MiFID II… second album syndrome or
regulatory game changer?
Has MiFID II built on the success of the first directive or does it fall short in comparison to its predecessor?
MiFID II a guide for financial advisers
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What's the story with MiFID II?
Nevermind the first iteration of MiFID, MiFID II is the latest swathe of regulation that is currently giving financial services the bends. Getting to grips with the colour and the shape of this sprawling directive takes time and lots of planning. Let's begin with the warning, those who doolittle will find that after 3 January 2018 modern life is rubbish.
If you are paranoid about a late registration for an LEI or how the new client reporting rules will affect your business then we have all the information you need for your discovery and planning for a post MiFID II world.
What is MiFID II?
The MiFID II (Markets in Financial Instruments Directive II) came into force on 3 January 2018. MiFID II covers a broad range of issues and delving into the directive in more detail reveals that there is a substantial impact on adviser firms and individuals who are involved in the buying or selling of financial instruments.
MiFID has been around since 2007 and much of UK financial regulation comes from it, it provides the framework regulation for how investment services and financial markets operate within the European Union (EU).
MiFID II aims to dramatically reduce the risk of market abuse, strengthen investor protection and increase the efficiency of financial markets. It covers a broad range of issues, but we have focused on those which are most likely to affect you as advisers.
Manufacturers and distributors
MiFID II will categorise all financial institutions/firms as either a manufacturer or a distributor. These are broadly defined as:
- Product manufacturers – firms that create, develop, issue and/or design investment products. Fund mangers and DFMs will fall into this category
- Product distributors – firms that offer and/or recommend investment products and services. Platforms and advisers (who do not have discretionary permissions) will fall into this category
Watch the replay of the MiFID II webinar with Phil Young
Nucleus' most recent white paper, MiFID II - a guide for financial advisers has been prepared in partnership with Phil Young of Zero Support.
On this webinar Phil discusses the white paper and the context and purpose of MiFID II, how the FCA plan to interpret and apply it to the UK and how it will affect advisers, and what actions they will need to take to meet the changes in this legislation.
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MiFID II issues for advisers to consider
Third parties who have the authority to deal on behalf of an entity such as a corporate, charity or trust client (excluding bare trusts) will be required to obtain a legal entity identifier (LEI). Without an LEI an entity will not be able to sell or buy reportable assets such as equities, ETFs and investment trusts.
There is a cost of £115 plus Vat to obtain an LEI from the London Stock Exchange and £70 plus Vat per year to maintain it.
Discretionary fund managers (DFMs) and adviser firms with discretionary permissions will also require LEIs.
Should any of your natural clients transact in reportable assets you will be required to supply a natural person identifier (NPI). For the majority of your clients this will be already in place because for UK nationals a national insurance number (NINO) is sufficient.
For all other nationalities you must use the appropriate identifier as set out in the guidance by the European Securities and Markets Authority (ESMA).
The MiFID II definition of independence should make little difference to advisers who have long been compliant with RDR other than a broader scope of investments to be considered. MiFID II will include shares, derivatives and structured products as well as the current list of retail investment products.
There are however a couple of changes to this area that are worth noting:
- Adviser firms can continue to offer both independent and restricted advice however individual advisers can only offer one or the other
- An adviser firm can call itself independent even if it specialises in a niche area of the market provided this is made clear in its marketing
Before recommending a product or investment a firm must determine the clients suitability by assessing their objectives, their relevant experience and knowledge and their ability to bear losses. Much of the MiFID II requirements on suitability will not come as a surprise to advisers and most will already have this in built to their existing propositions to some extent.
Periodic suitability assessments are required for investment advisers and DFMs at least annually.
Suitability is already addressed in the regulator’s conduct of business handbook and a new section will be created just for MiFID business.
There is an expectation of more clarification on the implementation of these rules from the FCA.
Under MiFID II all investment products will be defined as either:
- Non-complex – these will be available to all types of clients
- Complex – these cannot be distributed to retail investors without a suitability or appropriateness test
Complex products currently includes all non-UCITS funds.
Prior to providing advice, all clients must be categorised as retail, professional or eligible counterparty (ECP). The most notable change to rules will be that local authorities will be deemed retail clients and will have to meet qualitative and quantitative requirements in order to opt up to professional or ECP clients.
You will most likely be dealing with retail clients but you should review your client bank as you may need to re-catogorise any non-retail clients.
MiFID II will impose greater governance on product distribution to ensure that manufacturers and distributors define their target audience for a specific product and ensure that it is only delivered to that market.
This will require a greater flow of data regarding products and client suitability to flow between manufacturers and distributors. The European Securities and Markets Authority (ESMA) already issued guidance on product governance.
Manufacturers will need to provide distributors with information about the target market for complex products. Distributors must then ensure their clients meets the criteria of the target market by assessing the following factors:
- Investor type
- Client knowledge and experience
- Ability to bear losses
- Risk tolerance
- Client’s investment objectives and needs
The MiFID II directive will increase the scope and detail of client reporting. All clients must receive a quarterly report unless the client has online access via a portal and it can be evidenced that the client has accessed the information in the quarterly period.
The other major aspect of client reporting is where a client’s portfolio depreciates by 10% or more, there is a requirement to notify the client of the loss within 24 hours.
There is also a requirement to disclose all the costs and charges relating to a client’s investments and clients must be provided with details on costs both before and after the investment is made. This includes:
- Cost of acquisition – any upfront costs
- Ongoing costs – any management charges
- Costs of disposal – any exit fees
The information must be provided in both monetary and percentage terms.
MiFID II also requires advisers to maintain good client records. Following the consultation in March 2017, the FCA agreed that there was no need for financial adviser firms to obtain a full recording of telephone conversations but could instead provide robust note taking instead.
All conversations must be recorded relating to conclusion of transactions and the receipt, transmission or execution of client orders. Face-to-face meetings are not required to be recorded as the suitability report will be viewed as a record of the advice given.
Adviser action tracklist
- Keep a register of all conflicts of interest and review it at least annually.
- Review whether you need further qualifications, training or permissions to maintain your independent status, if applicable. Independent advice under MiFID II covers investments such as shares, derivatives and structured products.
- If you want to advise on structured deposits, you need to apply for the relevant new permission by 2 January 2018. If you’re not sure, it’s free to apply before this date and will cost £250 afterwards.
- Review your recruitment procedures and assess if they need tightening. Is there additional information you can obtain to inform your recruitment decisions, or should you involve someone else in recruitment decisions to make the process more balanced?
- Look at your remuneration structure - be careful not to incentivise activity that might negatively impact clients. Does your pay structure include qualitative measures rather than just commercial targets?
- Decide which staff the dealing on personal account rule should apply to, and create a record of all direct equities they hold.
- Decide if you need to apply for a Legal Entity Identifier. If you need one, apply for it as soon as possible through the London Stock Exchange in time for 3 January 2018.
- Establish whether your DFM or platform will offer online reporting access to avoid the need for paper reporting.
- Understand whether your DFM or platform will issue the 10% loss notification and how, and what the communication will look like.
- Check your agency agreement with your DFM – where model portfolio services are being used, does the responsibility for regularly checking suitability formally sit with you as the adviser?
What about Brexit?
What the impact of Brexit will be on the industry as a whole over the coming years is yet to be determined however it will have little or no impact on the MiFID II directive. The FCA’s stance is:
‘Following the result of the UK’s referendum on its membership of the EU, firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for MiFID II and other pieces of EU financial services legislation that are due to come into effect in the UK”