What are fund managers up against with MiFID II?
Fund managers are trying to deal with quite a complex piece of regulatory material that is very broad-ranging, and that runs through everything from relationships with research analysts, brokers, custodians and asset servicers through to intermediaries and advisors—basically everything that is billable to a fund. It has a very radical potential impact for the fund management community as a whole.
There are two broad components that really affect fund management in terms of ensuring appropriateness of a product. One is the issue of complexity. There is an expectation that if the investment product is anything other than a UCITS-qualifying fund, the client will have to be assessed on their investment knowledge. In the UK, that’s near 40 percent of all funds. There could be up to seven levels of complexity, level one being not very complex at all to level seven being extremely complex. Determining this could be quite complex in itself.
This would require clients to go through a lot more pre-validation before making the application. It doesn’t mean that they won’t be able to buy the product if they’re deemed not to have the investment knowledge required, but the fund managers would have to warn them accordingly. That’s not an easy message to put across politely.
Thereafter, and probably more importantly, there is the requirement for fund managers, and any financial service provider in fact, to ensure the ongoing appropriateness of the product. They will be expected to look at the market as a whole, look at the client’s business, and assess whether the use the client is making of the product is as the provider intended. The unanswered question, however, is what the manager should do if they find the product is being misused. It’s all quite opaque at the moment.
Has the deadline extension helped?
Now the deadline for the whole exercise has been extended from January 2017 to January 2018, the tendency has been to breathe a sigh of relief in anticipation of more time to prepare. That only actually works if the regulators produce papers to the original timeframe and, actually, the extension is primarily to accommodate the fact that they won’t be ready to produce anything on time.
The Markets in Financial Instruments Directive (MiFID) legislation has multiple different layers. We already know the tier-one principles of what the directive is trying to achieve, and the European Securities and Markets Authority (ESMA) is in the process of releasing elements of the second tier. This will specify the overarching guidance included in the regulation, which is mandated, and the directive, which can be interpreted and applied locally. Local regulators will need a consultation before they can produce tier-three documents, which will specify the requirements for institutions in each market.
We probably won’t actually get the third-tier documents any earlier in the process than we would have anyway. There will still only be six to nine months between finding out the final regulations and the implementation date, and that really isn’t enough. We had a similar problem with the implementation of the Client Asset Sourcebook rules and with the Retail Distribution Review. The details came in from the regulator far too late and we had to start guessing, based on the documents we had and on our interpretation of the second-tier documents, what the third-tier requirements might be, so that we could start building the capacity, the functions and the software to be able to comply.
That’s such a gamble. Firms end up guessing that they can do a better job of interpreting European regulation than the local regulator can, without the benefit of the consultations the regulators get. It’s not a nice situation, but I think firms will be changing processes, procedures and systems before they know for sure what they’re going to be asked to do.
Do you think the January 2018 deadline could be pushed back again?
I think more issues will arise in the consultation stage, and I think regulators will realise that this will only work if there’s a consistency of application across Europe. If we end up with every local regulator in every market each coming up with its own interpretation of how the product provider should assess appropriateness, it will likely kill the whole cross-border market.
If a Luxembourg cross-border administrator has do go through completely different processes for applications from Spanish, French and German investors, the whole benefit of having a centralised asset administration function based on a single domicile falls to pieces. Ideally more of this should have been defined at the MiFI Regulation level to ensure consistency.
The second thing that could stretch things out is the realisation that, if they go down the route they’re planning, those same regulations will apply to non-EU institutional investors, too. There is a risk that distributors in Asia or Latin America, for example, will decide to avoid all the investor qualification and appropriateness rules demanded by MiFID II and opt to recommend a fund domiciled in Singapore or Hong Kong instead. Alternatively, fund managers could be forced to create mirror funds in Singapore and Hong Kong just to avoid the European regulation, building a whole new layer of costs into their distribution model.
If the directive is applied in the way it’s currently drafted, it could be very counterproductive. So, with all of this in mind, I think it will be delayed further.
Are fund managers properly preparing for the implementation date, as it stands?
The big fund managers are alive to this—they’ve got global programmes and a lot of people working on it. The middle- and small-tier fund managers are not prepared, and actually, the 12-month delay has played in to them thinking they have more time to work on it, and that’s a mistake.
I am worried that MiFID II is just another brick in the barrier-to-entry wall and that small and medium-sized managers will find it proportionately harder to accommodate. It becomes just another load around their necks. You can be a very big global player or a very small specialist boutique, but there is no middle ground any more. Those firms are trying to be all things to all people without the revenue flow to justify it and they will probably be acquired or bought out, or they’ll just give up.
Even the bigger players are only just starting to understand just how big this is. MiFID II dwarfs the UCITS regulations, the Alternative Investment Fund Managers Directive, the Foreign Account Tax Compliance Act and all the know-your-client rules all rolled in to one. It’s huge in terms of its potential impact, and the fact that people aren’t properly engaging with it is quite concerning.
Are there firms that just don’t know where to start?
To be fair, there are thousands of pages to the directive, it’s not written in terminology anyone is used to and the structure is quite hard to get your head around. It’s not very accessible in the first place, and at the moment there are huge sections missing. It’s understandable that firms are planning to engage with it when it’s finalised, but the fact is that if they wait for it all to be there, they will be too late.
Some may be waiting to see how things develop and hoping that other fund managers or service providers might figure it out for first and do all the heavy lifting, but this isn’t the right approach. All affected parties should be keeping a dialogue open with the regulator, letting them know what is and isn’t working, and making suggestions for improvement. If fund managers don’t get involved in the process they can hardly be surprised if they don’t like the outcome very much.
They can rage against it and ignore it all they like, but MiFID II is coming, and they have to know how they’re going to deal with it.