The Ins and Outs of MiFID II

After much wrangling and debate, the industry is finally getting a bit more clarity around the Markets in Financial Instruments Directive II (MiFID II) explains Calastone’s managing director of data services Rob Swan.

By Soapbox

After much wrangling and debate, the industry is finally getting a bit more clarity around the Markets in Financial Instruments Directive II (MiFID II) explains Calastone’s managing director of data services Rob Swan. The Directive will come into force in January 2018, having been pushed back by one year as European regulators became increasingly mindful of the logistical challenges it posed for financial institutions within such a short compliance time-frame. This delay has been welcomed by market participants. Equally important has been the publication of MiFID II’s Delegated Acts by the European Commission in April 2016.

At the heart of MiFID II is product governance and the provisions contained within the Directive will have a significant impact on fund manufacturers and fund distributors. MiFID II is focused on investor protection and transparency, and seeks to prevent investors being sold fund products which are beyond their understanding and risk profile. At present, a fund distributor selling a product through an execution-only sale channel incurs responsibility if that product is not suitable for the end investor.

MiFID II will now require fund manufacturers to accept accountability as well as distributors for the products they sell. Manufacturers must ensure that their products are in line with the risk profile of their target market or face regulatory scrutiny and potential sanctions. It also obliges manufacturers to identify they have targeted the correct distributors and that the latter understand the products and have sound approval processes in place. This comes following a number of high-profile mis-selling scandals.

This will ultimately require operational changes to be implemented by manufacturers and distributors. Information sharing processes on products and distribution must be initiated between manufacturers and distributors, and data must be reported on a timely and frequent basis. Regulators are likely to demand evidence that this information sharing is actually happening. However, compliance with the rules is going to be a complex undertaking due to the sheer volume of data that will need to be collected, aggregated and reported.

The rules are extraterritorial and not just limited to EU-based buyers. If a Luxembourg SICAV uses a distributor which sells to Asia-Pacific (APAC) investors, the rules still apply. Given the diversity of distribution models globally, this could be a challenge for manufacturers although it is one they will need to overcome.

The data requirements are highly granular and will force manufacturers to understand their register beyond the nominee level (e.g. platform) and down to the end distributor, sub-nominee level (e.g. adviser firm). Building the technology to gather and aggregate this disparate data in a standardised format will be challenging. Distributors are prone to using legacy systems and antiquated technology, which can precipitate manual error and high costs. As such, some have called for a centralised market utility to obtain, cleanse and report the data to the relevant organisations.

Different markets are at varying levels of preparation. As with many European rules and regulations, product governance provisions are far from harmonised. A handful of markets have introduced rules on product governance, which does give them something of a head-start on MiFID II. The UK, for example, passed the Retail Distribution Review (RDR) in 2012 which obliged investment firms to assess whether their products were suitable for end clients.

Furthermore, the UK Financial Conduct Authority (FCA) has been keeping abreast of matters and has warned managers that funds in some circumstances had not been monitored properly on distribution channels. Holland has also introduced its own rules – detailhandel beoordeling (retail assessment) – in January 2014 which banned inducements between fund manufacturers and fund distributors. As with the UK, this legislation was enacted following revelations that mortgage and insurance linked products had been mis-sold to end investors.

Further Delegated Acts around MiFID II are expected over the course of 2016. Regulators need to clarify their individual interpretation while fund manufacturers and distributors need to determine how to adhere to the rules in this new market environment. One area of particular interest here will be how proportionality impacts the view on complexity and oversight requirements for individual products such as UCITS.