The second version of the Markets in Financial Instruments Directive (MiFID II) has implications for anyone seeking to sell funds in Europe.
(head of data services, Calastone)Steve Bennett
(head of conduct strategy, Aberdeen Asset Management)David Moffat
(group executive, International Financial Data Services)Simon Ellis
(global head of client segments, HSBC Global Asset Management)Sheenagh Gordon-Hart
(partner, The Directors’ Office)
Funds Global: Where are you at present in your planning and implementation for MiFID II?
Steve Bennett, Aberdeen AM:
MiFID II projects have been impacted by a delay in publication of detailed rules and the resulting lack of clarity about the actual requirements. At Aberdeen, we started our programme over a year ago and where there is clarity – for example on transaction and trade reporting – we’ve made good progress.
Where the requirements are uncertain, we’ve worked with the industry and regulators to try and find the right solution that meets the high-level intent of the regulation and is beneficial for our clients. One of these areas is ‘target market’.
Simon Ellis, HSBC Global:
For me, there is the upstream side and the downstream. Upstream concerns interaction between the sell side and asset managers. There has been a lot of heavy lifting in terms of technology to support implementation in areas such as the unbundling of research and commissions, as well as other technical issues. Yes, there has been a lack of clarity of exactly what’s expected of us as an industry, but it’s fairly clear what the direction of travel is.
Downstream pieces are the interaction between us as an asset manager, and the customer – whether end consumer or distributor. The industry has had to wait until very recently for the latest – hopefully final – set of delegated acts, which only came out in April. As an industry we have to puzzle out how distributors are going to respond to MiFID II, where it affects them directly. Again, it’s very difficult to do too much work there for the very simple reason that Esma has set some very high-level standards and principles and left it open for regulators – the Nationally Competent Authorities (NCAs) – to interpret the delegated acts.
We have been actively engaging with our distribution partners across Europe to help them understand what we think the situation is. Having our own retail and global private bank has helped with this. We hope local regulators will start coming out either with consultations or their first interpretations in the third quarter.
My experience of distributors is that they haven’t really been thinking too much beyond the inducements issue. For example, there is little consensus amongst distributors, outside the UK platforms, on the definition of target market or how they will meet the obligation to provide product providers with sales data reporting approach.
Fund managers underestimated the potential impact of RDR, thinking it was a distribution problem, not a manufacturing problem. A lot of distributors also waited until the last moment, so the lesson from RDR is to engage with them about how they will position themselves.
The other lesson from RDR is that MiFID II is not a one-off event that ends on impact day. Things happen afterwards. So we’ve emphasised with distributors the need to think about the direction of travel. MiFID II is part of a global phenomenon for regulators; it’s reasonably clear what they’re trying to achieve and difficult to argue that it’s not a good place to be.
In the UK, the Responsibilities of Providers and Distributors for the Fair Treatment of Customers (RPPD) has been in place since 2006/07 but firms haven’t quite known what is expected of them in relation to it. However, we know the regulators’ intent; we understand what they expect in terms of product governance. Now MiFID II has created the impetus for the industry to address the expectations of RPPD, particularly in relation to defining target market and addressing distributor oversight, in a systematic way.
However, in the rest of Europe this is a relatively new concept. Feedback from a number of trade associations suggests they see it as being more about compliance than recognising the regulators’ intent and its strategic implications. That’s a challenge for European firms.
David Moffat, IFDS:
Frequently the European rules-based approach to regulation does contrast quite sharply with the much more principle-based approach that we’ve become quite used to in the UK.
But the RDR has helped us recognise that there are some opportunities here with MiFID II. For example, it will present a much better picture of who’s selling the asset manager’s products, for what purpose and in what manner.
There is a sharp contrast between UK-based asset managers and continental businesses because of this.
Sheenagh Gordon-Hart, The Directors’ Office:
There is a problem in that European regulators create a regulatory framework for regulation and then Member State regulators expand on what their expectations are, potentially giving us 28 different rulebooks. So much for efficiency!
It’s a failure to not have a set of principles that an asset manager or distributor can, at their discretion and depending on the circumstances of the market, implement as they see fit rather than waiting for Member State regulators who may or may not be sophisticated enough to come in with a set of workable rules.
Local interpretation takes us down a route of individual implementation, market by market. A more harmonised and more cross-border jurisdiction-type approach has been created over the past 15 years, where European investors get the benefit of global scale and global standards – but MiFID II implies the conditions to unravel quite a lot of that may be created.
The industry is going to have to work harder at being heard and offering to share the burden of developing the regulatory framework, which is what happened in the UK 25 years ago. The fact this doesn’t happen now is a weakness.
Agreed, but I think the industry is starting to turn a corner in this regard. As an example, Aberdeen has been taking a very strong lead in working with the Investment Association, Tisa and the industry associations across Europe through the European Fund and Asset Management Association (Efama) with regards to target market and distributor market information. The aim is to propose a framework to regulators which addresses their concerns whilst being proportionate and workable for all parties in the industry.
From a transfer agency perspective, we are interested in certain MiFID II components around the definition of what consititutes a complex product and how they should be treated, and also around the ongoing monitoring of product appropriateness. I would say that what is coming from the FCA and Esma with regards to these issues is in line with what Efama has lobbied for, suggesting the industry is being heard about proportionality and that regulators understand the capability to collect every single snippet of data from every underlying investor does not exist. A sampling model would be better, proportionate to the complexity of the product. This would deliver a meaningful result and achieve what regulators are looking for.
Rob Swan, Calastone:
Generally I agree with much of what has been said: the platforms are clearly less engaged at this stage, their views are very siloed, and I do not think they see the larger picture. There are hundreds, if not thousands of platforms that many global fund managers are currently on and the complexities of collecting information is daunting. The fund management industry is coming together to work towards an industry solution – something that we don’t see currently on the platform and distributor side.
Individual distributors that I have spoken to will say they have a login that fund managers can download to get the information they need for MiFID II. But they have not considered the bigger picture that most firms they deal with may need information in a particular format or layout. This means that fund manufacturers will potentially have to collect information from every single platform and sort information from hundreds of different formats into one commonn format. There needs to be far more engagement from platforms and distributors for this to work and for them to work towards having an industry standard.
I fear that they have their heads in the sand, as they did with RDR. Worse still, as distributors are going to be hit hardest by MiFID II, they may look to see how they can raise revenue from it.
I agree, I think distributors are rather behind asset managers in grasping the full implications of MiFID II on their businesses.
The challenge of data volume and the number of different sources of data is huge. There are about 12,000 combinations of distributor and ISIN fund code in our Aberdeen UK and Luxemburg ranges alone. And that’s only distributors, not the direct holders – and that does not take account of the look-through the layers of intermediation!
Taking Cofunds as an example, we see only one entry per fund on our register – that figure does not reflect the number of distributors who use Cofunds as a platform. It is an enormous challenge.
Funds Global: What areas give you the greatest concern at present?
My greatest concern at present is the lack of engagement from distributors. I see that fund managers are now looking to work together to create an industry solution, however there isn’t any evidence of such engagement from distributors. Given it’s the distributors who will be the ones affected the most from MIFID II, this really does surprise me.
From the distributors I have met with, they are only looking at this from their own point of view and not giving consideration to the wider industry, which again disappoints and worries me.
MiFID II will give fund managers an understanding of their distribution chain that they may not have had in the past. In doing so, they will inevitably begin to question the amount of distributors they use. They will be looking to drive efficiencies from this newfound knowledge and this in turn, I believe, will lead to the reduction of the amount of distributors used. Do the distributors realise this? And if so, what are they doing to ensure their survival?
What concerns me more than anything is distributors’ reaction and their level of preparedness. At the end of April, there was a massive sigh of relief from the largest distributors across Europe when they realised that being non-independent would allow them to keep taking inducements. The head of one very large distribution bank in Europe said: “Well, that’s great, because we don’t have to change.”
I smiled inwardly because I thought this was an interesting view. They really need to think it through because their revenue is not protected when MiFID II’s requirement for advisers to be competent is combined with changes in the way remuneration works, and then the inducements rules and complexity.
There is even a lot of conditionality around them being able to maintain trail fees.
I’m in no doubt that within two to three years after implementation, the business models of every single distributor in Europe will be different than what they are today. In the UK we saw very quickly that mass-market distribution became difficult due to cost and risk, let alone the revenue side.
Much of the European distribution is predicated on a very simple mass-market distribution model. MiFID II creates the conditions for other entrants and those who’ve been struggling to compete on quality grounds to compete on price.
Absolutely right – and there are some important aspects of the inducement rules which may drive the changes Simon refers to. The requirement to demonstrate enhancement of service for the end customer, and that any inducement must be proportionate to that enhancement and only continue for as long as the customer enjoys that enhancement, has serious implications for rebates and trail payments. The proportionality requirement is particularly interesting when combined with cost transparency.
So distributors need to consider this: If you offer an execution-only service and an advisory service, what rebate will you expect for each? If the answer is the same for both, then the challenge is whether regulators are going to accept that the enhancement of service is the same for both. My guess is that they will view the protection afforded by a suitability assessment through the advisory service as offering a greater enhancement than is possible through the execution-only channel. This would lead to a differential in rebates between those two services over time.
This would also have implications for asset managers, as firms would find it hard to justify retaining more of the bundled management fee for a service regulators see as offering a lower level of enhancement. Quite rightly, they will expect us to pass this on to the end investor. Cost transparency is also likely to play a role here – ultimately managers may have to launch new share classes or find some other way of differentiating rebates to remain competitive.
We face a very fractured marketplace. It is complicated and costly enough to service the different markets and distributors already with multiple share classes. If, to continue to participate in individual countries and individual channels, there is even more proliferation of costs and risks around managing all these different channels, the implications are pretty clear. Firms will not want to compete in many different markets.
In Spain, the regulator’s view is that if there’s a cheaper share class available, then the distributor has to sell the cheapest available share class that is appropriate for that investor. But there’s an additional share class with an additional commission payment available. Unsurprisingly, it’s aimed at mass distribution where the advisers are paid sales volume commissions.
This ring-fencing of special terms designed to deliver special payments to distributors for the pain of selling to lower-end market customers will become very difficult and some distributors in Spain have told us they are probably going to have to forego that business going forward.
At the end of the day, the end customer gets a bad deal because the end customer, on average, won’t be able to get the investment saving opportunity that he/she needs.
If MiFID II is supposed to be about investor protection, it fails miserably.
I would challenge that. It is right to improve the competence of advisers and information providers; it is good that clients can see who’s doing what with their money and how much they’re charging for it; and right they are protected from being sold very complex products that are too difficult to understand.
Yes, though these sets of rules within MiFID II should’ve been on the table five years ago. Other big topics within MiFID II – such as high-frequency trading and pre and post-trade transparency in the fixed income market – make if difficult for the voice of the real investor and the asset manager to be heard. I believe investors will be totally confused by some of this.
I agree. MiFID II is happening against the background of a number of very well-established trends. In retrospect, it would’ve been better if some of the rules that are being carved out in MiFID had been part of the Markets in Financial Instruments Regulation to give more consistency of application across the whole of Europe.
The real risk is that MiFID II, by covering so many elements and leaving a lot to local regulators to apply, even down to the granularity of business processes, runs the risk of breaking the whole cross-border business model if each market becomes an atomised market within itself. Asset managers will have to make really quite hard decisions about which market to be in.
I am all for the transparency that MiFID brings. But the way it is executed is wrong.
I am a supporter of the inducement rules. If they are actually properly implemented as the words require and add value to the end customer, and if inducement is proportionate and time-bound, this could be a better result than a straight ban, which arguably could have contributed to the advice gap in the UK.
It’s a shame that regulation has had to act as the stick to make firms ‘understand’ their businesses to a greater degree. Just consider the efficiencies that could have been driven through had we just thought about how fantastic it would be to have a much greater insight into thedistribution channel.
Fund management firms have not had to take responsibility before and it’s been very easy to turn around and say, “Well, if there is mis-selling, I can just blame a platform or a distributor.”
The current drafting of MiFID II requires day-by-day reporting. Leaving aside the sheer impracticality of that, the reality is this is a ticking timebomb. The disclosed numbers will be way in excess for many asset managers of the underlying OCF [ongoing charge figure] and certainly the previously disclosed annual management charge. The reaction of the underlying consumer will be profoundly negative if they then conclude they have been badly misled historically and industry trustworthiness will fall further.
Funds Global: As with all new legislation, the concern is that it will increase the company’s cost base. How much impact will this have for you?
The obvious costs are mainly at the upstream end. The unbundling or research is something all firms are having to decide how to cope with. The cost of regulatory compliance; there’s a huge amount of regulation and we’ve all had to hire more compliance and legal people. And there is also the opportunity cost of having to spend time and resources on the regulation rather than doing other projects.
The big imponderable is what’s going to happen to revenues. The move towards much cheaper product of any hue, the implications of that for an industry which has been predicated on a fee model around active management and a value chain we were largely in control of, that’s ending. We end up in a commodity-pricing marketplace.
Ever-mounting costs are barriers to entry which I think is a really poor outcome.
MiFID II does the laudable thing of creating better integration between the product provider and the distributor. This means that there are going to be closer relationships between product providers and distributors – but with the result that there may be fewer such relationships. We may see small players, particularly those with a narrower product set, being squeezed out.
And a reduced number of platforms, which is a tough market to be in, they will all be selling mainly the same funds. There’s already no real differentiation between the funds that they’re promoting because the funds are those that have the biggest brand names they make the most revenue off.
In turn, platforms may try to charge for their market information data in order to raise revenue, which would also impact asset managers’ revenues.
If they do that, manufacturers will choose whichever platforms have the largest market share and you’ll end up with consolidation. Going down that route could be a catastrophe for the platforms industry.
In the UK, platform charges to fund managers for giving them services has been resisted quite successfully so far.
In the UK, there were some platforms that believed they could treat information they provided to asset managers, for them to complete their appropriateness requirements and disclosures, as marketing information and charge for it.
The FCA has made it very clear this cannot happen, but I don’t think that’s necessarily true across the whole of Europe – it’s a uniquely UK situation.
Some European distributors are talking about considering data supply as part ‘supplementary product’ to try and raise revenue. Well, this will mean fund managers end up with lots of supplementary products they have no intention of using!
There are some things they’ll just have to absorb as a cost of doing business. Unless they can say it clearly helps the client, they aren’t going to get paid for it.
Equally, that applies as much to fund manufacturers. An awful lot of activities that go on within the fund servicing side of an asset management business, such as custody, are essentially about taking costs out from the P&L of the asset manager and curiously letting it arise in the context of a charge on the fund.
If firms had to absorb some or all of that cost, many asset management businesses, particularly in the middle tier, will find that they are no longer profitable. Or we’re going to have to actually just find a much more coherent and much more direct fashion why those should be costs borne by the underlying fund and not the asset manager.
I just think, unfortunately, that our standing with the underlying consumer is such that we will not get much of a voice when it comes to trying to explain why some of this legitimately should be borne by the fund; and hence, we’ll end up being asked to eat a huge proportion of it.
Funds Global: How will asset managers deal with the requirements of ‘target market’, one of the chief concerns of MiFID II?
Most of my work has probably been this area.
There’s a requirement for asset managers to define a target market from a product-provider viewpoint, and make it available to a distributor. But equally important is the obligation on distributors to provide product providers with sales information to enable them to evaluate whether their products are hitting the defined target market.
Initially, I thought, we’ve got thousands of distribution agreements and hundreds of products. If we don’t have a common language, it is going to be chaos – for us and for the distributors. There was clearly a need for an industry standard. We started with Tisa and the Investment Association and developed a UK standard framework at the beginning of this year.
This was presented to Esma, and then we started working through Efama with the aim of reaching a broad European consensus.
The leaked Q&A from Esma provided us with a fantastic springboard for negotiations, as the proposal outlined in the leak was completely and utterly unworkable from product providers’ perspective. We simply couldn’t define target market in terms which are highly specific to individual circumstances. It was not appropriate for an intermediated marketplace.
However, using the nine elements from the Esma document (the UK framework already covered seven of them) and benchmarking the frameworks submitted by five countries, including the UK, the Efama working group reached a consensus for the European asset management industry, which Efama used as the basis for a letter to Esma.
However, defining the key elements is only a part of the framework – it is only useful if it drives ex-ante decision-making – decisions about how are you going to distribute, how you will market, the kind of due diligence needed, the kind of sales reporting you might look at, etc. You set that upfront before you’ve sent anything out to distributors and that provides you an ability then to frame what you need back in a way that’s proportionate.
We believe now that all we need from distributors in terms of sales data in the first instance is a breakdown by client type and distribution channel. We can use this to evaluate if there are any unexpected patterns and follow up with distributors as necessary. For example, if we saw high volumes of a more complex product through execution-only channels than we were expecting, this would act as a prompt for us to ask for more information from the distributors concerned.
The key point is you use target market elements to shape the decisions you take as a fund manager.
I think Esma is looking to make sure that firms are not selling a product that’s inappropriate to widows and orphans. This is the problem with defining target market. To define a client simply as ‘retail’, say, is not appropriate for all of the 90% of the population that might broadly fit this description.
It is at the end-investor level where the key stumbling block of this whole strategy comes in. A client could have lived in the US for the entirety of their life and moved to Europe in the last year and decided to put a little bit of cash into a high-octane fund while most of his/her money is still in the US. MiFID II might red-flag this just because there’s no history of this client outside of Europe.
That end-investor demographic information becomes irrelevant unless everyone is going to be tagged with an investment code that can be tracked anywhere in the world.
If regulators are trying to make asset managers or distributors responsible for individual client suitability, that’s a reach in regulation which is almost impossible to deliver, because our industry is based on a whole series of nominee structures or agency structures in between the maker of a product and the buyer of that product. So I don’t think that’s what regulators are trying to do.
We would resist that tooth and nail because we don’t want to be held responsible for an individual adviser selling something that is not suitable.
A suitability test exists under MiFID I and it’s very clearly the responsibility of the individual distributor to the individual consumer. I think what is being aimed for is to make that more effective by improving the possibility that the adviser really, genuinely understands the appropriateness of different products for different types of customers. Now, to expect us to understand the different segments in a distributor’s own mindset is impossible.
I think you’re quite right to say there’s no such thing as a retail customer, as such. There are whole categories of different customers. But it is incumbent on us to say, as an individual manufacturer, this product would be suitable for clients who are trying to achieve this sort of objective. The key here is you’ve got to tell them who it’s not suitable for.
It is in everybody’s interests, including the supervisors’, to have a common and proportionate regime that allows people to say this product is properly understood by the distributor, the target market is properly understood by the manufacturer. There’s a feedback loop to make sure that everyone knows that this is not being mis-sold. That’s what they’re trying to create.
I’m concerned that these broad categorisations don’t actually get where you need to go. And the other problem is the suitability at the point of sale is not necessarily something that continues throughout the fund holding period. The focus is on the asset manager and not enough emphasis has been put on the fact that the policing needs to be done at the distributing end. That is really where the focus needs to be. If you only have very general data from distributors, the feedback loop might not tell you about mis-selling risk.
Our focus is on defining the ex-ante decision-making process. The approach that we’re taking is to assess the product on the basis of whether a mass-market retail investor can make an informed investment decision based on the strength of the basic documentation alone. If the answer to that is yes, which it will be for the majority of Ucits, it’s OK to put this product out as execution-only and advertise it in bus shelters.
But for more complicated products, mass-market retail investors may struggle to make an informed investment decision. In which case, it may still be appropriate to make it available execution-only, for those more informed investors, but to limit advertising so that it is less likely to be drawing in investors who may be less able to make an informed investment decision.
The key is to develop the structures and governance processes to make appropriate decisions upfront, demonstrating that you thought through the product and its target market, and then oversee that sales activity aligns with this.
We know of some product types Esma doesn’t like. They don’t like funds full of derivatives or with liquidity constraints. It might even be asked if advisers understand them.
Funds Global: As with most pieces of legislation, it often produces opportunities. What opportunities do you see coming out of MiFID II?
Some asset management companies see MiFID II as a strategic business opportunity, not just as a compliance obligation.
Opportunities with MiFID II are to do with what you get out of it on the distribution side and how you can start to understand your business with much greater granularity. I suspect certain firms will move into the consumer market as a result but question why they are on so many platforms and therefore rationalise the platform range guided by revenue.
There are far too many asset managers running businesses based on poor-quality market information. It’s just ‘guesstimate’, little more than chasing every bit of distribution opportunity that arises.
MiFID II should force a much greater focus on markets and segments and, therefore, better strategic positioning.
Greater consolidation of the middle tier will play into the hands of the big, well-resourced organisations. But this clearing of the middle ground probably creates more space for small, specialist boutiques, as long as they remain very focused.
We will get better consumer outcomes as a result of MiFID II. I think we’ll have more honesty when the buried costs of active management are made bare and it’ll become much easier to make the case for active management when it becomes clear just how much actual value is added.
The quality of the IFA sector in the UK now is far better than it was five years ago and I think it’s the same here with MiFID II. A higher-quality industry creates the conditions for good-quality product and better-quality businesses.
But the transition from where we are today in terms of profitability and familiarity of process will be painful.
Large, well-capitalised, full-service asset managers like HSBC and Aberdeen will be able to forge deeper relationships with distributors across continental Europe. Those that are more specialist and mid-tier may struggle.
I also agree that cost transparency will lay bare some of the charges which are so egregious in parts of Europe that it’s difficult to see how investors can make any money in funds. There will also be opportunities for more fintech-like delivery of products into those markets and in the longer term, bank-driven distributors with high rebates might find it hard to compete.
Overall, consumer confidence should increase, which would result in higher savings rates.
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