MiFID: One month on - are investment firms still in the dark?

Before the go live date, asset managers and regulators seemed to be struggling to be fully prepared for the second iteration of MiFID. Luxembourg’s regulator, the Commission de Surveillance du Secteur Financier (CSSF), one of the more dynamic EU regulators, was, and still is, actively engaging into the topic and addressing the relevant questions for the investment fund sector, according to Evelyne Christiaens, Head of Legal at ALFI, the funds industry association of Luxembourg.

While the industry itself has generally worked hard to prepare for the advent of MiFID II, two principal areas of concern and areas of concern remain:

1. how to define the target market; 
2. how to deal with the question of inducements and research costs.
   

Under MiFID II, financial product manufacturers and distributors will have to define a target market, which is in-line with the client’s needs and requests, for each product.

This entails a shift of mindset and communications, with funds now needing to work with intermediaries to ensure a product’s suitability for various types of clients. The question of whether the fund or the intermediary initially establishes the target market is, in many cases, unresolved.

EFAMA has produced a target market template, which is a good starting point and has been endorsed by many fund associations. But, asked Florence Stainier, a Partner at law firm Arendt & Medernach, will this EFAMA document be sufficient for compliance purposes or should manufacturers provide more substantial detail on their funds? Some distributors may wish to receive additional details.

ALFI set up a working group to address this question. The thinking emanating from it so far is that manufacturers and distributors will have to compromise on who does the work. Although manufacturers – asset managers – are often not present at point of sale, they will almost certainly bear responsibility for ensuring a product is suitable. Another grey area is the responsibilities (or otherwise) of retail platforms offering execution-only services.

The creation by manufacturers of bespoke suitability documents is a possible alternative to the EFAMA template, said Ms Stainier. “But would that be recognised by intermediaries?” she asked. “And how should feedback be given to manufacturers about the type and quality of information provided?”

Apart from potential compliance issues, manufacturers have a vested interest to engage in the debate. This vested interest even applies to intermediaries who are not captured by MiFID, said Gary Janaway, COO of KNEIP, a data management company. “Some people think that if they don’t fall under the regulation, there is nothing to do,” said Mr Janaway, who chaired the roundtable.

“Strictly speaking, that is true, but commercially maybe not. You still need a commercial relationship - people won’t distribute your funds if you don’t fall in line. You still need your information to be correct, you need product governance and a target market. It will become an industry standard, much like a kitemark.”

Fund board members will need to keep abreast of this key MiFID II issue. They should be demanding concrete evidence, said Mr Janaway. That includes evidence of agreements, reviews and in particular action points. “As a board member, I would want to know straight away when things are going wrong, not three months after,” he added. The potential for non-compliance is particularly high when the risk profile of a fund is altered, potentially changing the target market.

It is clear, then, that defining the target market is not a one-time activity. “You need to know if the product is performing, if it is maintaining its risk limits,” said Mr Janaway. “The industry is moving to this level of transparency. It’s clear that January 3 2018 was just the start of a process rather than the end.

Deep into 2018, manufacturers and distributors alike will need to know if the right products were, after all, sold to the right people. If data collection and analysis was not in place before the January 3 start date, fund managers cannot hope to have this information to hand a year later.

The second area of confusion is around inducements and research. Under MiFID II, brokers must price research separately from execution, instead of bundling the two together with a single fee. Investment research must either be paid from a fund manager’s own account, which may be offset by increased fees, or through a separate research account. In other words, research cannot be used as an inducement to trade.

Asset managers have mixed views on how to deal with this requirement. Some are passing the costs of unbundled research through increased fund fees, while others are waiting to decide or plan to absorb the costs.

Important considerations are how research is valued and how payment is made. The UK’s FCA wants to see full transparency in fund prospectuses.

The costs of research, said Ms Stainier, have probably been underestimated until now. “It seems that currently about 70%-80% of bundled costs (transaction and research) consists in research costs”, she said. “So this may completely change asset management business models.”

The increased transparency will allow comparisons between funds and create an additional measure of competition. In particular, investors will be able to judge the effect on performance of higher (or lower) spending on research.

M’Rabti concludes: “Asset managers should not be surprised if this is an outcome of MiFID II: improved competition is, after all, one of the key objectives. It is a reminder that we are all here to act as stewards of investors’ capital. It must be positive for the end-investors. At Euroclear FundsPlace, transparency is the core of our entire solution. Making sure everyone in the chain has the level of control they need is paramount.”