Improvement of protection and transparency is mission possible
• Regulators take cues from northern climes and FSB will soon implement a type of Mifid 2
It doesn’t seem too logical for SA to import most of its financial regulation from the UK. With all the fuss about colonialism last year you would think it a most unlikely role model.
Yet whether it is the corporate governance of the King reports; the retail distribution review, which is changing the way financial products are bought and sold; or Mifid 2, which is seen as the model for market trading; our regulators take their cue from northern climes. No sign of drawing on our Brics allies, no importing of corporate governance standards from Russia or distribution rules from China, even though these might be more suitable role models for a developing country like ours.
The introduction of the retail distribution review has been slow. The headline change will be the abolition of commissions, especially upfront commissions on recurring premium savings products. There will be scope to earn commission on risk products, such as death and disability, but commission will be prohibited on replacement risk policies. The other main change will be the classification of advisers, which in the UK are divided between independents (a small minority) and the rest, who have the rather odd tag of “restricted”.
Financial Services Board (FSB) special adviser Leanne Jackson says the regulations have to cope with the reality of SA, with its widespread need for low-premium policies. For these clients flexibility, will be allowed in the somewhat bureaucratic suitability (financial needs) analysis regime.
Amazingly, certain quite obvious ethical requirements for advisers have only just been introduced. Only now the Financial Advisory and Intermediary Services Act general code requires advisers to take account of the needs of end customers. The FSB is also looking at the much-abused system of category I and 2 licenses.
Category 2 covers everyone from an adviser with limited investment experience who throws together a couple of unit trusts into a wrap fund, right up to a full-service asset manager. Yet investment management is treated as part of the advice universe and is not recognised as a separate licensed activity.
It makes sense to distinguish between entities that have a one-on-one relationship with clients — brokers or financial advisers — and asset managers who run a wholesale business with little if any contact with the underlying client.
Asset managers have not had tied agents but a form of dedicated distribution could be introduced through a new category called product supplier agent.
The FSB will soon be implementing some variant of Mifid 2. This might sound like a Tom Cruise spy movie, but it will be familiar to any reader of the Alex comic strip carried by Business Day. The headline feature is to end the fiction that fund managers get “free” research from stockbrokers, which is paid through brokerage.
There used to be a similar view that financial advisers provided “free” advice because the fee wasn’t disclosed, it was just embedded in the product fee — not that the product fee was remotely transparent.
Mifid aims for the removal of potential conflicts of interest to ensure “best execution” of trades. I am grateful to Brian Thomas, a portfolio manager at Laurium, for a succinct note on Mifid 2. By the way, Mifid is not some variation on Mission Impossible Force. It is the much less exciting “markets in financial instruments directive”.
There are three main aims of Mifid 2: to make European markets safer, more transparent and more efficient. It is highly unlikely that the UK, given its leading role in financial services, will opt out after Brexit. Such a regulation was necessary to restore investor confidence following the 2008 financial crisis. Another aim, very much in line with the JSE and FSB’s thinking, has been to move a significant part of over-the-counter trade to regulated trading venues.
The new rules don’t just affect the sell-side brokers or the buy-side fund managers, which are in its immediate sights. They will also affect banks, exchanges and other trading venues, pension funds, retail investors and high-frequency traders. Under Mifid 2, fund managers need to come up with a research budget, quantifying what they expect to spend. It will be interesting to see how much is set aside. In Europe and the UK it is quite common for asset managers to have very little in-house research and to rely entirely on the sell side.
In SA, fund managers are much more likely to do their own research, even a six-man shop such as Electus. Sell-side research is most commonly used to light braais. Will an Old Mutual or Allan Gray, both with very good research capability, really want to pay in cash for the often underwhelming reports coming from stockbrokers? It will be still less palatable as they will have to explicitly pass on the cost of research to their clients, unless they just absorb it. But in Europe 44% of fund managers are planning to source more research in-house and 78% plan to source less from the sell side.
In anticipation of Mifid 2 many on the buy and sell side undertake commission sharing arrangements. In this way a rand amount is paid according to the fund manager’s assessment of the quality and usefulness of the research. Once this has been paid, the stockbroker is simply paid for execution. The reality is that brokers who are good at research are not often also good at execution. I am looking forward to the day when stockbrokers return to their core competence of trading and leave research to independent research houses that work on a straightforward fee for service.
Thomas says European brokers have been scurrying around the major financial centres trying to sign fund managers to subscribe for their research. But it seems highly unlikely that anyone will subscribe for the 20 or more analysts who cover large caps such as Nestle and Unilever. The number of analysts covering a share looks likely to fall, and perhaps it’s about time. In the short term, the effect in SA will be reduced coverage of dual listeds such as British American Tobacco, Anglo American and BHP. Coverage of small caps will be hit even harder.
WILL AN OLD MUTUAL OR ALLAN GRAY ... WANT TO PAY FOR UNDERWHELMING REPORTS FROM STOCKBROKERS?