What to ask about MiFID 2 a year on
More than a year has passed since MiFID 2 came into force, and still the financial sector is working hard to adapt. What questions should directors be asking in the boards of investment funds and private banks as these rules bed-in? Anne-Sophie Minaldo of KPMG offered some pointers at the ILA Breakfast on 5th June.
Most MiFID 2 rules are now embedded in procedures manuals, but there are still some grey areas and details that need further work. Anne-Sophie is KPMG’s head of regulatory for Luxembourg, and she and her team have noticed several areas where there is room for improvement, and these points formed the basis of her presentation. This was a highly interactive session, with members able to ask detailed questions.
The biggest challenges
Anne-Sophie highlighted five main areas where she sees the challenges being the greatest: product governance, best execution, costs and charges (including inducements), re-papering, and client data. She also considered the robustness of the notion of the “three lines of defence” related to internal control frameworks. There was also discussion about the possibility of MiFID 2 being reformed or rewritten.
For product governance, Anne-Sophie spoke of on-going questions related to where responsibility lies between manufacturers and distributors in relation to MiFID. These points are particularly acute when third party management companies are used, as a case can be made that either the investment firms or the ManCo is ultimately responsible. As the rules are not clear, boards must ensure that management has a good answer for how such relationships fit into the MiFID framework.
Vigilance and reviews
In this regard, product manufacturers and distributors need to be vigilant. They must conduct on-going periodic reviews to ensure that the product or service remains consistent with the needs, characteristics and objectives of the identified target market. For example, has a recent event materially affected potential risk, product performance, or the nature of the target market? Care must also be taken to provide distributors with all appropriate information on the financial instrument, including the product approval process. There are also still many questions of how to deal with products produced outside the EU and thus not within the framework of MiFID.
Regarding MiFID provisions related to “best execution”, boards must ensure appropriate strategies and procedures per type of financial instrument are in place. There can be particular complications if the parent company is outside the EU. Anne-Sophie also pointed to details such as oversight duties when orders are routed to a group entity using straight through processing, or the need to publish the top five execution venues. She also summarised the debate around payment for “investment research”, an area where several questions remain.
Clear explanations required
How costs, charges and inducements are managed is an on-going strategic question for wealth managers. How and in what format costs are communicated to clients is a particular concern. Practitioners need to have solid answers to these questions, even if “right and wrong” would be a matter of discussion with regulators.
The issue of providing information “in good time” to clients is also somewhat fraught. Anne-Sophie recommended studying the Q&A on this topic published by ESMA on 29th May 2019 to add some clarity. Repapering and client data also remains a complex challenge. Not only must practitioners understand each client’s capacity to bear losses, but often this must be carried out when information is incomplete.
On internal control frameworks, the idea of “three lines of defence” sounds robust, but there can be the temptation to pass the responsibility down the chain. The client facing teams might assume compliance or internal audit will pick up potential problems, but Anne-Sophie warned that it is easy for busy teams to miss important details. She recommended management setting the tone in favour of a culture of compliance. The potential for substantial fines lurks.
MiFID 3?
The texts will be amended for inclusion of ESG objectives.
As for a reform or rewrite of MiFID, she said nothing was in the pipeline yet, but with new European Commission and European Parliament no one should be surprised if there is movement. She urged businesses to work with local professional associations to ensure a strong Luxembourg voice is heard as changes are considered.