events, it was manually intensive and made it an operational burden that carried a lot of risk. This was demonstrated by some high-profile instances where platform technology got it wrong.
This did not need to be the case as there was technology available to make this a seamless and automated process in the form of micro-services. Along with the general scepticism of the regulation, this is why I believe it was scrapped.
Wouldn’t it be a good idea to tell customers when their portfolios move 10 per cent – be that positively or negatively?If we strip it back to basics and try to understand what the regulation was trying to achieve, there must be some reuse of the surrounding technology that could benefit the customer or something from the regulation we can reuse.
More regular alerting to better inform investors through consistent accurate reporting of portfolio performance can’t be a bad thing, surely? Wouldn’t it be a good idea to tell customers when their portfolios move 10 per cent or more over a period – be that positively or negatively?
We want clients and customers to be better engaged (at the right times) with their portfolios so alerting with positive performance could build that trust and encourage them to invest more, especially as our data shows the concern over panic selling was unfounded.
With a more robust and automated process, and consistency with other performance reporting, this could be something of great benefit to wealth management firms and their clients.
We have all the tools and technology available to make this a seamless process. Let’s recycle, not throw away. After all, single-use anything should be a thing of the past in 2023.
Tim Williams is business development director at FinoComp
