Curmi & Partners

Mifid II – The Behemoth returns

By David Curmi

Back in 2007, a few months prior to the onset of the 2008 financial crisis, a new set of regulations was introduced aimed at creating a more homogenous  single market  in financial instruments in Europe.  At the time, financial markets were fragmented and consumer protection was low.  The Market In Financial Instruments I(Mifid I) was designed to change all that, and in some ways it did.  The financial crisis of 2008 however brought to the surface a number of issues that highlighted serious deficiencies that still existed and in December 2010 the EC began the journey to implement a revamped version of Mifid I.  After years of consultation and in true EU bureaucratic style, according to the FT, over 1.4m paragraphs of rules Mifid II will be born to the world on 3 January 2018.  From that day onwards life in the investment world is likely to change significantly. 

What is the objective of these new rules?

The main objective of Mifid II is to substantially increase both the level of transparency in financial markets as well as the consumer protection afforded to investors who make use of such services.  Naturally the highest level of protection is being afforded, quite correctly to the retail investor.  There is a delicate balance that however must be achieved even in Malta.  Investors should never be taken for a ride.  For example hidden costs charged to investors need to banned completely and investors should be properly assessed before investment advice is provided.  However an approach which assumes all market players are guilty of misconduct before being properly assessed for their conduct should likewise be stopped.  Sadly, the new Mifid II rules will I fear, only give further fuel to this concern and the usual sledge hammer approach adopted by the EU once again means that there is no concept of proportionality for the smaller independent firms.  One of the outcomes, possibly unwanted, is that a number of these firms are likely to close shop or change their model and stop giving advice.  The new rules are simply too onerous, require far too much due diligence, data collection and place too much risk onto a market participant to perhaps warrant the returns that are made. 

Mifid II covers numerous areas, from client reporting to upgrading the information held by firms on their clients, to the restriction of inducements paid by fund managers, to the control of research issued by investment houses.  All of these and a raft of others will force businesses like ours to change the way we operate, some more significantly than others.  Unfortunately the level of intrusiveness that clients are going to experience will take the whole client investing journey to a new level.  The constant collection of information and data on the ability and willingness of clients to take risks on their investments is likely to be taxing on both the recipient of the info as well as the provider of such information.  I doubt however that the level and quality of service is likely to improve much.  In my opinion more time will be taken to complete ever increasing numbers of forms in order to record data and to tick the right boxes  without adding much value to the investment relationship between the service provider and the client.  Alas it is a new reality that we need to deal with if we are to remain in business.  The cost of doing business will however go up and it is for the client to decide whether these extra costs are leading to a better overall service.

This is not to say that there are not many parts of Mifid II which will create a better investment experience for clients.  The level of transparency is due to increase substantially.  For example valuations which were previously sent to clients at least once per annum, now need to be sent four times a year. Included in this report will be a much wider array of data, including for example the total amount of fees that the service provider has charged and the impact that this has had on the performance of the portfolio.  Together with this report must be a suitability report that outlines the type of information used by the investment firm to ensure that each client is eligible to hold the investment she/he owns in the portfolio.  This is not a one time review but a dynamic process that must cover any recommendation, be it a buy/sell or even hold decision. 

Criticism has often been leveled at our industry, often justifiably so, for the amount of hidden charges clients unknowingly pay.  This is nowhere more so than in the sale of structured products and funds. Inducements (the payment of rebates and return commissions to investment providers for recommending a particular fund) will need to halt where advice or portfolio management is being given by independent market players.  The objective here being that advice needs to be untainted by potential benefits that the advisor will derive.  Surely a good thing.  A distinction is however being made where a service provider is tagged as non independent.  Here inducements may still exist in some form as the advisor is not purporting to give unbiased independent advice but is acting as a pure salesperson.

Similarly, rules on the marketing or distribution of funds will also need to be carefully monitored to ensure that the marketing is only seen by investors who are eligible investors for that product.  In today’s hostile environment there is way too much risk to an investment firm to allow the distribution of funds to take place without closely monitoring who the recipients are to ensure their eligibility. 

These and many more rules will change the way our business is conducted.  The challenge market operators have is to ensure that the onset of these rules do infact help us to improve the quality of service being given to our clients.  Disclosure for disclosure’s sake will achieve nothing.  My fear is that the life of a truly independent adviser whose business model is open and transparent, and acts only for the benefit of the client will become a romantic relic of the past.  Surely this is not good for clients.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business