June 2017

INSIDE VIEW: Share classes and the Spanish regulator

MadridSpain will have a hard time implementing MiFID II into national law by the July deadline, says Miguel Sánchez Monjo, a Spanish lawyer at Cuatrecasas in Madrid.

At the time of writing, in mid-May, there is still no sign of a public draft bill implementing MiFID II in Spain. No more than a public consultation was released in March to gather the sector’s views on issues that the EU member states may address. Foreseeably, Spain will have a hard time fulfilling its obligation to approve the implementing national law
before the July 3 deadline.

In this context, it is not currently possible to clearly envisage what the Spanish legal landscape will look like under MiFID II, particularly in relation to the payment of inducements for services other than portfolio management and independent investment advice. Of course, this is no minor issue considering that remuneration for fund distribution in Spain is mainly channelled through rebates from management companies.

This remuneration scheme explains why the Spanish regulator (CNMV) has focused on how firms square this practice with their obligation to act in the best interest of clients. It also accounts for its recent steps to clarify its criteria on the distribution of funds with different share classes, conditioning the future legal framework under MiFID II.

As far back as 2009, the CNMV published a communication on the payment of rebates for the distribution of funds with share classes differentiated only by fees. According to the CNMV, distributors must offer classes that, when accessible to the relevant client under the prospectus, are most beneficial to that client from an economic standpoint.

In particular, when providing discretionary portfolio management and investment advice services, firms must choose classes meeting the above requirement, provided that they are suitable for the client. The same is required when firms commercialise those funds at their own initiative, or if the client’s initiative is generic (i.e. it does not refer to a specific fund).

However, in a communication released in October 2016, the regulator revealed it had identified several practices that infringe these requirements in firms providing portfolio management and investment advice services, which has resulted in disciplinary proceedings and sanctions. These malpractices are the following:

   • Investment in or recommendation of share classes without ensuring whether there are other more beneficial classes the client could access. The CNMV states that firms must invest in or recommend these classes, even if they do not ultimately receive a fee for rendering their services.

   • Pre-selection of a single share class for distribution to all the firm’s clients. Although this practice is based on operational considerations, it does not ensure that certain clients meeting the conditions for investing in other more beneficial classes can access them. This is the case with shares with high minimum subscription amounts that are not restricted to institutional investors, and those requiring a separate fee arrangement between the firm and the client, which may be offered to certain retail investors.

   • Lack of periodic internal procedures to detect situations where, due to market evolution, clients do not invest in the class that benefits them most. When providing investment advice, these situations should be identified (and rectified) if recommendations are ongoing, and taking into account the client’s global position, or if firms agree to monitor that position. In the CNMV’s view, it is unacceptable that clients receiving this advice should hold a less beneficial class because of having invested at their own initiative in the past.

Beneficial
On the last of these points, these internal procedures must also monitor the classes available in the funds distributed by the firm. If new, more beneficial classes are identified, firms must ask their distributors (or the management companies directly) for access to the new classes and their distribution in Spain. According to the CNMV, firms cannot be discharged of their liability to act in their best interest of clients just because their habitual distributor does not provide more beneficial classes. Indeed, if the platform or distributor does not offer those classes after receiving the firm’s request, the firm will have to seek other channels granting it access to them.

Letter of clarification
The CNMV clarified these criteria in March this year in a letter addressed to the national banking and fund management associations (AEB and Inverco). The CNMV reiterates that procedures for monitoring new available classes are required when providing portfolio management and investment advice – even if this advice is not considered as such by firms, as the CNMV has observed in its recent mystery shopping endeavours.

If the management company has not notified the CNMV of a more beneficial class for distribution in Spain (registration is only required for funds and sub-funds, not for share classes), then firms must formally request this notification from the management company, either directly or through its distributors.

This would not be overly burdensome for the management company as it only requires drafting documentation similar to other existing classes. Indeed, the CNMV maintains that the foreign management companies it has approached have been willing to distribute new classes if a Spanish distributor requests them to do so.

The CNMV believes that the management company should reject the request only on the basis of justified reasons, although the European Securities and Markets Authority will have to analyse this matter with other national regulators.

The CNMV insists that it has no intention of imposing a particular distribution model in Spain with these criteria. However, they are clearly already having a significant impact on how fund distribution and non-independent investment advice may be remunerated, particularly considering that international management companies have started launching clean classes ahead of MiFID II.

Ostensibly, execution-only will be the single case where the payment of rebates would be possible, but this will depend on how the final MiFID II framework ends up being defined in Spain, which is not clear today.

Miguel Sánchez Monjo is senior associate at the Spanish law firm Cuatrecasas

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