MiFID II is arguably the biggest regulatory shakeup to hit the asset management industry since the Retail Distribution Review.
The refreshed version of the Markets in Financial Instruments Directive is a huge piece of legislation from Europe which came into force in January this year. It is designed to protect investors and push the financial services industry towards greater transparency.
MiFID II has the potential to reshape the Financial Services landscape, with changes affecting all asset classes and institutions from banks and brokers to Asset Managers and pension funds.
Among its main tenets are stricter rules around suitability, especially in relation to complex products, better transparency around trading, changing the remit of rules to include commodity derivatives, stricter controls on algorithmic trading, and limits on the size of trades that can be made in so-called ‘dark pools’ (private stock markets or trading forums used by institutional investors).
Research and MiFID II
MiFID II’s emphasis on itemising and disclosing all costs to clients has implications for firms’ distribution strategies. One rule which has particular significance for Asset Managers concerns the way firms deal with research. Under MiFID II, firms have to charge clients separately for analyst research, for example, on companies or sectors, rather than bundling the cost in with other services.
Firms have been struggling to decide the right course of action as they try to balance profitability against customer service.
Asset management giant Fidelity International recently did a U-turn on its policy on third party research. When it first announced its plans in October 2017, the group had planned to pass the costs of external research on to clients in a bid to be more flexible and transparent, while reducing its base management fee in order to offset the cost. The idea was to make sure all clients were treated equally, regardless of whether they were captured by MiFID II regulation or not. But, in February this year, it decided this was not in the best interests of clients, and it would instead absorb research costs itself. This brings it in line with the rest of the industry and ensures its clients will not be singled out to face “disproportionate operational and reporting consequences”, which could also make Fidelity look less competitive.
Adrian Lowcock, investment director at Architas, said most Asset Managers are now on the same page in how they plan to handle research under MiFID II, but noted the industry could still face unexpected consequences as a result.
“It is good to see that the industry has reached a consensus approach which should make it easier and cheaper to access funds. However, the long-term impact of absorbing research costs is still unknown and could result in unforeseen consequences, so fund groups, advisers and researchers need to remain vigilant to ensure this approach remains the right one for the industry and its clients.”
One possible consequence could be cost-cutting to help fund groups and banks shoulder the cost of research, with potentially the loss of many analyst jobs. McKinsey & Co has estimated that the $4bn annual spend on research by the top 10 sell-side banks could drop 30% after MiFID II. However, the other side of the coin is that some groups, such as Schroders and Vanguard, are building up their in-house research teams so they can rely less on external sources.
MiFID II is not the only legislation with which financial services firms have to contend. UCITS, PRIIPS and FATCA are among the other acronyms which could be giving industry executives sleepless nights, especially given the fact some aspects of these regulations overlap.
Implementation and administrative costs so far may have burdened asset managers, and they may also face higher costs in future as their reporting requirements go up. Asset managers will no doubt slim down, adapt and innovate to cope with these latest changes, as they have always done, and the strongest will survive. If MiFID II achieves its laudable aim of making markets fairer and rebuilding investor trust in financial services, which is still lacking a decade on from the financial crisis, surely that can only be positive for the industry’s future.