The malevolent finale to Mifid II

By Russ Bryan | 14 November 2018

Cost disclosure may well yet prove to be the most pernicious element of the EU’s entire consumer protection strategy. Part of Mifid II, these changes apply to all wealth management transactions where there is a cost of investing money in the market. Some advisers refer to the aggregated information on costs and charges that they must present to clients under the regulation as ‘aggravated information’ – and for good reason. Mifid II significantly increases the granularity and complexity of the entire costs and charges framework.

From January 2019, advisers will need to disclose all costs and charges that relate to their retail recommendations. Indications of expected (ex-ante) costs and charges need to be provided pre-sale, and details of the actual costs and charges need to be provided post-sale (ex-post), where applicable on at least an annual basis. These need to be aggregated and expressed both as a cash amount and as a percentage.

In broad terms, therefore, the following must be disclosed: all one-off and ongoing charges, and transaction costs, associated with the financial instrument; all one-off and ongoing charges, and transaction costs, associated with the investment service; all third-party payments received, and the total combined costs of these three categories. These disclosures must also be accompanied by an illustration that shows the cumulative effect of the overall costs and charges on the return.

The potential repercussion of these rules on the UK wealth management scene is that some of the larger industry powerhouses may be able to undercut the competition, as the market becomes more price-driven. This could theoretically drive some of the smaller boutiques out of business. Alternatively, the big fish in the wealth management pond may consider that their performance record is such that they do not need to cut their prices, with the result that competition on fees between the smaller boutiques intensifies. Indeed, we have seen some wealth managers slash their fees down to as little as 0.1%. For a discretionary wealth manager charging fees at these levels, their long-term viability becomes questionable.

Another theory is that alternative, more straightforward fee models will emerge from the industry. Due to client discomfort with current fee levels and a rise in demand for transparency, performance-based or modular fee models are likely to gain traction. Performance-based fees models will naturally levy a higher cost if the wealth manager achieves better returns on a portfolio. There will also be more transparency: for example, a lot of wealth managers make their money through exchange rates or issuing duplicate contract notes. When disclosure comes into effect, it will be harder for wealth managers to do this as the client will know exactly what they are being charged for. Wealth managers will need to find a way to wrap these activities into a service, developing a fee model that is almost a ‘subscription’. This subscription will include market charges, running costs and client charges all wrapped into one, with investors just paying a fee for being a client (rather than a fee, plus all of the extras).

Of course, the more complex the fee structure, the more cost it would entail to comply with the disclosure regime. It means every type of fee outside of the simple ones would have a cost associated with being able to report it, which might mean that the simpler fee structures will prevail because they are cheaper to administer.

At present, fee models can appear to be a little difficult to fathom. Some firms will charge 0.2% on the first £10,000, 0.1% thereafter, plus 0.5% for each transaction. Even trying to assimilate this on a client pack at the end of every year is something of a challenge. Anything that simplifies this process and makes it more transparent is a good thing for consumers. This would aid the cost disclosure initiative as it would remove the need to retrieve costs from, say, five or six different charging mechanisms and instead, present the client with one fee, with clear breakdowns.

From the client perspective, the presentation of so much more data on their investments will not always be appreciated. Their first port of call will still be to check the performance of their portfolios. The cost disclosure report has to be published once a year, to be delivered with the tax pack in April – or end investors can request an ad hoc report at any time. The report will provide more granularity as to how the costs are broken down. How wealth managers actually display that information in the client pack will really be determined by how many questions are going to be asked. For an investor that has earned, say 15% in a year, it is unlikely to delve deep into the cost disclosure figures (unless those charges account for 5% of the total holdings). The likelihood of an investor that has made just 5% return drilling down into fee data will be significantly higher.

In this way, it will be net performance that will dominate in the new era of cost disclosure. In a bull market, of course, this is not a problem; but when the bear market arrives one wonders if the wealth management community is ready for the fact that their costs (that they are having to now disclose) might be higher than the gains that they are making for their investors.

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