With the recent election now behind us and the Brexit negotiations likely to drag on for much of the next two years we can turn our attention back to ensuring our businesses are prepared for what we already know is coming at us. MiFID 2 will still be implemented on 3/1/18 and while it is anticipated to have a modest impact as the FCA have already been driving many of the changes sought by the European directive it is worth considering the T&C implications – some action will be required in certain situations.
MiFID II has restricted the types of products that are classified as ‘non-complex’; as a result debt securities and structured deposits will now be considered complex if they have a ‘structure which makes it difficult for clients to understand the risks involved’, including the cost of exiting before term.
In future, it is likely that any shares and bonds that embed a derivative, structured UCITS and non-UCITS collective investment undertakings (sometimes known as NURSs), will be considered complex. Esoteric investments such as binary trading, emissions allowances, cash settled forwards, etc are caught by the rules. Many firms argue they can get the level of returns clients seek without these but adviser awareness and understanding may need enhancing.
If your firm is involved in structured deposits you should be aware that these have been designated as a new investment type and that the FCA expect to be notified that you operate in this market. If you don’t make the deadline then a variation of permission would be required with the delays that entails.
With products being added to the complex list, training and competence professionals will need to work with their firms to identify whether they will be marketed and if so what additional training is needed to ensure those distributing the products understand them sufficiently.
For firms with a passport, the changes in scope, financial instruments and exemptions mean that it will be sensible to review whether the passports need to be amended. Below is a list of the changes made:
it is worth considering the T&C implications – some action will be required in certain situations.
Portfolio managers will be required to show the costs of underlying holdings within a portfolio (the good ones have been doing this for some time) and will have to issue quarterly valuations. Depending on markets the new requirement to communicate with clients if their portfolio falls by 10% or more may be more onerous. There was a lot of confusion as to the interpretation of how immediately you need to report this to the clients. The answer we received from the FCA is that daily valuations of portfolios are required so that clients can be informed on the day that losses since the start of the reporting period cumulatively reach the 10% threshold. The suggestion is that firms carry out the valuation at the same time e.g. early morning so they have enough time to draft and issue the required communication.
There may be some CPD requirements around the need a Legal Entity Identifier (LEI) in order to trade in listed or Over The Counter instruments on regulated EU venues. There are other providers but the London Stock Exchange (http://www.lseg.com/LEI) would be one source if you have companies, trusts or other entities as clients.
There will be increased transaction reporting obligations for these types of investments too. It is anticipated that platforms and brokers will meet the reporting requirements given the range and volume of data sets required (up by 40 items). Portfolio managers are exempt if they transmit instructions to another MiFID firm who have confirmed that they will handle the reporting. Such managers should be talking to their brokers or platforms to
establish what additional information will be required at the point of instructing trades.
Use of dealing commission has been curtailed by the FCA so for many firms the MiFID II rules won’t make a difference. However, the concept of having a separate research payment account has been created – funded by clients and fully disclosed to them. We anticipate that most firms will continue the current practice of paying for research themselves.
It is anticipated that best execution policies will need to be revised as it is proposed that firms break down the investment classes and sub-classes to 22 instruments and identify the factors considered in selecting venues as well as their relative importance. Then create a list of venues permitted by the firm for each class – the final straw being that each year firms will have to ‘publish’ their top five execution venues.
It also appears likely that client agreements will need to be updated once the final rules are clear – more information and disclosures.
Product manufacture and distribution is impacted in that a clear responsibility has been created for those creating products to start with defining a target market and then design the product to meet their needs. Distributors are responsible for suitability or appropriateness and therefore must understand the characteristics and target market before distributing the product. They will be expected to provide information back to the manufacturer to provide reassurance that the product has been sold in accordance with the aim in its design.
It is anticipated that further detail will become available over the coming weeks and months – but watch out there’s a July deadline for firms not holding the right permissions or product types (except structured deposits which is the end of 2017).