MiFID II introduces many of the UK’s established principles of transparent markets across the EU, and lays down clear rights and protections for EU citizens.
In general, MiFID II requires firms dealing in or advising on shares, bonds, commodities or derivatives to improve transparency by collecting, reporting and publishing data on transactions, trading and advice. It covers banks, fund managers, exchanges, trading venues, wealth managers and, as we know, advisers.
Potentially the most significant part of the directive is to improve pricing transparency, with clients now able to obtain a breakdown of all costs associated with an investment. While this should lead to a more competitive industry, in the short term publishing fund transaction costs is bound to cause confusion among investors.
Media headlines of ‘fund managers’ hidden charges’ were unhelpful, when it should have been clear these are not revenues to fund managers, but the cost of buying and selling securities in the markets. Trackers and other buy-and-hold strategies should provide the lowest ongoing trading expense ratios (expect sub 0.2 per cent), while the most active stock-picking funds may show expenses exceeding their annual management charge (AMC).
Any professional fund buyer will take all costs into consideration, especially controllable costs like the manager’s AMC and ‘other fixed costs’ (OFC) that could dampen returns. However, transaction costs are far more subjective. Any manager worth their salt will weigh such costs and market impact against the potential gains before trading. If they don’t, or they judge poorly, transaction costs will quickly erode any benefit of changing the portfolio. No manager wants returns to suffer to the point where the fund underperforms its peer group. Therefore, the interests of fund managers and investors towards keeping transactions costs to the necessary minimums should be aligned.
In this respect, MiFID II has helpfully closed one area that presented a conflict of interest. Previously, the same security brokers who charged fund managers dealing commission also provided them with investment research, free of charge. Over time, the move to directly paid independent research should lead to less biased and more cost-efficient generation of investment research.
Lastly, financial reporting rules have tightened significantly. Now, clients of discretionary portfolio management services must be informed if the value of their aggregate investment portfolios falls by more than 10 per cent over the quarterly reporting period. Previously, there was not even a requirement to report portfolios’ investment returns to end clients.
In the run-up to MiFID II, the big question was whether the new rules would exert any influence on the ongoing liquidity of equity, bond, derivative and commodity markets. It was feared it would limit market participants and trading volumes.
The biggest concern was subdued dealing would lead to a tightening of liquidity across asset classes. Only time will tell. However, the early signs are the transition has been fairly smooth. This is good news for the industry, and excellent news for investors.
To download the Nucleus white paper MiFID II: A guide for financial advisers, prepared in partnership with Phil Young of Zero Support, click here
You can also download a paper produced by The Lang Cat and Tatton Investment Management on the impact of MiFID II on centralised investment propositions by clicking here