The Mifid II requirement to notify clients if their portfolio falls by 10 per cent or more in a quarterly reporting period is nuts. If you don’t agree, I’ll convince you, but first a bit of background.

    The requirement, in the main, affects discretionary-run portfolios. The rules refer to ‘portfolio management’ which is defined as "managing portfolios in accordance with mandates given on a discretionary client-by-client basis where such portfolios include one or more financial instruments." Despite the reference to ‘client-by-client’, this applies to discretionary-run model portfolio services as well as traditional, bespoke discretionary management run via a tripartite agreement. We’ll come back to model portfolios shortly.

    On the whole, this exempts advisory portfolios. There is a particularly daft (even by Mifid II standards) rider to this in that if your client holds any leveraged financial instruments or other contingent liability transactions, for example, geared exchange-traded funds or investment trusts, there is a requirement to notify clients of a 10 per cent fall in those specific funds as well. This is an issue the FCA has been questioned on for some time and I’m reliably informed it has now verbally confirmed this is the case.

    Picking holes in this is relatively easy.

    • Why 10 per cent? Will it trigger panic selling?
    • Because the requirement to notify only applies to part of a client’s portfolio, such as the DFM-run element, it could give a misleading message about the client’s overall position. If the client’s total portfolio goes down by 10 per cent there is no requirement to notify.
    • If the portfolio goes down by 9 per cent on 31 December and 9 per cent on 1 January, straddling two reporting periods, presumably no notification is required?

    Where a model portfolio service is used it becomes more interesting…again, by Mifid II standards.

    When a model portfolio service is used and run on a platform, the DFM has no idea who the client is, but remains lumbered with the regulatory responsibility for notifying. Furthermore, as the notification has to be made the business day that the portfolio breaches the 10 per cent drop, the platform as custodian is the most reliable source for calculating that loss. I doubt many advisers would feel comfortable relying on their back office data for that level of consistent, daily accuracy.

    So the platform is the obvious tool for calculating which clients need to be notified. However, the platform does not have the obligation to notify.

    The adviser is already recommending the model portfolio service under an agency agreement and I fully expect to see the obligation to notify passed on to advisers via a revision to agency agreements terms. This is alongside the DFM’s responsibility to undertake an annual suitability assessment also imposed by Mifid II.

    As an adviser, you need to think carefully about the implications of this.

    The DFM cannot avoid their regulatory obligations, so the FCA should really go after them if the 10 per cent notification is not sent. An agency agreement is a way of you, as an adviser, contractually accepting the liability for issuing the notification on behalf of the DFM and potentially indemnifying the DFM from any costs should you fail to do it.  Fines tend to relate to turnover and ability to pay, so a fine on the DFM could be far greater than a fine normally imposed on your firm. Getting this wrong could be costly, particularly if any indemnity is not capped, and it might even be something to talk to your professional indemnity insurers about.

    Should you take this obligation on (and I struggle to see how a DFM can avoid passing advisers the responsibility, even if the liability is up for debate) you will need to understand how to discharge it. Not every platform is taking the same approach. If the platform is going to issue the notification for you, you will still keep the liability for it unless they provide you with an indemnity, which I imagine is unlikely. Wouldn’t you want to see the list of people the notification is to be issued to for double checking?

    One platform has suggested it will simply notify every client where the portfolio depreciates by 10 per cent, regardless of whether this is necessary or not. How comfortable are with that? The majority are offering the ability to provide you with a report of clients affected so you can issue the notification yourself. Do you have email addresses for clients or just postal addresses? If postal, do you have the ability to export and mail merge data and issue a letter in a day?

    The fact this situation will occur rarely gives me no real comfort. It will happen. If anything, it makes it even more likely that things won’t go to plan when it does happen.

    What we see in place for Mifid II compliance on 3 January 2018 is unlikely to be the finished article in this and other areas. I may have convinced you it’s all nuts, but there is an opportunity for platforms to continue to develop this as well as other client notifications. There is also a clear incentive for advisers to get better at collecting client email addresses if they don’t already. That won’t be a bad thing.

    And don’t forget: you must send out a notification for each incremental 10 per cent depreciation after the first 10 per cent. The first person to get to a 30 per cent notification be sure to let me know.

    To download the Nucleus white paper MiFID II: A guide for financial advisers, prepared in partnership with Phil Young of Zero Support, click here
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