Many MiFID requirements are keeping the buy-side awake at night, but investor protection obligations, which entail fund manufacturers and distributors working more closely, top the list. Lynn Strongin Dodds looks at how firms are looking for support from service providers.
The more onerous tasks in fund management operations might have been handed over to third-party providers in the past, but in future, asset managers will have to be much more accountable.
“One of the biggest changes with MiFID II is that the buy-side can’t duck out of its responsibility when either choosing a broker, vendor or asset servicing firm,” says Cosmo Wisniewski, director at consulting firm Citisoft. “They will still need to work with them, but the responsibility has clearly shifted and they can no longer hide behind the letter of the law.”
However, the clock is ticking and fund managers are unlikely to have time to make sweeping changes to their systems and processes to meet certain aspects of the regulation, known fully as the Market in Financial Instruments Directive II. In fact, the latest CBI/PwC Financial Services Survey shows that regulations such as MiFID II as well as the FCA Market Study could be slowing down the pace at which asset and wealth managers invest in technology and innovation over the short term.
“The larger fund managers have the resources to deploy new technology but, given the timescale, the majority are trying to get their heads down and leverage existing technology and work with existing service providers,” says Paul North, regional head of product management at BNY Mellon Asset Servicing.
“Once they have got through the January milestone next year and come up for air, they may begin to look at new data management technologies to help with MiFID II compliance and other regulations.”
Adrian Whelan, senior vice president of regulatory intelligence at Brown Brothers Harriman, adds that asset managers are addressing challenges through a mix of outsourcing, vendor solutions and enhancing internal systems and processes for capturing and reporting data elements required by regulation.
“There is no single technology-sourcing strategy that works for all asset managers, and it even varies by requirement,” he says. Ultimately, the asset manager’s decision will come down to organisational capacity and systems strategy.
BY FAR THE BIGGEST CHALLENGE
Whelan believes that the target market rules are by far the biggest challenge for asset managers on the distribution and governance front. In the past, the fund distributor was in charge of checking that the appropriate products were being sold to the intended audience, but fast-forward to 2018 and both manufacturers and distributors will have to divulge their arrangements. This means that the latter, for instance, will have to devise the appropriate ‘target market’ and ‘distribution strategy’ for products and justify what they are selling, to whom, and why.
“In their current form, the MiFID II product governance requirements present a problem for Ucits funds in particular, which typically include multiple intermediary layers between product manufacture and end investors,” says Whelan.
“For example, the market currently lacks any mechanism to allow for investment suitability confirmations to travel up and down the fund distribution chain.”
Wisniewski adds: “Disclosure, transparency, good behaviour, conduct of business have all arrived at once. It will prompt significant changes in the UK
and European distribution that have followed the US open architecture model. There will now be a big emphasis on the relationship between the manufacturers and distributors and the needs of the clients at a time when the investment coverage has expanded.”
This will not only require more in-depth and granular conversations between the manufacturers and distributors, but also with wealth managers, financial advisers and banks to keep the communication flowing.
“There are three main parts to the distribution chain: the investor that is being sold to; the distributor who is selling to them; and the manufacturer of the fund,” says Matt Davey, head of business solutions at Societe Generale Securities Services.
He adds: “Information on the target market is passed between the manufacturer and distributor. While that may sound simple, it is complicated because there can be multiple layers within the distribution chain, including platforms, and in many cases manufacturers do not know who the end investor is.”
Manufacturers will be further tasked with designing and stress-testing products that meet the needs of the target market, as well as assessing the charging structure is appropriate. The aim is to divulge specific details before an investor makes an investment so that they can compare and contrast different products and gain a better understanding of their exposure to risk.
PRIIPS DOUBLE WHAMMY
It is still unclear, though, how the costs will be calculated and if the methodology will be aligned to the Packaged Retail and Insurance-based Investment Products (Priips) directive, which also comes into force next January.
“How to disclose the charges is also part of the challenge,” says North. “It’s a double whammy for asset managers to calculate the cost and feed the information flow down a complicated distribution channel and then personalise the costs for the
end investors. There are potentially a number of participants in the distribution chain that all need to share and disseminate data on costs.”
While there are still many moving parts, there is no doubt that data management will play a significant role. Fund managers will need access to both distribution data for the target market as well as due diligence information to address the various regulatory components. Moreover, monitoring and reporting tools will be required to keep track and analyse the continual stream of data.
“Manufacturers will need to have a greater understanding of the distribution chain,” says Rob Swan, managing director, data services, at Calastone. “This is because the responsibility of mis-selling a fund which currently lies with the distributor is being moved to the fund manufacturer as well. They will need a comprehensive look through their entire chain, which will not be easy – particularly for the larger firms who, for example, may have 11,000 distribution agreements.”
Jean Devambez, global head of product and client solutions, asset and fund services at BNP Paribas Securities Services, echoes these sentiments. “Although people are still waiting for more clarity on different aspects of the regulation, it will have two big impacts, the first being on how information is extracted, calculated, published and disseminated. This will require a combination of technology such as web-based front-end portals, data science tools and artificial intelligence to not only scrub the data but also read and structure the data.”
The second challenge, according to Devambez, will be the reinvention of the distribution platform, moving towards digital solutions.
BRIDGING THE GAP
Patience will also be needed before a fully fledged data management offering is on the market. “Currently, there are vendors that offer either pre-or post-trade solutions only but it’s difficult to bridge that gap,” says Diane MacFarlane, regional head of fund services at JP Morgan. “However, I do think in the future, one or two will rise to the surface and create services to meet these requirements.”
MacFarlane also believes that distributors will have a role to play in helping asset managers. “I think we will see asset managers look to reduce the number of platforms being used because the level of oversight and connectivity will be challenging and costly.
“However, those platforms that can offer access and package information on investor demographics and profiles will be invaluable and a key differentiator.”
JR Lowry, regional head of State Street Global Exchange, also believes that MiFID II will favour the larger distribution platforms, although they will need to invest in technology in order to get people online, compare funds and analyse risk profiles.
“The retail segment is growing in importance, especially as countries such as the UK move from a defined benefit to defined contribution [pensions] market,” he adds.
“This favours incumbents, but they will need to invest in a client-facing online toolkit that is multi-channel and has good analytics.”
Consolidation, though, will be inevitable. Last year saw Aegon’s £140 million (€161 billion) purchase of Cofunds, creating the largest platform business in the UK, while Hellman & Friedman and Singapore’s sovereign wealth fund, GIC, recently paid €1.8 billion for European Allfunds Bank, which has more than €250 billion in assets under intermediation. Then there is the £11 billion merger between Aberdeen Asset Management and Standard Life, giving them the clout to compete more strongly.
“I think we will see a massive reduction in the number of platforms, because the majority are single-country and they will need to move to cross-border and compete with the UBSs of the world if they want to survive,” says Swan.
“It will become a volume game and hard to differentiate, because manufacturers will realise that 80% of their revenue is coming from 20% and they will not want to use the more expensive platforms.”
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