The MiFID 2 directive fundamentally overhauls the producer-distributor relationship

The European directive that will come into force at the start of 2018 is in many ways an opportunity for a healthy rethink.  But the work ahead is ambitious.

Asset management companies and distributors are facing a major overhaul of the ways they relate to one another, with the impending implementation of the MiFID 2 directive next January. This new European regulation covers many different subjects, but several of them will directly impact the way that asset managers and distributors work together. The texts are not yet binding on asset managers, but by imposing new tasks on distributors, the lawmakers are necessarily also demanding greater responsibility on the part of producers.

 

Warnings in the event of market variations

As has already often been said, simply abandoning their independent status will not in itself be enough for distributors to continue receiving distribution fees, which are today at the heart of the economic model of many distributors. The distributor will have to demonstrate an enhancement of the quality of service provided to the client to justify remuneration. The suitability of the product to the investor profile must be evaluated not only at the time of subscription but also throughout the period of investment. The suitability of the product must be constantly analysed with regard to the evolution of both the client’s profile (in this context, the adviser must conduct regularly updated assessments with the client, at least annually) and of the markets: this requirement is strictly regulated, since the directive states that the client of a management mandate must be alerted to every significant variation in the value of the mandate (to be precise, a fall of more than 10% in value since the last report must trigger a warning). Therefore, the role of the asset management company will be to provide a “warning” on its own initiative to distributors, so that they can perform this duty. However, this action must be carried out with great sensitivity, because there are fears that it could be pro-cyclic. These fears focus on the risk that in the light of this disclosure, investors will all want to cut their positions at the same time, “pulling out” at the lowest point, which would be against their interests. So, good consultation between asset manager, adviser and client will be vital in these crucial moments. This need is all the more urgent given that the immense volume of information to be disclosed, in particular in retail networks, will require new and more highly automated processes.

 

Via the distributor, the directive reinforces the role of the producer

Additionally, one of the major areas of work required to ensure full compliance with the MiFID 2 directive right from the outset in January 2018 is that of product governance. The distributor will have to define the target clients of each product. To do so, the European regulator encourages distributors to coordinate more closely with “producers”. However, in practice, this definition of the intended clients will be the responsibility of the asset management companies, which will now consider that their commercial duty includes the provision of “turnkey” information, product by product, to their partners. Consequently, French asset management players that have distribution agreements with pan-European players decided, through the AFG (“Association Française de Gestion Financière”, the French asset management industry association) to plead for Europe-wide harmonization of product governance criteria. The fear was that each local player would interpret the regulations in their own way in the context of their own market. This appeal was heard, and all partner parties agreed to establish five criteria, which were validated by ESMA, the European regulator. In particular, the aim is to identify the different types of client (professional/non-professional), their relative capacity to tolerate losses and the different types of experience and knowledge – basic knowledge, informed investor and experienced investor. However, the regulator accepted that a product could be sold outside its intended client group for reasons of diversification or hedging.

Nevertheless, several issues remain unsettled. One such issue is the question of transparency, which must be total, regarding costs and charges. This notion covers not only management costs but also the transaction costs paid by the UCITS. However, the methods of calculating the costs of the brokers that asset managers turn to when placing their orders for fixed-income instruments have not yet been clearly established… And, very rapidly, it will be necessary to define a format for exchanging data between producers and distributors. A single format to be applied across Europe is currently being worked out.

With MiFID 2, all distribution agreements will have to be reviewed, in order to take into account the status of the distributor (independent or not), to specify the operating methods and to establish the roles and responsibilities of the parties. This new relationship between producer and distributor must also take into consideration the major role now played by platforms, whose responsibilities must also be clearly determined. So, at the end of the day, the relationship that the players must redefine is tripartite.

 

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