Making wealth managers ready as the MiFID II deadline approaches

By Rodney Taylor | 27 June 2017

The regulators have been clear in communicating the instruction that they expect best efforts to be made to comply with the fast approaching 3rd January 2018 deadline for MiFID II. Whilst an army of consultants have spent months explaining the challenges and interpreting the regulation, now is the time to move to the next phase if you have not already done so. For many wealth managers two years of work needs to be squeezed into the next six months. With such a tight deadline it is inevitable that choosing the right technology will be key to achieving the best outcome.

So where should wealth managers be focusing their time?

Inducements and suitability

The requirements for Investor Protection under MiFID II is likely to result in an increase in the level of document production. This is an area that will place a heavy burden on Wealth Managers where the primary advice is given to retail investors and does not include the ‘eligible counterparties’ that are largely excluded. The key areas to implement solutions will be conflicts of interest, product disclosure, and cost disclosure.

a) For conflicts of interest ESMA has been explicit that a generic disclosure will no longer be sufficient and that any conflict should be specific and tailored to the recommendation being made. The approach here is to record any corporate interests and compare them to the corporate structure of the products being advised upon.

b) ESMA has also counselled that for independent advice any suggested product should be evaluated against a diversified selection of products and that the comparison should not be limited only to products that firm provides. Under MiFID II the solution should be set up to ensure that the criteria used for comparing instruments are built into the organisation’s workflow to minimise inefficiencies. Also included in this it will be important for the Wealth Management solution to ensure that the classification of the type of client being advised determines which financial product is marketed or sold.

c) Inducements are another area that is significantly strengthened under MiFID II. There is a clear direction that any third-party fees must be passed on in full to clients as quickly as it is possible at firms providing independent advice. From a practical viewpoint, it will be essential for the Wealth Management system to be able to account for fees such as execution fees, research fees or other commissions and benefits and that these are clearly communicated in reports to the clients. Research fees will of course be the major change here and firms will be left with the choice of either paying for research themselves or passing the cost on to customers, and most importantly research cannot be linked to execution fees.

What should be clear is that for each of these requirements the addition of more cookie cutter paperwork for the end customer will not be the ideal solution and in some cases may not meet regulatory requirements either. Using technology though may have the dual benefit of automating the wealth managers’ workflow whilst at the same time enhancing the customer experience. The regulators have been clear that putting the customer first is what lies at the heart of MiFID II and its Investor Protection requirements. Putting the right system in place will be essential to achieving this.

Product governance and sales

The other key area for wealth managers to consider will be the ‘product manufacture’ and ‘product governance’ rules within MiFID II. There are new and detailed requirements to ensure that any newly created product passes an approval process, an appropriateness test, and is fit for the intended target audience. Closely linked to this is the need for those involved in selling these products to fully understand what is being sold, which will include any parameters that were set during product manufacture.

a) For product manufacture the governance process should be proportionate to the type of product being sold. Put simply, this is not a one size fits all requirements and the complexity of the product, the type of target audience and the risk profile of the product should all be taken into consideration.

b) For product distribution, the fundamental question will be how it is ensured that all information from the product manufacture stage will be distributed to sales department. For those Wealth Managers that need to meet customers on location a multi-channel solution that can be taken on the road will negate the need for mountains of paperwork.

c) A new area for wealth managers will be passing exception reports back to product manufacturers so that they can form a holistic view of where products have been sold outside of the intended audience.

Best execution and Algo testing

There has been much discussion around best execution and the change from the MiFID definition of ensuring ‘all reasonable steps,’ to the MiFID II requirement of ‘all sufficient steps’. Before getting too engrossed in dictionary definitions the key in both cases is to ensure the best possible outcome for customers. For this:

a) There will be an ongoing need to monitor the execution quality of trades that are made.

b) There should be appropriate governance around and identification of who is responsible for best execution.

c) If voice trading is performed today then there will be a need to capture the relevant data points for monitoring execution quality.

d) Storage of the relevant data is a must in order to produce the annual reports required under ESMA’s RTS 28 identifying Top 5 venues by Sub-Asset Class. These reports also need to be made publicly available.

e) Client Execution Policies will need to be updated to reflect the above changes.

f) One of the finer details to consider is that electronic trading should be reported separately from trading via a brokerage firm.

g) Another detail for some wealth firms to consider will be where any SMART Order Routers fall within the definition of Algo Trading. In this case all of the steps of Pre-Deployment Testing, Ongoing monitoring and general governance measures, such as kill switches, will need to be implemented.

The technology perspective to MiFID II requirements

To address the above concerns the solution should provide:

a) A client onboarding process that can be adapted easily to internal policies and regulatory changes

b) Know Your Client (KYC) including collection of all required data, documents, regular revision of collected client data and renewal of expired documents

c) Client regulatory classification (e.g. retail or professional).

d) Risk profiling (client’s risk tolerance), suitability and appropriateness tests (client’s knowledge and experience on various financial products) through the use of user-defined questionnaires; Continuous Suitability (Suitability Reassessment); historicity of prospect & client questionnaire replies.

e) Financial planning that captures all aspects and details regarding the financial situation of a client and his/her investment / financial objectives.

f) Investment proposal formulation using model portfolios according to the client’s investment profile and suitability and appropriateness rules; support of interactive investment proposal session with the client.

g) Financial advisory report generation that includes completed questionnaires (KYC, risk profiling, suitability and appropriateness), investment proposal which in turn includes comparison of (the actual) existing portfolio vs a model portfolio, recommendation of required changes (i.e. transactions), comparison of proposed portfolio vs a model portfolio and the actual portfolio vs the proposed one, ex-ante (estimated) transaction & ancillary services costs, risk assessment and an agreed action plan with the client.

h) Information to the clients on costs and charges. All historical (ex-post) or estimated (ex-ante) costs, fees and charges related to the products or services involved (both investment and ancillary services) can be disclosed, including retrocessions (inducements, kick-back fees). The information on costs and charges is aggregated and approved.

i) Issue warning in a standardised format to the client when a product or service is not deemed appropriate upon order and/or transaction entry.

j) Product governance process including initial approval and review process, selection of distribution channel and target market, as well as sufficient product documentation.

k) Pre- and post-sale regular client reporting.

l) Alerts informing the wealth manager and the client based on various user-defined alert rules (e.g. comparison of historical vs expected risk and return)

m) Client interactions tracking including meeting minutes, correspondence, phone call minutes, etc.

n) Best Execution and

o) Transaction Reporting.

With the deadline of MiFID II approaching, companies are evaluating how their current data and compliance programmes are fit for purpose. Evaluating and deploying a platform that would help them address their regulatory requirement becomes a necessity to foster transparency and profitability.