A year on from MiFID II’s implementation, Mark Latham investigates the extent to which the industry is innovating as it implements the directive’s costs and charges disclosure requirements.
When the second iteration of the EU’s flagship financial markets legislation, the Markets in Financial Instruments Directive (MiFID II), came into force in January 2018, it was the culmination of years of negotiation in Brussels and consultation with the industry and national regulators.
The main aim of updating MiFID, a directive first implemented in 2007, was to increase protection and transparency for investors and stimulate greater competition into the trading of bonds and derivatives and other instruments as well as equities.
While the first version of MiFID had also aimed to lower prices and expand choices for investors, the global financial crisis had highlighted some of its structural weaknesses.
So, as the first anniversary of MiFID II approaches, is the new legislation showing signs of achieving its aims? Is it enough to help consumers compare costs and charges or is there anything else that could or should be done?
Since the start of 2018, distributors and advisers providing services under MiFID II have been required to provide information about all costs and charges within the funds they offer to clients.
The revised rules also require product providers to support distributors in fulfilling their obligations by providing the relevant cost information.
It is estimated that the industry collectively spent €2.36 billion preparing for MiFID II. And, while some firms were scrambling to be ready for the implementation date of January 3, 2018, there has been no sign of market disruption since.
Andrew Glessing, head of regulation at Alpha Financial Markets Consulting, believes that – together with the Packaged Retail Investment and Insurance-based Products directive (Priips) which also came into force in January – the cost and charges requirements of MiFID II have been one of the most difficult pieces of regulation that asset managers and wealth managers have had to implement in recent years.
“Regulatory guidance on how to calculate costs and charges only goes so far, which has resulted in different methodologies being used across the industry,” he says.
“Firms have grappled with how to calculate implicit transaction costs and the impact of cumulative costs on returns, with some methodologies producing negative costs.
“For distribution, there is the additional challenge of collating data from different asset managers and platforms, all of which may use different methodologies, and then bringing it together into a meaningful figure.
“To combat this challenge, we have noticed a trend where investment firms are increasingly moving away from using internal design solutions to third-party systems, partly in recognition that outsourcing complex data management is lower risk.”
Investment firms, Glessing says, are concerned about meeting the minimum requirements of MiFID II and producing accurate costs and charges disclosure based on reliable data.
“But, despite firms wishing to demonstrate a sound interpretation of the rules within deadline, the desire to innovate has not gone away,” he says.
“Financial firms are looking at new and incumbent vendors, improved data management systems and how to improve customer experience in an increasingly digital age.
“Time will tell whether new disclosures are as useful for consumers and clients as the regulators would like and whether investment firms gain competitive advantage from the way they are able to deliver these new requirements.
“At this stage, clients may find it difficult to fully understand costs and charges disclosures, make meaningful comparisons between providers and benefit from the intended outcomes. Hopefully, as the requirements mature and with further regulatory guidance, firms will see MiFID II as a means to gain competitive advantage and innovate in this space.”
Jean White, senior consultant for regulatory solutions at Northern Trust, also cites transaction cost calculations as the area where the funds industry has struggled most as it implements MiFID II. Because of the way the arrival price has to be calculated, she says that in certain situations, the result could appear as a negative cost. This is because the costs and charges that have to be disclosed in MiFID II are split into explicit and implicit costs and transaction costs are within the implicit cost side. The calculation is based on the difference in cost between the initiation and conclusion of a transaction, known as price slippage.
“The performance of that particular calculation is referred to as the arrival price methodology and it is because of the way it needs to be calculated that the cost could appear to be a negative cost in some situations,” says White.
“I think the aim to increase the information provided to investors is entirely admirable and the desire to arm investors with a full understanding of what the cost of investing is to them is a very good thing.
“The intention was to make costs more easily understandable, but I am not sure that it has currently achieved that outcome. I think it will be a work in progress, seeing further work being done in the costs and charges space.”
Noting that some providers are exploring how to use artificial intelligence and blockchain to help with reporting obligations, White adds: “I am not sure we are yet seeing a level of innovation that is taking advantage of the new technology.” But, she says, “while this will inevitably happen at some stage, we are not quite there yet. Financial institutions are generally pretty risk-adverse and won’t be likely to use these technologies immediately. Many are waiting to see what happens.”
Sarj Panesar, global head of business development for asset managers at Societe Generale Securities Services, points to a paper published by the UK’s Financial Conduct Authority in April – “Now you see it: drawing attention to charges in the asset management industry” – which found that when the information is available and clearly displayed with the impact of costs modelled and presented, the investor will buy the cheapest fund.
“We can expect managers to use this information to position their cheapest products using digital tools to highlight costs,” he says. “We have already seen a few managers announce zero-cost investment products and we can expect some more announcements in the future.,”
Panesar also points to the burgeoning number of asset managers in the US who have announced zero-cost product this year. By comparison, he says, competition in the European market has not been on price alone.
“This will come, particularly as new technology allows easy comparison of all relevant data points,” he adds. “In conjunction with managers looking at direct consumer models, price will become one of the major factors for final investors.”
©2018 funds europe