Heading into the autumn of last year, hands down the biggest regulatory issue facing European asset managers was the coming implementation of the updated Markets in Financial Instruments Directive (MiFID 2). Although the live date for MiFID 2 was originally scheduled for January 2017, there was growing disquiet in the industry that there was not enough time to implement the necessary changes. This concern was based on a combination of factors, including the sheer scope of MiFID 2 and the fact that many of the rules had not been finalized. Initially, the EU Commission and Parliament was resistant to granting a delay, since many feared that the industry might use the extra time to attempt to have the regulation watered down. However, the EU Commission and Parliament acquiesced and indicated they were willing to delay the live date until January 2018.
The news of the delay was greeted with a sigh of relief by the industry, but this is no time to take the foot off the gas with preparations.
ASSET MANAGERS TAKE ON TRANSACTION REPORTING
The biggest operational impact of MiFID 2 is on transaction reporting. Under the current regime, the responsibility for reporting rests with brokers, but under MiFID 2, the responsibility will shift to asset managers. One of the main reasons for the shift was that policymakers were not pleased with the quality of data received from brokers under the current regime, and they felt making asset managers responsible for reporting would improve matters. In addition, reporting expands from twenty-three to an expected sixty-five data fields and there are format changes to existing data fields. The change in responsibility for transaction reporting leaves asset managers with three options:
- Delegate reporting to brokers and develop a more robust oversight and compliance process
- Develop in-house reporting capabilities
- Purchase a third-party solution
Given the regulatory scrutiny, most asset managers have indicated that they will take responsibility for transaction reporting. The decision then becomes build versus buy with regards to system capabilities. With either approach, preparing for transaction reporting is a huge project for asset managers that will require a significant amount of resources for implementation and testing to ensure they are prepared.
ADDITIONAL IMPACTS ON ASSET MANAGERS
Beyond transaction reporting, there are a number of key issues that asset managers need to consider. On the distribution side, MiFID 2 will have an impact in several ways. Following the example set by the UK Retail Distribution Review, MiFID 2 will introduce a ban on inducements for independent financial advisors. Independent financial advisors will no longer be paid by the product provider; instead the client must pay for financial advice. In addition, asset managers must have a product approval process that identifies a target market for each product. There is also an obligation to review products regularly to assess whether the product remains consistent with the needs of the identified target market.
Under the new rules, asset managers will also be required to provide clients with a single aggregate figure of all costs and charges, and an itemized breakdown of charges must be available upon request.
Another key impact of MiFID 2 is that structured UCITS will be classified as complex products, which means that they cannot be sold to retail investors on an execution-only or non-advised basis. To ensure that investors have a clear understanding of what they are buying, investment firms will be required to apply an appropriateness test when they sell these products.
One of the most controversial aspects of MiFID 2 is another element inspired by the UK: the proposed unbundling of research costs. Rather than using “soft dollars” or paying for investment research as part of trading commissions, managers will be required to pay directly for investment research. This will require a specific charge for investment research that will be funded through a portfolio management fee or increased charges to the client. If implemented, this will likely lead to reduction in research available from brokers, as managers seek to control costs. However, after significant pushback from a number of EU countries, it appears that the proposals will be softened and that full unbundling will be avoided in favor of increased disclosure.
In the first half of this year, the EU Commission will finalize its rules for MiFID 2 and the industry will have a clearer picture of what lays ahead. The industry should take full advantage of the extra year that it has to prepare; January 2018 is not that far away!
This article was originally published in the 2016 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.