You may not have heard of the Markets in Markets in Financial Instruments Directive, or MiFID, but it is central to how financial products are provided and marketed across the European Union.
Now the directive is being updated so that “MiFID II” will come in force in January 2018, 11 years after the first legislation was implemented in the EU. The UK financial regulator, the Financial Conduct Authority, said that the directive is going ahead despite Britain’s planned exit from the EU in early 2019. Brexit negotiations have yet to tackle Britain’s trade relationship with the EU, so the revamped Mifid is set to be in force for at least a year.
MiFID II touches on many aspects of individual investing, including investment advice, how products are sold and regulated, information and costs. The overarching aim is to “enhance protection” for retail investors, according to EU regulator, the European Securities and Markets Authority (ESMA). In simple terms, this means greater transparency over the way funds are sold and a downward push on costs for retail investors.
MiFID II will strengthen current rules on how investment firms receive commission when they provide services to their clients. “In the future, any portfolio manager or firm which says they provide you with individual financial advice will no longer be able to accept or retain payments from a third party,” ESMA says.
Under the new directive investment advisers will have to be clear about whether the advice offered is strictly independent. Fund managers will have to provide more details about the risk profiles of each product they promote, and advisers in turn will have to look more closely at how this product matches the risk profile of their clients.
Checking Funds' Suitability for Investors
Companies, from asset managers to advisers, must have a detailed understanding of their products and whether they are suitable for retail investors. This is closely related to another tenet of MiFID II: that investment firms must “provide you with appropriate and clear guidance” about the risks associated with each product.
Under new regulations, discretionary fund managers must now tell professional clients such as financial advisers every time their portfolio drops by 10%. Currently there is uncertainty whether these advisers then need to pass this information to clients, and what form this communication would take.
Under MifID there should also be greater clarity on the cost of investments and the advice associated with it; product providers must be able to give an itemised breakdown on costs.
One potentially troublesome aspect of this focus on costs is connected with how research is currently provided and paid for.
What Research Does
Research is considered an integral part of what fund managers do and can cost millions of pounds a year. Some companies have in-house research teams while others buy in research. This research is targeted at financial professionals and is not meant for retail investors.
Research may be on macro themes such as the UK economy, or focus on specific assets or individual companies. The quality of research gives prestige to investment firms, bringing in clients, which lowers the cost for retail investors through economies of scale.
Under MiFID II the cost of research may end up being passed on to customers for the first time. Financial advisers fear that the retail investor may face higher charges as a result as these costs are passed down the investment chain. Some asset managers – among them Invesco Perpetual – have already said they are planning to pass on costs. The rest are either absorbing the costs themselves – such as JP Morgan Asset Management - or have not decided how to proceed.
Morningstar’s Head of EMEA client solutions Connor Sloman says: “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.”
Smaller or boutique asset managers may not be able to absorb the extra costs imposed by MiFID II, particularly those offering thematic or top-down research. These smaller firms will find themselves in direct competition with the bigger investment houses, which can more easily absorb higher costs from revenues in other areas.
Life After Brexit
One of the key issues in Brexit negotiations to be decided is that of passporting, which allows companies from one area of the European Economic Area to market and distribute financial services across borders.
If the financial services industry loses passporting rights, Britain’s withdrawal from the European Union could lead to a reduction in fund choices for investors. As an example, much of the growth in the fund industry in recent years has been driven by exchange-traded funds, some of which are distributed and marketed by European investment banks.
The City is lobbying for at the very least, transitional arrangements that will allow firms to plan better for life after Brexit. The best-case scenario for the City is that the UK government manages to negotiate a separate passporting deal for the UK. But this would involve Britain remaining as part of the European Economic Area, whose key tenet is the free movement of people and goods. The current fractious state of Brexit negotiations suggests that the City will not be allowed to keep its special passporting rights.
What does this mean for the UK investor? In the short-term, under Mifid, investors should have greater clarity over costs and pay lower charges. In the longer-term, if Mifid is replaced by UK legislation, advisers are concerned that the range of fund choices may end up being restricted.
Work in financial services and want to know what Mifid means for your business?
