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How the latest shake-up to finance rules affects you

We may be leaving the European Union, but not before new investment rules shake up financial services. Here's how 'Mifid II' affects investors.

How the latest shake-up to finance rules affects you

New European Union (EU) rules aim to make the charges and costs associated with investing clearer for private investors.

This wide-reaching piece of legislation, known as Mifid II, came into force on 3 January and affects banks, asset managers, traders and brokers. The rules intend to improve the way that investment firms and advisers communicate with their customers about performance and fees.

Mifid II is a second iteration of the Markets in Financial Instruments Directive, which was initially introduced in November 2007 to make equity dealing more transparent for private and institutional investors.

The rules now apply to businesses that provide investment or trading services for ‘financial instruments’, such as shares, bonds, units of open-ended funds and derivatives. Investment trusts and companies do not fall into this category because of their company structure, UK regulator the Financial Conduct Authority said.

Given that the UK is poised to leave the EU in March of next year, you may be wondering why these rules have been introduced. As the initiative has been seven years in the making, Mifid II was scheduled to be implemented long before the UK voted to leave the EU. This means that UK firms still have to comply with the rules – something that the Financial Conduct Authority (FCA) has been very clear about.

'Pounds and pence' costs

The UK watchdog’s asset management study, published last year, concluded that fee breakdowns for funds were unclear to investors. In some cases, the FCA found that transaction costs were not disclosed to investors or were estimated in advance, so they ran the risk of being inaccurate. 

Mifid II aims to rectify this situation by requiring investment firms to disclose all costs and charges relating to financial instruments and any ancillary services. For example, advisory, custodian, fund entry and exit charges.

Under the rules, costs must be outlined not only in percentage terms, but also in pounds and pence. As transaction costs vary from year-to-year and depend on market conditions, firms must disclose costs in two ways: ex-ante (forecast) and ex-post (costs that have actually been incurred). 

Asset managers, financial advisers, investment platforms and wealth managers must notify clients about the costs incurred at least once per year.

Research costs conundrum

Many fund managers use research from investment banks and brokers to help them to identify investment opportunities. The cost of this research was traditionally combined with trading fees and were typically passed on to the fund’s investors.

Under the new rules, fund managers will have to pay separately for research and trading costs. This ‘unbundling’ of costs has resulted in the majority of fund groups deciding to absorb the research costs themselves. The exceptions include Carmignac, Fidelity International and Crux Asset Management. The latter, founded by star fund manager Richard Pease, has raised its ongoing charges across its European Special Situations and European funds as a result of this decision.

The median cost for research for fund groups is estimated to equate to 0.1% of total assets under management, according to a survey carried out by the CFA Institute based on the views of 330 asset managers and investors across Europe. This is a sizeable cost for small fund groups, so they stand to be hit the hardest by the rules.

Fee structures are likely to change over the coming years in response to the unbundling of research and trading costs – a trend that is starting to emerge. For example, Fidelity recently cut its ongoing charge and introduced performance fees across its equity funds.

Ratings agency Standard & Poors expects wealth managers and fund managers to reduce their research budgets and the number of research providers they use. This is likely to result in certain parts of the market attracting less analyst coverage, particularly in the small cap and investment company space. This could create investment opportunities for asset managers with strong in-house research capabilities.

Are your investments appropriate?

The new rules aim to ensure that investors are buying products that are appropriate for their needs and expertise. With this in mind, online stockbrokers like Hargreaves Lansdown and Fidelity must now assess whether DIY investors have the relevant knowledge and experience to buy ‘complex’ financial instruments, such as leveraged exchange-traded funds (ETFs).

Danny Cox of Hargreaves Lansdown said the so-called ‘appropriateness test’ will be in place for any new investments in complex financial instruments.

‘We need to make sure that people are not accessing products they should not be,’ Cox added.

If you use a wealth manager or financial adviser, they will also come under greater scrutiny to demonstrate that the investments they have selected are suitable.

More paperwork

If you invest via an online platform or stockbroker, you are likely to have received a letter from them asking for your nationality and a ‘national client identifier’, typically a national insurance number. For example, Hargreaves Lansdown wrote to 520,000 clients as a result of this Mifid II requirement. The broker has temporarily suspended trading on accounts where this information has not been received.

‘We and other brokers are making sure that investors have got the right identifying numbers for transaction reporting behind the scenes. We are making sure that all trades are valid,’ Cox explained.

Investment managers who run portfolios for clients on a discretionary basis are also required to notify investors within 24 hours if the portfolio falls by 10% or more.

While improved reporting should be welcomed, there has been little guidance about who has responsibility for notifying the client if a financial adviser has appointed an investment manager on behalf of their client.

Complicating matters further, the adviser is likely to administer the portfolio via an external platform. So, who is responsible for communicating with the client – the investment manager, the adviser or the platform?

‘In the absence of hard and fast rules this means that it is likely that each platform has developed different systems and definitions for the 10% calculation and the way the fall is reported,’ said Sarah Lyons, head of marketing at the Ascentric platform for financial advisers.

4 comments so far. Why not have your say?

Donald Chan

Jan 08, 2018 at 16:38

Just what we need - more paperwork. Yet still haven't sorted out the proper relationship between the investment manager, the adviser or the platform.

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Jan 08, 2018 at 17:29

Nanny state, pointless over-regulation, typical of the continental EU mentality. I will now have to apply for and pay out for a stupid 'Legal Entity Identifier' every year just to be able to buy and sell normal investments in a small family trust I'm a trustee of.

We can't leave the EU soon enough. If there's no deal on services (and that doesn't include deals that we pay for or shackle us), just go WTO. The city would be better off in the medium term. (and they don't even know it).

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Anonymous 1 needed this 'off the record'

Jan 08, 2018 at 21:14

We wouldn't need speed limits on the roads if everyone drove sensibly and with due respect for others. All these rules are the result of not a few in the industry taking "unfair" advantage of customers. Putting the savings of 90 year old pensioners who might soon need care into equity funds with a 5% commission was not the worst of such sins.

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Jan 08, 2018 at 22:00

@jvl, the nanny state over-regulation is at least in part down to the FCA gold-plating the EU directives. And the WTO "understanding" on financial services is optional and not in any way related to the vital passporting that many financial services companies will need in order to survive post-Brexit.

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