Register to get unlimited access to Citywire’s fund manager database. Registration is free and only takes a minute.

Everything advisers need to know about Mifid II

Mifid II will gold plate the original EU directive’s requirements, and financial advisers need to be clear which regulatory changes will affect firms the most, writes the Chartered Insurance Institute's director of policy and engagement.

Transaction costs

Mifid II will give advisers information about transaction costs, including broker commissions, stamp duty and ‘slippage costs’. Slippage costs are those customers incur as a result of the time that lapses between placing an order and fulfilling it.

During this time, all other things being equal, the price of the asset is likely to increase slightly when assets are being bought, and decrease slightly when assets are being sold. For funds that trade frequently, this cost drag is likely to be greater than funds that trade less frequently.

This information will be given to customers at the point of sale, and annually after the point of sale as a single figure. Under the Mifid II rules, asset managers will have to give customers a more detailed breakdown of transaction costs if they request one.

Some transaction costs, such as stamp duty and broker commissions are relatively easy to calculate, but others, such as slippage costs, have never been calculated before and require firms to compile historic data going back years.

The annual disclosure of charges in particular will be difficult to disclose because customers will have incurred different charges depending on when they went into and came out of a fund. Fund managers will have to calculate changes in transaction costs (perhaps on a daily basis) and then apply that to customers’ data to produce a personalised statement.

Fund managers do not like slippage costs, not just because they are laborious to calculate, but also because they contain a lot of irrelevant information about changes in the market that have nothing to do with the cost of investing, so much so that some slippage costs show up as a negative number. In other words they actually show up as a benefit to customers, not a cost.

Fund managers have suggested that instead of slippage costs they should disclose spreads between buying and selling costs but the Financial Conduct Authority (FCA) is resisting this. It thinks fund managers will use different methods for calculating these spreads, which will not be comparable.

What it means for advisers

This will increase the information available to consumers, and enable advisers to make comparisons between different funds in a more detailed and insightful way. However, just because customers receive more information, they may not be able to use it, especially because transaction costs relate to processes that customers have never seen or experienced.

This hands advisers a significant opportunity to add value by explaining what this information means, and how clients should use it to make investment decisions.

Transaction costs

Mifid II will give advisers information about transaction costs, including broker commissions, stamp duty and ‘slippage costs’. Slippage costs are those customers incur as a result of the time that lapses between placing an order and fulfilling it.

During this time, all other things being equal, the price of the asset is likely to increase slightly when assets are being bought, and decrease slightly when assets are being sold. For funds that trade frequently, this cost drag is likely to be greater than funds that trade less frequently.

This information will be given to customers at the point of sale, and annually after the point of sale as a single figure. Under the Mifid II rules, asset managers will have to give customers a more detailed breakdown of transaction costs if they request one.

Some transaction costs, such as stamp duty and broker commissions are relatively easy to calculate, but others, such as slippage costs, have never been calculated before and require firms to compile historic data going back years.

The annual disclosure of charges in particular will be difficult to disclose because customers will have incurred different charges depending on when they went into and came out of a fund. Fund managers will have to calculate changes in transaction costs (perhaps on a daily basis) and then apply that to customers’ data to produce a personalised statement.

Fund managers do not like slippage costs, not just because they are laborious to calculate, but also because they contain a lot of irrelevant information about changes in the market that have nothing to do with the cost of investing, so much so that some slippage costs show up as a negative number. In other words they actually show up as a benefit to customers, not a cost.

Fund managers have suggested that instead of slippage costs they should disclose spreads between buying and selling costs but the Financial Conduct Authority (FCA) is resisting this. It thinks fund managers will use different methods for calculating these spreads, which will not be comparable.

What it means for advisers

This will increase the information available to consumers, and enable advisers to make comparisons between different funds in a more detailed and insightful way. However, just because customers receive more information, they may not be able to use it, especially because transaction costs relate to processes that customers have never seen or experienced.

This hands advisers a significant opportunity to add value by explaining what this information means, and how clients should use it to make investment decisions.

Complex products and the appropriateness test

Mifid II will ban execution-only sales of complex financial instruments to retail customers. These complex instruments include derivatives, but do not include Ucits (except for structured Ucits, which pay out according to a pre-defined formula).

All customers wanting to buy complex financial instruments without advice will have to pass an ‘appropriateness test’ to see if they have the necessary knowledge and experience of investing. Interpretations of what an appropriateness test is vary, but the FCA has said customers are not allowed to self-certify, for example, by answering ‘yes’ to the question ‘do you have the knowledge and experience necessary to make a decision about buying this product?’

There is some debate over whether customers have to do an appropriateness test if they already own a similar investment product.

Appropriateness tests can vary according to how complex the product is, and it is likely the least risky types of complex products will have an appropriateness test that discloses certain risks in detail, with a tick box to confirm they understand the risk. The most risky products are likely to have more elaborate appropriateness tests.

There has been much debate over whether non-Ucits retail schemes (Nurs) should be classified as complex. The European Securities and Markets Authority (ESMA) thinks they should be, because they can include a wider range of investments than Ucits funds. However, the industry has argued Nurs funds are so similar to Ucits funds they should not be complex.

The FCA said: ‘As in Mifid, non-Ucits retail schemes and investment trusts are neither automatically non-complex nor automatically complex. They need to be assessed against the criteria in the Mifid II delegated regulation. When firms apply these criteria, they should adopt a cautious approach if there is any doubt.’

If Nurs funds were to be considered complex, a large number of retail funds sold on a non-advised basis would have to be sold with an appropriateness test.

What it means for advisers

If advisers sell funds on a non-advised basis, they are responsible for deciding if an appropriateness test is necessary and what form the test should take. This will probably be rare, because most funds will be considered non-complex. However, advisers will need to decide what their overall approach will be, and how this relates to the funds distributed on a non-advised basis.

Product governance

Mifid II requires product providers to define a target market. Advisers must tell a provider how many of their clients were inside the target market when the provider’s products were recommended. This means advisers must have systems to record whether or not new customers are in the target market, and to communicate this information to all fund managers.

There is a danger the product governance requirements could balloon into a highly bureaucratic process. For example, if advisers are required to track whether a client remains within the target market throughout the lifetime of the investment.

What it means for advisers

The FCA has said it does not want unnecessary bureaucracy, so it is important advisers keep talking to the FCA about what should and should not be part of the process, to stop it growing out of control.

Recording telephone conversations with clients

The Mifid II provisions require ‘recording of conversations and communications with all clients where these relate to or intend to lead to the conclusion of a transaction, even where the transaction is not concluded.’

Mifid II requires these or ‘analogous’ requirements to be imposed on all advisers. The FCA has recently said the record can be written up by the adviser afterwards instead of being recorded. These requirements currently do not apply to advisers that do not hold client assets.

What it means for advisers

These requirements will introduce significant process changes for advisers. There will be particular challenges, for example, where advisers use personal mobile phone numbers for work.

Reporting to regulators

Stockbroking services must report data about trades to regulators, in order to get a better handle on what is being traded and by whom – in an attempt to gather data to track market abuse.

The number of items stockbroking services have to report to the regulator, including platforms that offer stockbroking services, is increasing, from around 24 to 65. This means big systems changes with narrow deadlines.

What it means for advisers

Not much, unless they run a stockbroking service.

Definition of independence and commission

The EU has followed the retail distribution review to an extent by banning commission payments, but only for advisers that label themselves as independent.

What it means for advisers

Little impact on advisers.

Inducement rules

Mifid II tightens existing inducement rules. The most significant one will be the banning of the rebating on inducements to portfolio management. The logic is providing rebates creates a ‘ceiling’ for fees. This means the provider offering the rebate is giving signals about the remuneration that could be taken, which undermines competition.

What it means for advisers

Limited significance for advisers.

Changes to rules on best execution

There are more prescriptive rules about best-execution requirements, including disclosure to clients about the choice of execution venues. These will apply to portfolio services, and some of the rules will apply to advisers.

What it means for advisers

The FCA has said that for adviser firms that do not look after client funds: ‘We believe that implementing the new requirements will not entail any significant material change.’

Rules on paying for research

Up to now, wholesale brokers have conducted research and ‘sold’ it to fund managers by bundling up research with the commission charged on buying and selling assets in the wholesale markets.

This cost has not been included in the charges that are disclosed to customers, so the only way they have of knowing about the cost is on the effect it has on their investment returns.

Under Mifid II, research will have to be paid for either:

  • By fund managers from their own resources, ultimately funded by product charges.
  • From a specific account that can only be used for research costs. Transfers to this account from customers’ funds have to be disclosed to them.

It will mean significant systems changes for fund managers, and will end cross subsidies in research costs between large and small fund managers, so it could create problems for some small fund managers.

What it means for advisers

There will be more transparency for customers. If some fund managers are to be believed, this will be balanced by a slightly small number of fund managers in the market.

Mifid wheel of relevance

This diagram ranks the regulatory changes from most to least important for advisers.

Comment & analysis

Twitter