Requirements for greater investor protection under MiFID II will significantly impact a firm’s workflow – from product approval, marketing procedures, and the level of transparency in charges. Robin Poynder, Director at FMR Advisory explains.
Having attended the ESMA open consultation meeting in Paris on the subject of Regulatory Technical Standards (RTS) relating to MiFID II, it is worryingly evident that many institutions are still arguing for changes to the approaching reworked Directive and new Regulation – changes that are no longer possible as they are already written into Law. On 3rd January 2017 MiFID takes effect. Whilst that may seem a long way away, working back from that date and ensuring testing of developed technical infrastructure, it is quickly obvious that planning should already be well underway with early development in flight.
There are so many elements of MiFID/MiFIR that are going to affect the underlying markets profoundly – from trading platforms to transparency, from available liquidity to how a firm may interact with their customers. Much of the Directive is written with Retail protection in mind, but with profound effects on a far wider set of market participants.
Investor Protection
Those firms that operate in the UK will already be familiar with the level of Duty of Care that is owed to the Retail client sector. It is not quite as simple as this, but imagine taking swathes of that UK Retail approach and lifting it onto the EU-wide non-bank client sector. Without wishing to sound too alarmist, that is pretty much the shock that is about to hit the EU institutional markets. Many EU jurisdictions do not impose the same requirements that the PRA/FCA regime sets out in the UK. The additional burden will already be severe for UK based firms – for wider EU firms the additional burden is going to be extreme.
Without going into all the relevant areas of change, they include: revised client classification, more disclosure to investors, restrictions on inducements, product governance and distribution, requirements around independent advice, recording and record keeping requirements, extension of conflict of interest rules, increased service reporting to clients, detailed execution policy and transparency… the list goes on.
Rather than going through each item, imagine a prospective structured product that a firm wishes to sell, so that their clients can buy protection against market changes.
Product approval
Before the product can begin to see the light of day there will be a strict product approval process that must be satisfied internally to the firm, including a highly detailed definition of the target market and why that product is suitable and appropriate for those clients. Assuming the product is deemed suitable, the distribution method, either through the firm’s own sales force or third parties, must be defined and consistent with that identified target market.
Costs and charges
Costs and charges relating to any trades must be broken out and sent explicitly to Eligible Counterparties and their risk appetite and ability to absorb any possible losses, which will be transparently discussed with them, must be identified – and before you ask, only having a piece of paper signed by the client, saying that they are professional and happy to trade in a given instrument, will not be sufficient. The firm genuinely needs to have undertaken research into each client and be able to demonstrate a correct approach to each one. Any sort of cross-selling or packaging requires that the costs relating to the trade should be broken down with evidence of the charges relating to different components broken out.
Marketing material must be sent only to specifically targeted clients, for whom the products will be appropriate – no more fishing expeditions. A complete record of any interactions with that client that relate to any trades must be recorded, so that any future queries can be answered fully. Essentially a formerly executed trade must be able to be reconstructed from initial marketing contact, through any telephone conversations in which the trade was discussed and then through the trading technologies to settlement. Physical meetings with clients are part of this process and the obligatory minutes/notes of that meeting, will be signed by the client. Bear in mind that the phone conversations may have covered multiple trades, so each conversation will need to be tagged appropriately to identify each of those trades.
So what next?
The kind of process defined above and the related super-database to handle all that data flow, does not normally exist in financial institutions. The database access layer that currently sits on top of disparate historical databases in most firms, may not be able to handle the required relational back-links. Talk to any IT manager in your firm and when asked about how to develop that sort of capability the reply will almost certainly include the phrase ‘non-trivial’ – which is to say ‘really really difficult and resource intensive’.
Right now firms should certainly already be in the middle of a solid gap analysis, if not ideally already in the early development stages of the broad preparation required to be ready for MiFID. Various management teams will inevitably be looking at MiFID in a given firm, however that doesn’t mean that you can relax. The approach taken by the legal department will be entirely different from that of the operations team, which is again different from the sales desk. Each department has a completely different and valid set of concerns and needs to fully understand the impact of MiFID on their own area of business – and a view across all areas is an absolute requirement if a firm is to be certain that all elements are being correctly mitigated and prepared for.
The time available to manage process change, technical change and sales force education is running short and distractions due to implementation of other regulatory drivers are legion, but there can be no excuses. The time for waiting is past, the time for action is now.