With countless EU regulations having come our way during the last 10 years or so, asset managers and administrators have incurred many process and system challenges, as well as significant costs. These will have come in the form of executing projects to re-align or change systems and processes, to ensure compliance with these regulations.
The reams of post-crisis regulation have simply overly encumbered this investment management industry, however, the reasons should be well understood based on the events like the Lehman’s collapse in 2008 and the Madoff scandal that followed a few months later.
The challenges in some of these regulations, such as the second Markets in Financial Instruments Directive (MiFID II), have shown us that the deadline for implementation is not, in fact, the end of the work that needed doing, but in reality, it’s just the beginning.
On the whole, there is a mixed bag of firms that were truly MiFID II ready, and those not quite arriving at the ‘start line’ as they thought they would, come 3 January 2018.
Now in 2019, a year down the line from the MiFID II regulatory implementation date; the challenges of getting this all right has become apparent with the multitude of teething problems experienced in the industry.
Some examples of these were in the form of data warehousing and data collation; unbundling of dealing commissions from research, research payment processes, regulatory technical standards (RTS) 28 top five venue reporting and increased challenges with best execution processes.
Best execution processes will now take a multitude of teams to deal with this function, to prove best execution requirements have been met. No longer will trade execution be under the sole purview of a trading desk.
The changes brought about, focused on better client outcomes and enhancing processes. The Financial Conduct Authority has, as we know, taken steps to let the industry know they are falling short of expectations. It is believed that in 2019 we will see more initiatives in this area.
Another fairly complicated piece of this regulation relates to the setting up of research payment accounts (RPA) or commission sharing agreements (CSA), the data feeds, profit and loss application and then reporting on rebalancing processes. This is usually quarterly as its labour intensive and adds an extra burden on teams managing this function.
From an investor’s perspective, we would justifiably expect that they have the right to know how and where we are spending research commissions, as they are mostly being asked to fund it. It is worth noting, there are some asset managers who have decided to ease their administrative and reporting burdens, by rather taking the costs through to their own profit and loss; and not passing on costs to investors. This scenario enables them to utilise RPA/CSA arrangements for internal purposes alone, therefore not reporting into investors on those associated costs.
This direct cost to a firm’s profit and loss will simply be attributed to a cost of doing business and asset management budgets will very likely have catered for this change in the 2018 budgeted year. Fund managers and their investment teams will have come to an agreement on how those costs are apportioned between them, if not passed onto investors.
The process changes, data supply and vendor engagement to manage all these were perhaps mostly underestimated. Now, firms through 2018/19, are still struggling to effectively and smoothly integrate into their business functions, working with the data vendor providers to streamline the processes.
It’s also very likely regulators are receiving some challenges themselves as local European industry bodies will be lobbying and reporting into regulators, the difficulties the industry and their members are experiencing with the MiFID II challenges.
Plain and meaningful cost disclosures for funds remain firmly on the regulatory agenda and more and more of the EU regulators are also scrutinising the level of costs and charges in the industry.
We all know that the research market for investments/funds has had a tremendous shake-up due to this regulation, and although not entirely unexpected, reverberations are still being felt as complex processes are bedded down. Over time though, we can expect clearer transparency and more sustainable solutions as resources and systems are applied and deployed.
Another interesting and complicated piece of MiFID II is trading cost analysis (TCA) where implicit and explicit costs are to be assessed, collated and reported, for the purposes of producing the European MiFID II Template (EMT) or European PRIIPS Template (EPT) data sets.
Ensuring your vendor data provider produces this accurately can be a challenge; a few have been found to be lacking in data accuracy; but, is this due to firm’s data feeds being questionable or with vendors reporting capabilities, or, perhaps even both?
Further than that, reporting such as RTS28 top five venue reporting with the first publications made on 30 April 2018, allowed for some leniency on data delivery. This year though, regulators expect full and complete data delivery.
There are complexities in RTS that would have required added data capturing—potentially with system and database field change implications. This means that through the year as trades were executed, data points such as passive/aggressive orders—the definition of which was deemed somewhat ambiguous—will need to have been captured. Passive/aggressive is the term used to describe adding or removing liquidity from the market and this will be expected for the 2018 reporting due on 30 April 2019.
Similarly, for directed orders, again, there was some ambiguity as regards to definition. Firms should have already been well in process during 2018, with additional analysis sessions with their vendors who assist with this data collation, to start capturing, collecting and reporting this data in 2019.
While the RTS quantitative reporting was allowed to be performed on a “best endeavours” basis, in the first year of reporting it was made clear that regulators would expect a high level of qualitative reporting in year two and beyond. Firms should also expect qualitative reporting changes, as these will not remain static.
If we look at best execution, as a firm’s policies and business as usual processes in this area evolve, the regulators expect firms to update their disclosures.
Investment firms should also consider the language they use in qualitative reporting, depending on whether their client base is primarily institutional or retail.
This is the over-arching challenge asset managers have faced over the last three to four years since MiFID II work will have begun; assessing systems, selecting systems, selecting vendors, re-engineering processes, staffing the functions, capturing data, collating it, and reporting it.
Other regulations like the General Data Protection Regulation presented similar data storage and security measures to firms, in order to secure investors and clients personal information.
Rafts of communications were required to inform people of their rights, and the firm’s obligations to comply with these regulations. The system and process implications in this area again added a huge workload to compliance, HR and investor services teams with associated costs.
As can be seen on just a few of the topics covered here, there are many data providers, many issues and many complex regulations to consider when implementing solutions.
Regulator’s sights shall remain very firmly on transparency with investors, cost disclosures particularly, reporting obligations and compliance, product governance, fund distributors more widely, and financial advisers in particular.
Compliance with regulation is a long and winding path, and sadly we are nowhere near the end yet.
