In an article first published in Finance Dublin’s August 2014 issue, Brian Binchy, MiFID II Solution Leader, and Shiela Nicoll, former EY Senior Advisor, discuss the benefits to thinking early about MiFID II. By managing regulatory challenges as part of their overall strategy, companies will capture market opportunities that elude those that view implementation merely as a compliance task.
It seems no time since we were tackling the complexities of the first MiFID (Markets in Financial Instruments Directive) and yet we are now already facing the sequel – in four volumes. A new directive (MiFID II) and a new regulation (MIFIR) have been finalised and now the European Securities and Markets Authority (ESMA) has issued a consultation paper and a discussion paper covering more detail, with the whole thing due to come into force on 3rd January 2017.
There is a danger of delaying doing anything as not everything is finalised, and to put off thinking about MiFID II for the moment. Procrastination is, however, not a good idea as the general direction and many of the broad strategic issues are clear. MiFID II is one of a range of key regulatory initiatives that will change market structures and business models.
Firms that start thinking early and manage the regulatory agenda as part of their strategic evolution will capture market opportunities that elude those that view implementation merely as a compliance task.
MiFID has traditionally focused on capital markets, and MiFID II brings in some significant changes in both equity and non-equity markets including the introduction of a consolidated tape; limitations on trading in dark pools and on high-frequency and algorithmic trading; mandatory position limits on commodity derivatives; more formal requirements for internal matching and cross systems; and, in particular, increased pre- and post-trade transparency and reporting requirements.
A very significant feature of MiFID II is the focus on investor protection issues. It is important not to overlook the significant implications MiFID II will have in terms of how firms conduct themselves and behave towards their customers. It has, in particular, the potential to fundamentally change distribution of investment services and products around the EU. It also reflects the regulators’ ever closer scrutiny of governance of firms, the product value chain (including a push against complex, higher cost products), suitability and getting a fair deal for investors.
MiFID II introduces a product governance regime which will result in investment firms having to set up an approval process for new products. This process needs to consider the type of customer who might buy it, the needs and wants of those customers and the inherent risks in the product, before determining the optimal route to market for the product. Product producers will have to provide distributors with sufficient information to ensure the product successfully reaches the intended target market, while the distributor will be responsible for complying with the relevant suitability and appropriateness criteria. Firms will also be required to periodically review the identification of the target market and the performance of the products they offer.
ESMA proposes imposing a positiveduty on firms to check that products function as intended, rather than only requiring them to react when detriment becomes apparent or at issuance/re-launch of the same product.
Another aspect of MiFID II is the ban in payment of ‘inducements’ to independent advisers and discretionary portfolio managers, – this means both product providers and distributors will need to think through their business models, distribution strategy and relationships. Distributors will also need to consider where their revenue stream will come from if not from commission or retrocessions.
The implications of MiFID II are, therefore, likely to be profound. Profitability will be affected as margins are put under pressure. The focus on product may lead to fewer products being offered with greater focus on the alignment of product and customer profiles. Providers are going to need to apply more scrutiny as to how and by whom their products are distributed – there will also be a requirement to communicate to distributors and end investors. The number of distributors is likely to fall and platforms, using technology to consolidate portfolios, are likely to grow further. Independent fund houses may find distribution more challenging if the response of distributors is to remain very firmly “non-independent” and thus continue to receive commission, but technology is likely to open up new distribution and advice models. Market infrastructure changes will force operating models amendments.
This, combined with technology changes, will require operational changes. As a result, firms are going to need to have much greater awareness of their cost base and product profitability.
There are still unknowns and debates to be had, for example, around whether asset managers should be continue to be allowed to pay for research out of dealing commission or the limitations on non-independent distributors receiving commission or retrocessions. Some inconsistencies between the client information requirements in MiFID II and PRIIPs (the Packaged Retail Investment and Insurance Products) Directive also need to be sorted out, but none of these are an excuse for inaction. Forward-looking and cost-conscious firms need to start thinking about the implications of MiFID II sooner rather than later. Firms need to be taking an integrated approach to shaping their strategies and projects to comply with MiFID II and other proposed regulations to prevent inconsistencies, costs and duplication. Now is the time to start taking action.