Often referred to as a regulatory monster, MiFID II has kept the industry in a state of suspense even after it entered into force at the start of January 2018. The expected huge impact has, according to many experts, failed to materialise, but the long-term strategic effects will nevertheless be considerable. Ensuring an efficient implementation of the regulatory requirements in day-to-day business activities is increasingly being seen as a critical success factor. But what effect will this have on banks and independent asset managers? What strategic decisions have to be made regarding the business model? When is it particularly efficient and advisable to use a digital platform to map out MiFID II?
The correct way to deal with incentive payments
When it comes to investment advice, a fundamental strategic decision has to be made – should this advice be independent or non-independent? This decision will have far-reaching consequences for the way in which incentive payments are dealt with, as well as with the breadth of the range of products on offer. Incentive payments (e.g. retrocession and kick-backs) cannot be retained as part of independent investment advisory and asset management services. If there are no incentive-free products available, these payments have to be passed on, i.e. ‘paid out’, to clients. Smaller non-monetary benefits, however, may be retained, as long as they create added value for the client.
It must be noted that restrictive criteria have to be met with respect to the added value. If payments are paid on a continuous basis, the added value likewise has to be created on a continuous basis. The principle of proportionality also has to be preserved; all incentive payments and benefits provided to clients must be disclosed as a matter of principle. In practice, this means that all non-monetary benefits are to be recorded in a list and a detailed explanation provided for the added value. If non-independent investment advice is provided, incentive payments are allowed to be retained in compliance with the added value criteria. The payments have to be disclosed to clients in the interests of cost and fee transparency.
How do I reduce the risks of providing incorrect advice?
The method introduced within the framework of MiFID I of categorising clients as private clients (retail clients), professional clients (per se or elective) and eligible counterparties remains in place. Client categorisation is relevant, for example, in the suitability and appropriateness tests, which have to be carried out before every transaction. In the case of such repetitive processes, it is worth carefully considering whether to use digital solutions. By using a system to carry out these processes, time-consuming and error-prone manual tests and calculations can be done away with and the risk of providing incorrect advice is significantly reduced. This holds particularly true, as retail clients have to be provided with a written declaration of suitability in the case of investment advice. This declaration can be created by the system when using a tool to map out the MiFID requirements.
Cost transparency is extremely important
Also key to MiFID II are the extensive cost-transparency guidelines that are designed to allow clients to make an informed investment decision. At the start of the relationship, clients must be provided with a cost overview that provides comprehensive information about the costs and fees associated with both the financial service and the financial instruments, along with an information brochure that summarises the main aspects of investor protection under MiFID II.
The costs and fees for the services and financial instruments offered, including the costs charged by third-party providers, have to be disclosed prior to every transaction. As previously mentioned, the incentive payments received and the value of the research services received also have to be declared. The effect of the aggregated costs on the return also has to be presented in a chart or in a table to ensure that the client is able to understand the effects of the costs on performance. It quickly becomes apparent that the introduction of a digital solution is extremely sensible here.
The added value of using digital solutions to map out MiFID II requirements
MiFID II also places specific, partly event-driven demands on clients within the reporting process. These demands can be efficiently met using digital asset management software. An example of this is loss threshold reporting, which requires clients to be informed if the value of their assets falls by 10% or more within the space of one day.
As part of the recently introduced target market concept, product providers have to identify a target market or client group whose needs are addressed by the product offered. Organisational measures should be used to ensure that the issued products meet the target market criteria. In this context, the remit of product distributors is to make sure that products are only marketed to clients that fulfil these criteria. The target market criteria take priority over the suitability and appropriateness tests. When mapping out MiFID II target market criteria, a system-supported test can generate efficiency gains in day-to-day activities and also minimise the risk of sales to client groups outside the target market.
If you look at the requirements of MiFID II in their entirety, it becomes clear that their implementation may take a considerable amount of time and result in a significant increase in costs. The use of professional compliance solutions and a digital MiFID-compatible platform can provide a great deal of assistance during implementation. We recommend factoring the mapping out of MIFID II requirements into your selection of digital asset management software.