How will the changes impact investment firms and benefit consumers?
Much has been said on how the Markets in Financial Instruments Directive (MiFID II) will change the investment services landscape. Come January 2018, the proposed changes will mean fairer, transparent and more accessible investment services.
MiFID II is a wide-ranging Directive. It will impact authorisation processes, conduct of business rules, and organisational requirements at investment services providers. The Directive also seeks to consolidate existing consumer protection measures with the introduction of new product governance requirements across the entire product lifecycle.
In addition, companies will face revamped requirements on the provision of investment advice. The changes impact inducements received by firms, cross-selling practices and investment staff remuneration. Consumers should therefore get a better picture on whether the advice they are receiving is actually independent and free from commission-related bias.
From an operational perspective, MiFID II will require firms to reconsider a number of key business decisions. This will include their commercial strategy with regards to product offerings, avenues to market and their relationships with suppliers. In addition, the sustainability of certain business models also comes into play. The new requirements may impact the viability of business models or even render them obsolete.
The expectation is that changes in business model are implemented with the consumer firmly in mind. There could also be benefits for investment firms. By reviewing current processes, efficiency may be improved. Firms may also develop new business models, diversify their revenue streams and attract new types of clients.
Investment firms need to focus on the key areas impacting consumers. Product governance and investment advice are two such areas. Best execution and suitability and appropriateness testing are also a point of focus. Understanding the impact of the requirements is critical to obtain the full benefit from the Directive.
Under MiFID II, the range of products deemed complex will be broadened. Fewer products will be able to be sold on a purely executiononly basis, without any assessment of the investor’s knowledge and experience. In addition the Directive aims to make product comparison easier. New client disclosure requirements will make it easier for both clients and competitors to compare product offerings. The involvement of departments such as marketing and product development is critical. This will ensure a comprehensive approach to product governance throughout the firm.
MiFID II will also require increased segmentation of target markets. Investment firms need to take reasonable steps to ensure that products are distributed to the identified target market. It is therefore important at this stage that there is ongoing communication between product manufacturers and distributors.
This will ensure that product strategies and distribution channels are aligned. It will also mean that investment managers with multiple distribution channels and robust links with distributors will be in a stronger position.
One key change is around independent advice. Claiming independent advice comes with strict obligations around disclosure and ensuring that a wide pool of products are considered when providing advice. In fact, due to the changes on inducement and remuneration, distributers may need to evaluate their business models in this area.
One solution could be to combine non-independent and independent advice. This would require the application of different remuneration models depending on the situation. Non-independent advice would be similar to the current model. Independent advice would involve a strict ban on inducements and a revised remunera- tion model.
Changes also need to be made to the current suitability and appropriateness exercise. New criteria now including an assessment of the clients’ “ability to bear losses” and risk tolerance. This needs to bring with it a change of mindset around how advice is provided.
For example, suitability must be assessed on different levels, both at an individual product and at a portfolio level. This clearly adds another layer of complexity. For example, a product may be suitable for a client on its own, but it may not be suitable when assessed in the context of the wider portfolio. So, if suitability criteria changes, such as client knowledge or risk tolerance, tests must be conducted in real time.
One final and important point within the changes relates to best execution. The European Commission only made subtle changes to the requirements, but they do increase the obligations of investment firms. Whereas under MiFID I firms had to take ‘all reasonable steps’ to obtain best execution, firms must now adhere to a stricter requirements.
This change ensures that all firms are measured against the same standard and no firm can delay ensuring best execution requirements. These require- ments need to be supported by policies which are clear, easily comprehensible and sufficiently detailed so that clients can easily understand how firms will execute their order. In addition, investment firms must now be able to demonstrate best execution not only to their clients, but also to the regulator on request.
The costs of MiFID II implementation are significant and the full consequences of the Directive remain unclear. What’s more, MiFID II will increase costs and reduce margins, as the increased costs are unlikely to be passed on to investors. This is mainly due to competition between firms and the increased disclosure requirements under MiFID II making charges more transparent for investors.
Investment firms are likely to face a broad set of challenges as they work to implement their response to MiFID II. They will need to take an integrated to ensure a successful, cost-effective implementation of the requirements. Their response will need to consider the full end-to-end impact, across the business. The time left before MiFID II goes into force should be wisely employed to ensure compliance from day one.