The MiFID II directive will apply some of the same rules seen in the UK's retail distribution review to the whole of Europe. What must advisers do to prepare? George Mitton reports.
It may not perturb fund distributors in the UK or Netherlands, where adviser commissions have been banned, but the prohibition on inducements in the second version of the Markets in Financial Instruments Directive (MiFID) will have an effect on the rest of Europe, and fund companies need to prepare.
Though the ban is not as thorough as, for instance, the retail distribution review (RDR) in the UK – it only applies to products covered by MiFID, for instance, which currently does not include insurance-based products – it will require step-change for those advisers who want to provide “independent” advice.
But how will advisers change? Are there ways around the more onerous provisions? And what will the changes do to fund costs?
According to the latest MiFID II consultation paper, published in May, any investment firm offering independent advice will be forbidden to “accept and retain fees, commissions or any monetary or non-monetary benefits” from a third party in relation to clients’ services.
This will effectively outlaw the traditional distribution model, in which advisers receive commission for recommending funds to their clients. The European Securities and Markets Authority (ESMA) says it will be strict on the kind of “minor non-monetary benefits” that fall outside the scope of the ban. It says that research given to advisers could, if sufficiently valuable, fall in the ban.
Clearly, the directive, once it comes into force, will prompt a shake-up in the European market. However, the prospect need not be as daunting as it first appears. For a start, many fund companies have a headstart in dealing with this aspect of the directive because they have already created “clean” share classes – free of adviser commissions – to comply with the RDR in the UK. It is likely that fund companies can simply sell these same share classes in Europe under MiFID II, therefore, sparing the cost and complexity of introducing new share classes.
Another comforting factor is that MiFID II seems to be less strict than the RDR on the role of fund platforms, and may allow independent advisers to offset the cost of their advice by way of some kind of unbundled payment, as long as they are clear to clients about what the costs are.
“Clearly the adviser cannot accept and retain a commission,” says Simon Vernon, head of fund regulatory strategy at Schroders. “But the directive could still allow you, as an independent, to provide a share class which has a commission included in it, which is paid on the platform direct to the client’s account to offset the cost of advice – as long as it’s clear to the customer that they are paying for advice.”
The details of the directive are still being worked out and an explicit ban on platform rebates could be included at a later date. However, it could be argued that platform rebates are compatible with the spirit of the regulation, which is intended not so much to clobber the financial advice industry as make costs to the end investor completely transparent.
BLACK AND WHITE
There are other aspects of the directive that have yet to be finalised. One issue concerns the definition of independent advisers. The original version of the MiFID II directive said that the ban was on inducements to both independent and non-independent channels, but the parliament decided that it should only apply to the independents.
The upshot is that the most onerous provisions of the directive apply only to independent advisers. Some have wondered whether this gives an incentive to some fund distributors to classify themselves as non-independent. But how will the regulator distinguish between the two categories?
“It would be interesting to see where ESMA come out on this,” says Vernon. “If you wish to carry on receiving commission payments, you don’t want to call yourself an independent. But will ESMA say, ‘If you distribute products from more than X manufacturers then you must be independent’ or will they say ‘it’s not so black and white?’”
The end investor will be wondering what the effect of the MiFID II ban will be on fund costs. Here the example from the RDR is instructive. According to research by fund analysis firm Fitz Partners, the fall in fund costs after the RDR varied across different fund types. The cost of a post-RDR, “clean” share class of an equity fund was about 70 basis points less than a traditional, commission-bearing share class, yet for a bond fund the difference was 40 basis points.
The extent of the saving offered by the clean share class is important because it is from this chunk that any adviser fees will come. An adviser has less of a margin to cover its costs when distributing a bond fund than an equity fund, according to the research. What no investor wants is for their overall cost of investing to go up as a result of the directive.
“If you were buying a bond fund and the RDR comes along, you invest into the clean class and it gives you a 40-point saving, you don’t want the financial adviser costing more than 40 points,” says Hugues Gillibert, chief executive, Fitz Partners. “This is the tricky part – for the distributors and advisers to ensure they get the right level of cost.”
The question of cost could become pressing if returns in the funds industry go through a bad patch. Christian Pellis, global head of external distribution at Amundi, is attuned to events in the Netherlands and says the ban on inducements there could backfire if it leads investors to question the value of the advice and stop paying for it. A few months of poor investment returns could hasten this trend.
“The first quarter of this year was OK in terms of returns from clients, but you could argue that if the market takes a hit of 5-6% in a certain quarter – if clients lose money in the equity market and in addition they get an invoice for advice services – they might say, ‘I don’t get it’.”
He adds: “They need advice, the question is are they prepared to pay.” Perhaps regulators should hope for a few successive quarters of stable investment returns while the inducements ban is brought in and investors become used to the idea of paying for advice (or, rather, they get used to the idea of having the cost of advice made explicit rather than concealed in the commission model).
Certainly, a 2008-style shock to the financial markets could disillusion investors, who might decide never to pay for financial advice again. This could lead to the worrying scenario, forecast by some analysts, in which investment advice becomes a service only for the rich.
NOT A SURPRISE
However, for fund companies, although it will be a headache to adapt, the process of adapting to the MiFID II inducements ban should be straightforward. The issues are known and the examples of the UK and Netherlands can be followed.
“It shouldn’t be a surprise to anybody,” says Massimo Greco, head of European funds at JP Morgan Asset Management, on the inducements ban. “It’s been known for a while.”
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