Legend has it, that Horatio Nelson, the famous English admiral, had only, One Eye, One Arm and One Leg. Cricketers have long believed any combination of “A Nelson” is unlucky. (David Shepherd a now retired English Umpire would balance on 1 leg whenever the score on the board was 111, 222 etc.) However balancing on 1 leg will not achieve MiFID II compliance for Asset managers 333 days from now.
On 3 January 2018, (333 days from today) MiFID II, the Directive and MiFIR the related regulation will come into force. Although the overarching impact will be greatest for sell-side broker dealers and markets, there are significant changes for asset managers which need to be provisioned for. There is no transitional period.
Most sell-side broker dealers, have already spent, hundreds of millions of Dollars/Euros preparing for the impact on MiFID II, many with implementation programmes that have been in progress for 18 months or more. While the headline effects of MiFID II are most defiantly going to impact the sell-side, there are many hidden organisational changes applicable to asset managers and buy side firms. For instance, AIFMs or UCITS managers which solely carry out collective portfolio management are out of scope for MiFID II. However, the extent of their authorisation to carry out advisory and portfolio management activities are subject to MiFID II rules, many of which are now more onerous than the current AIFMD/UCITS regimes.
A high level review of MiFID II requirements will include looking at not only internal processes and procedures but also distribution strategies and relationship with clients and other third parties. From this review, several workstreams will be required to follow up implementation. Technology solutions are likely to play a key role in supporting many of the new requirements and consume the majority of any budget set aside. Legal will be required in updating many client agreements and ongoing disclosure material. A full review of internal Policy and Procedures will also need to be carried out in order to ensure full implementation.
A summary of the key changes covering ONLY business conduct and organisational requirements for Asset managers is set-out below along with the often “Subtle changes” that MiFID II brings from MiFID I rules.
Portfolio managers will no longer be able to accept and retain fees, commissions or any monetary benefits from third parties (issuers and product providers) relating to the services provided to their clients. Under MiFID I these benefits could be received so long as they complied with the rules on Inducements. Additional changes in the requirement for quality enhancements will be more strictly enforced, generic disclosure is no longer allowable and the payment of placing fees are now in scope for inducements.
By far the biggest single change under MiFID II is the proposed abolition of payment for research product with dealing commission. ESMA has proposed full unbundling under which managers must either pay for research out of their own cost base or agree with each client, a separate Research Payment Account or “RPA”; the cost of which will be paid directly by the client, as a contribution to the research budget of the asset manager.
Article 27 (5&6) of the Directive, sets out a firm’s obligation to “Execute orders on terms most favourable to the client”. It is within this article that the most onerous effects of MiFID II Best execution are set-out.
ESMA issued no fewer than 17 guidelines when it published its Technical Advice to the commission on MIFID II and MiFIR, the vast majority of which directly affect Asset managers dealing practices.
Reporting to clients
The frequency with which asset managers must report to clients increases from six monthly to quarterly. The report must include, valuations or at least a “Best effort basis” where necessary. A review of all activity and performance during the reporting period and any depreciation in the value of the portfolio if it exceeds 10%. However, the baseline for any reset in this calculation is still unclear even after an ESMA RTS published in Dec 16 (1444).
There are new requirements governing the composition and qualification of a firm’s management body and its responsibilities. Plus, new rules on the organisation and duties of internal compliance and its interaction with other business functions.
Operations and Compliance procedures
Complaint handling rules are extended to complaints by professional clients and potential clients. There is also a formal requirement to establish a complaints management policy, publish the details of the policy and report to national regulators. To list and summarise the new obligations around record keeping and retention here would more than double the length of this article. Approximately 10% of the ESMA technical advice is dedicated to this topic alone!
Algorithmic and high frequency trading (HFT)
Any firm using an algorithmic strategy, including a manager, will be subject to new prescriptive organisational requirements, alongside new regulatory notification, reporting and record keeping requirements.
Financial collateral arrangements (TTCA’s)
MiFID II prohibits firms from concluding TTCA’s with retail clients and seeks to restrict their use for Non-retail clients unless appropriateness can be confirmed. It additionally requires investment firms to adopt specific arrangements for retail and non-retail when conducting security financing transactions (SFT’s) and ensure that the borrower of client assets provides the appropriate collateral and monitors on a continuous basis.
As is clear from above, looking at only one sub-section of the MiFID II requirements on asset managers, the effect of the forthcoming regulation change is not only a “Sell-Side” issue. Although many of the larger asset managers already have long running implementation programmes running and established, it is feared that many smaller firms are maybe following David Shepherd’s example and are standing on one leg as we pass this milestone. Unfortunately, by 25 May 2017 they will be back on 1 leg again as we pass 222 days.
By the time we reach 111 days on 13 September 2017, they may not have a leg to stand on if they want to be compliant by 3 January 2018.