Confused by the latest investment regulation? We’re here to help. The Markets in Financial Instruments Directive (MiFID II) comes into effect January 2018. Described as a single rule book for financial institutions in Europe after an era characterised by conflicts of interest, the Directive aims to increase investor protection, transparency, product standardization and financial market stability.
For asset managers, MiFID II is driving further focus on costs and transparency. MiFID II’s unbundling of payments for investment research will prohibit asset managers from receiving research as a ‘free’ added-value service on the back of commissions paid for broker and investment banking services such as trading and execution. Instead, asset managers will be required to explicitly cover investment research costs from a separate account, or from their own profit and loss account, making the cost of research highly visible and forcing asset managers to better define and ascribe value to their research budgets.
Which Fund Providers Will Be Most Affected?
Mid-sized asset managers in Europe, and particularly those with limited resources yet wider research needs than more niche players, are likely to feel some cost pressures from this change. Less able to absorb research costs into their general business profit and loss accounts, the new transparency around investment research may deliver a disproportionate effect on their business models and we can therefore expect asset managers to make more considered and value-based choices when selecting their research providers, be they internal research teams or independent third-party providers.
Many of these asset managers are already facing headwinds, not least from the downward pressures on fees and the increasingly large flow of assets to passive products. The catalyst that is MiFID II is likely to bring further pressure.
Defining Who Funds are For
MiFID II will also require asset managers to define the target market for their investment products and provide this information to distributors. Morningstar strongly supports the discrete data-driven framework advocated by EFAMA, the European Fund and Asset Management Association, and other industry stakeholders. Such a framework will be vital for information to be distributed, validated and utilised efficiently and consistently within firms’ databases and systems across the value chain.
An objective approach to target market assignment, for example based on investment product type and portfolio characteristics, will also be important to ensure manufacturers are not disadvantaged by their products being screened out by distributors or investors should they take a more conservative approach to target market assignment than their competitors.
New cost transparency requirements are challenging manufacturers most in relation to transaction costs within investment products. However, there is now more clarity in terms of disclosure requirements across the four main cost types, being one-off, ongoing, transaction-related and incidentals. The recent clarification from ESMA, the European Securities and Markets Authority, that annual costs can be applied pro-rata when distributors report to clients will also simplify post-sale reporting.
MiFID II is of course much more than a compliance exercise, and firms are evolving their business models and distribution strategy to respond to resulting trends. In many cases the investment industry is already ahead of these changes and many of the firms winning today are those that got ahead of the emerging trends on their own. MiFID II will serve to further drive those trends and advisers and asset managers must be ready to adapt their business models accordingly.
This article was written by Connor Sloman, Head of Client Solutions, EMEA, Morningstar and has appeared in Professional Adviser magazine. If you are a financial adviser concered about how to navigate MiFID II, check out our page on how to prepare for the new regulation.
