Wealth managers must not fall into the trap of thinking that Mifid II will only have a direct impact on the largest financial firms which are amply resourced to manage its complicated requirements.
In fact, of the 9,000 firms operating in the EU that will be affected by the legislation, at least 6,500 are small- to medium-sized firms (SMEs), including numerous wealth managers and family offices.
It is the SMEs, with a shortage of time and/or capital to devote to compliance, which are likely to have the toughest time complying with the legislation.
One requirement of Mifid II is that wealth managers keep detailed records of all services, activities and transactions they have engaged in for up to seven years – including intended transactions, even if they never actually take place. Firms must store these records in a digitised, tamper-resistant format and be able to produce them at the regulator’s request within a reasonable time frame (expected to be around 72 hours).
Such demands could put a huge burden on IT systems, with many wealth managers planning to upgrade their technology to handle the new levels of scrutiny. Any audio recordings of conversations that relate to transactions, for example, must be kept on file for five years – this alone will necessitate large amounts of storage space. More importantly, if a firm is not already recording voice communications, they must be prepared to do so.
In an attempt to improve transparency, Mifid II obliges wealth managers to send fund houses detailed reports on who is buying their funds. Firms will also have to inform retail investors more frequently about the performance of their portfolio. Among the regulation’s provisions is a ‘best execution’ obligation, which includes the requirement that firms disclose their top five execution venues for each class of financial instrument – on demand from its clients, its internal supervisory committee or its regulators.
Moreover, Mifid II overhauls the way wealth managers pay for investment research from brokers and investment banks. Fund managers will be prohibited from receiving research in return for placing trades with banks or brokerages. Instead, they will be required to pay for sell-side research separately, and to provide investors with a clear breakdown of the cost of any research they undertake.
A daunting prospect
All of this sounds quite daunting for small businesses and many are beginning to feel the pressure of the impending deadline. For wealth managers and family offices to best adapt to this transformation of the regulatory environment, they must first identify the parts of their businesses to which Mifid II applies, if they have not done so already.
The deadline for firms to apply for a ‘passport’ to undertake Mifid II-regulated business in another European country is 2 December 2017. To comply with Mifid II’s ‘best execution’ requirements, wealth managers should take pains to explain their approach clearly to clients, and ensure that they make client documentation a priority.
With regards to the requirement to pay for sell-side research rather than bundling it with their trades, certain firms may decide to bear the costs themselves rather than passing it on to their clients. But, according to the Financial Times, some banks have put forwards quotes of $10 million (£7.7 million) a year to provide larger asset managers with complete access to their research. Smaller boutique firms could struggle to meet the costs they are quoted without being put at a competitive disadvantage. Systematic management of research interactions with third parties could provide firms with an effective means to deal with their Mifid II research obligations.
The most important thing is for wealth managers to prepare for Mifid II as thoroughly as possible before it is implemented in January 2018. According to an estimate from EY, a typical medium-sized UK wealth manager is spending between £3-5 million on ‘getting ready’ for Mifid II.
That might seem an onerous amount to bear, but the cost of not doing so is likely to be much more severe – potentially including financial sanctions and reputational damage.
Even more of a threat, is that businesses who under-invest are likely to find themselves unprepared for the new market landscape – with resultant smaller margins and higher compliance costs. Making the right preparations for Mifid II now is the surest way to ensure that wealth managers do not fall behind their better-prepared competitors.