We all bemoan changes in regulation, but it does not take much time before the new standard becomes the norm.
Whilst 3 January 2018 may seem a long way off, the delayed introduction of Mifid II is bringing some significant implications to investment businesses as they look to plan operational changes in the coming year. Therefore it is important to embrace the changes and see if there is an opportunity to proactively enhance our relationships with clients.
An example of this is the new requirement to tell a client if their portfolio has dropped by 10% since the last time they had a regular report. Irrespective of the clients agreed risk strategy, the requirement is that we must report a 10% decline, and multiples of 10% thereafter, ‘no later than end of the business day in which the threshold is exceeded’.
This presents several problems for traditional firms. If we exclude the impracticalities of putting in place an intra-day revaluation process and use yesterday’s closing price to assess this new obligation, then firms have until the end of that day to communicate this 10% drop to the clients affected.
Enhancements to the firm’s database, to store the last reported market value and make this calculation daily, is relatively easy and in normal market conditions this should not really present a problem. However, in an exceptional market such as 2008, you could envisage a situation where almost every client needs to be contacted within one day! This means that at the very moment when your portfolio manager needs to be working hard to maintain, assess, research and decide how to manage all their client portfolios, they are deluged with a sea of calls from panicked clients looking to get immediate answers. Whilst you can see where the regulatory authorities are coming from, it is possible to envisage a scenario where the rule could become counterproductive.
For the above reasons, we are considering how best to communicate this rule change to clients to prevent creating a panicked reaction to a situation and, potentially, making it worse.
Clients confer discretion of their portfolio so their assets can be managed in a professional and considered way. A client’s emotional reaction to six o’clock news headlines referring to ‘billions wiped off share values’ and then a letter from their portfolio manager could cause them to decide to sell everything at exactly the wrong time.
Ironically, another proposed Mifid II change: a requirement for mandatory quarterly reporting could help with the above issue. The more frequently you report to a client, the less the likelihood that their portfolio will fall by 10% and trigger the above client communication.
Quarterly reporting is already the norm for most firms, but some have legacy systems, processes and clients who have selected a longer reporting period. Once again, this is an opportunity to communicate this change to clients in a positive way. For most clients, regular contact and reporting is considered a positive thing and builds the relationship between the client, their portfolio manager
and the firm.
Within these regular reports there is the new requirement to provide absolute transparency regarding the costs of managing the portfolios; both in cash and percentage terms. This is obviously beneficial to clients, but firms need to be clear on the added benefit they are providing when the value of the portfolio is down and costs have added to that underperformance.
Firms must also be able to provide a full detailed breakdown of those costs on demand. There is also a requirement to disclose ‘ancillary services’, which means platforms and collective funds purchased. So, not only must firms change the structure and detail of client reports, but there is also the need to source, and store, the data that will enable the firm to aggregate those costs in accordance with the new rules.
Another new development being introduced for investment firms, is transaction reporting; something that was previously left to the broking community that executed our trades. Now we must disclose the underlying client identifier, the decision maker (portfolio manager) and the executor for every trade. That is a huge amount of data that needs to be collected, collated, checked and transmitted on a daily basis.
Most UK clients will have a Legal Entity Identifier (LEI) in the form of a National Insurance number but for overseas clients the rules are different and in the case of Non-Personal clients (e.g. Trusts) they will need to apply for an LEI. I would suspect that most trustees are not even aware of this requirement.
It is clear the authorities are looking to take in huge volumes of data to analyse trading and spot individuals behind nominee names. I would suggest that we should be making our clients aware that we will be sharing their trading data from the start of next year.
There is much to do to comply with the new rules from an operational perspective and it is important we keep our clients on side with developments so we can maintain our working relationships for the years to come and, no doubt, further regulatory changes.
Simon Ray is the group chief operating officer at European Wealth