After much toing and froing between regulatory authorities and the European Council, the eventual delay to the implementation of the second Markets in Financial Instruments Directive (MiFID II) came as something of a relief for an industry under serious regulatory pressure.
But the regulation remains infamously broad and complex, and the changes it will bring to funds management and distribution operations should not downplayed. As the new deadline of 3 January 2018 creeps ever closer, all affected parties are being increasingly urged not to dilly dally in getting their solutions up to scratch.
Gary Janaway, newly appointed COO of KNEIP, suggests that one of the key issues asset managers should focus on is that of the notion of their ‘target market’ and the management of data relating to the products they manage and the distributors that promote them.
The information included in the target market universe of data includes expressions of a fund’s level of risk, suitability for investors, and the type of assets held and the investment strategy.
This will need to be provided by asset managers to each distributor for every fund they agree to distribute to their clients. The frequency by which asset managers should exchange the target market data with distributors, and the specific data content is not yet clarified.
“The target market data required is only in its nascent form as the industry has only just started the work to define what is required and in what form,” Janaway says. “This will need to be defined quickly.”
According to Janaway, it would be preferable to have one definition for target market requirements for all fund domiciles in Europe, rather than, for example, one definition in cross-border and international centres, and another for domestic markets.
He says: “Slight adaptations or flavours might be able to work, but if there are distinct differences in each market, it will be cumbersome and increase costs.”
Asset managers typically register funds for distribution in many different markets, through multiple distributors. If the definitions of target market data are not standardised, they will create one master set of target market data, consisting of sub-sets for each cross-border and domestic market. Extracts or sub-sets of this data will be sent to each distributor, depending on the domicile of the funds they distribute.
Distributors will, in effect, have the same exercise to perform but in reverse, once they have received target market information from the assets managers. In practice, this will likely be a positive confirmation sent to asset managers built around the idea of ‘negative target market’, the process by which distributors will confirm to asset managers that they are in compliance with the target market.
Etienne Deniau, head of strategic marketing at Societe Generale Securities Services, also notes that distributors have a lot of work to do. He suggests that affected fund managers have generally done everything that’s required of them already, at least to an extent.
Fund managers have to look at the suitability of their products, and define their target markets. Deniau explains: “They’re not part of MiFID II directly, but their distributors will require them to specify which market each product is for.”
As each distributor will have agreements with many asset managers to promote a selection of their funds, in several countries where the distributor has clients, they too will need to maintain details of each relationship.
This will include details of each asset manager, its funds and the target market data covering these investment products.
Janaway says: “So, distributors too will need to maintain a super-set of data, made up of the target market data of each fund they promote for each asset managers, large or small. Thus, each distributor will create the mirror image of its relationship with its asset managers. So we have a situation where distributors and asset managers have more or less the same exercise to complete in preparation to be MiFID II compliant.”
While the framework of interaction between asset managers and distributors is reasonably clear, the conditions and details as to precisely what needs to be exchanged, how frequently and when, is not. This is particularly true when considering the notion of negative target market. In the case of an investor buying an unsuitable fund, or in a jurisdiction where the fund is not registered—or if the risk profile of a fund changes and renders it unsuitable to certain investors—this needs to be reported to the asset manager. How and when this should be done is yet to be defined, but more importantly, there is less information available as to how to rectify such cases.
Further, it will be one thing for asset managers and distributors to work together, but there are yet more question marks as to the extent of work required to prove that each party is compliant.
Janaway asks: “What will they need to produce to demonstrate that the actual investors in a fund are eligible investors who have been sold suitable products? Once this is known, how often must this exercise be performed?”
“It’s a distinct possibility that this exercise may require asset managers to analyse the custody chain, allocating investors’ shares in funds to the account where they are held by the custodian of the distributor.”
While the register of shareholders is usually maintained by the fund’s transfer agent or fund administrator, many of the shareholder accounts are likely to be nominee or omnibus accounts of large custodians that often operate with central securities depositories. These accounts can have complex custody chains involving multiple financial intermediaries.
This may sound extremely challenging, but, as Janaway points out, it would be in keeping with MiFID II’s focus on transparency.
He says: “If the strictest interpretation of transparency is required as a result of MIFID II—which is very possible—it is going to be a very demanding year for distributors and asset managers.”
Similarly, Deniau highlights issues around identifying beneficial owners that are natural persons, because of the different identification methods used in different EU member states.
“It is a difficulty because member states have different ways of doing it,” he says.
Just as different countries have different ways of identifying people—social security identification that last a lifetime versus identity cards and passport numbers that change every ten years, for example—markets are not uniform in identifying retail end investors. This will pose yet another complexity to those asset managers and distributors trying to keep track of all their target market information in a clear and transparent manner.
Delay another day?
With so many uncertainties still remaining, and the deadline looming less than 11 months away, some institutions are wondering if, even with the 12-month extension, they will be prepared to meet the requirements under MiFID II.
Deniau notes that parts of the directive are “a bit blurred”, and suggests that the very nature of it being a directive means it requires a lengthy, two-step negotiation for institutions to get any clarity on the work they should be doing.
He says: “You might go to your local regulator and ask which interpretation, A or B, is correct. The regulator might say A, but then they will go to the European regulator for further clarification, and they could come back a few months later and say the correct option is actually B.”
“They need to validate and confirm that with the European regulator, and then on that topic we could lose six months.”
Janaway is more optimistic, however, suggesting that clarifications are starting to emerge. He says: “I would expect that by the end of Q1 2017 there will be enough certainty about what needs to be done to allow the industry to progress.”
KNEIP, he says, is anticipating the need for more transparency, and so will not delay the start of development on its solutions. In fact, Janaway estimates that KNEIP’s prototype MiFID II services will be ready for the market by the end of Q3 2017. However, the pressure on the industry will grow the longer it takes to finalise the target market data, frequency of exchange and terms for managing exceptions.
He says: “We will need to keep refining our services from Q4 this year through 2018. Our approach is twofold: to develop a service around the management and exchange of target market data and; an extended service to overlay this information across holdings of a fund’s register of shareholders.”
Deniau is of the opinion that the 12-month delay may still not be sufficient, given the overhaul required. For large distributors, banks or insurance companies, the process of changing internal systems can take about a year in itself.
“You need to know the necessary requirements, code in the business requirements, test them, put them into production, train the users—and if you’re talking about a network with a few thousand people, this process takes more than a year,” Deniau says.
“Today there are still some uncertainties on the technical details. There are two ways to manage this, either you make a hypothesis that you may have to change at a later stage, or wait for the final details to be confirmed. Either way, you risk not being compliant by January next year.”
In drafting the designs for solutions, KNEIP has made certain assumptions, Janaway says, and so by building modular solutions, it should be well placed to incorporate the final requirements.
He says: “We know there are certain data sets that people will need to store, we hold a lot of data for asset managers already, so we see MiFID II as an extension of services we provide today. In addition, we have the capability to transmit and receive data on an industry level today and do so in providing a range of services to our clients and their counterparties.”
Janaway and Deniau agree that the initial delay was sensible, as requirements to report security transactions involved considerable complexity; so much so that it took the focus away from the requirements for asset managers to meet the new rules relating to the target market needs covering product and distribution. Equally, however, neither expects to see another reprieve come January 2018.
They also agree that the new timeframe is still pretty tight, with Deniau calling it “difficult to cope with”.
Despite this, Janaway suggests that further delay could actually be damaging to the industry. It would preferable, should 1 January 2018 be deemed to soon for full compliance, to introduce a grace period of a few months. “If delay is discussed on the agenda today, people will start to down tools or lower the priority of their MiFID II projects,” Janaway says.
“If we want to change our industry, we need to get on and do it, putting the effort and commitment into making it happen.”