Do Banks Comply with MiFID II? – Insights from the German Regulator

Today, it’s been 133 days that MiFID II has become applicable. Time to take stock and have a first look at MiFID II compliance – Do financial institutions follow the new rules? What are the stumbling blocks? And where do they need to improve? It is indeed early for a conclusive picture, but the outcome of a recent market enquiry of the German financial regulator, BaFin, gives some interesting first insights.

For its enquiry, which is published in BaFin’s monthly update, the financial watchdog asked 40 selected financial institutions to answer a number of questions that focused on three rules of conduct that had been introduced in January: Taping, suitability reports, and information on costs and charges (Ex-Ante Cost Disclosure).

Taping

Starting this year, financial institutions are required to record all conversations and electronic communications with clients that relate to the activities in financial instruments like arranging, dealing and managing investments and others. Financial institutions need to inform the client of this obligation and ensure protection of these records against unauthorised access. The use of this data is also limited for example for the execution of client order or in case of a request from the authorities.  Nonetheless, the report found that clients had voice their discomfort with recording of telephone calls due to the often very personal nature of the conversations they had with their financial advisors. Prior to the introduction of the new rules financial institutions were only required to produce a summary of each conversation. The new rules however empower the client in the sense that all conversations are now recorded in detail and could potentially give prove to any form of misselling. While BaFin found that in general the financial institutions that participated in the exercise were compliant with the recording obligations, a number of situations gave cause for concern: for instance, in some cases employees reduced the recording to a mere summary of the conversation by simply taping the relevant facts then were summarised for the client. The report states that more than 20% of the telephone calls that were subject of the enquiry were missing relevant parts of the conversation then the financial institutions were required to record in accordance with the new rules.

Suitability statement

In accordance with MiFID II, following a consultation banks need to present their customers in writing with a report that outlines whether their recommendations concur with the investment targets and the personal circumstances of the client. This document in particular needs to explain why the suggested financial instrument suits a client’s term of investment, knowledge and risk appetite. In almost 90% of the examined suitability statements a qualitative comparison of the suggested financial instrument and the specifics of the client was missing. Most samples reduced their suitability assessment to a generic statement of accordance of the client’s investment objectives and the proposed solution.

The German regulator made it clear though that general declarations without reference to the respective customer and its circumstances are insufficient to meet the requirements. Instead, in the suitability statement, the institution must reconcile the customer information with the product characteristics in a comprehensible manner for each of the listed criteria.

Ex-Ante Cost Disclosure

MiFID II also requires investment firms to disclose to the client information on all costs and charges related to financial instruments and ancillary services like advisory fees, management fees, custodian fees, etc. The information has to be presented both on ex-ante and on ex-post basis. Ex-ante disclosure in this sense means that appropriate information shall be provided in good time to clients or potential clients with regard to the investment firm and its services, the financial instruments and proposed investment strategies, execution venues and all costs and related charges. The firm has to inform the client at least annually on costs incurred and any margin embedded in the margin of a financial instrument has to be disclosed.

Die ex-ante disclosure potentially represents an immense advantage for customers as it should put clients in a position to have a comprehensive picture regarding the costs of any financial instrument or service offered, and thus be able to make better decisions. However, this approach possibly creates obstacles for certain groups of customers or business models. If for instance a customer cannot receive the information in time, he or she may not be able to place an order early enough.

In reality, the exercise showed that almost half of the sample disclosures differed from the eventual costs with a third of all samples have in variations of more than 5%. The BaFin report also highlighted that financial institutions struggle with the correct allocation of product and service costs.

Conclusion

As a result, BaFin concluded that while the investment firms that participated in the report had made significant efforts to implement the new rules, many had difficulties in complying with the requirements. The financial watchdog also stated that this was not unexpected given the sheer volume of new requirements, especially considering the early stage of the sampling. Nonetheless BaFin expects improvements in the short term and will continue to monitor the situation closely, while also offering a helping hand by introducing sensible market standards where necessary and possible.

Lastly, the German regulator highlighted that clients, too, required time to adapt to the new market situation, which on the whole should create only additional benefits.