Thu. Oct 17th, 2019

Planet Compliance

Innovation & Regulation in Finance

The State of MiFID II?

8 min read

On Thursday, the German financial watchdog BaFin announced that it would conduct another review into compliance o financial institutions with the rules introduced by MiFID II one year ago. In a first review, which was published in May 2018, BaFin had asked a group of forty financial institutions that consisted of private banks, foreign branches and subsidiaries, credit unions, cooperative and savings banks questions that focused on taping, suitability reports, and information on costs and charges (Ex-Ante Cost Disclosure) – rules that had been introduced or amended only a few months earlier. Naturally, it was still early days for MiFID II, but the review produced a number of interesting results:

Taping

Following the introduction of the new rules, 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 unauthorized 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 mis-selling. 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. The 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.

Once again the focus is once again on the newly introduced behavioral requirements that are particularly relevant for consumer protection. BaFin therefore contacted once more forty financial institutions and requested details on ten transactions to examine the compliance with these rules. The contacted banks have until 22 February to respond and describe in detail how they comply with the regulatory requirements.

BaFin states that the objective of this second review is to get an up-to-date, market-wide overview and identify changes compared to the last survey. Christian Bock, Head of Consumer Protection at BaFin said in the statement that the authorities expect that the initial difficulties, which appeared to be acceptable given the early stage of the implementation, have now been overcome. He also said that it is also of particular interest to BaFin whether and how the new requirements impact investor protection in practice.

Regulators had initially given financial institutions some leeway appreciating the size of the task that was the implementation of MiFID II. It was therefore accepted market practice that despite the 12-months delay of MiFID to give banks more time to prepare, most financial institutions even several months after the due date were not fully compliant. For instance, a study found that about 40% of financial services firms were at risk of being fined up to €5 million for failing to comply with record keeping rules under MiFID II since only the other 60% of companies in financial services have sufficient technology and processes in place to record and capture real-time communications. The study refers to Article 16 of MiFID II, which envisages fines of €5 million or 10% of the annual turnover of financial institution if found non-compliant.

A turning point in the general approach to non-compliance with MiFID II rules became apparent in the second half of last year. In July, the European Commission refers Slovenia and Spain to the Court of Justice for failing to fully enact EU rules on markets in financial instruments. This followed a formal request from the Commission in September 2017, that demanded from several Member States to transpose MiFID II and its Delegated Directive. In a statementthe Commission said that in January 2018 reasoned opinions were issued against those Member States that had not notified full transposition yet, but by July 2018 Slovenia had not notified any measures related to the Directives at stake and Spain had notified partial transposition only.

Around the same time, the head of the UK Financial Conduct Authority, Andrew Bailey also stated that the time for coasting along was over and that firms non compliant with the rules would be held accountable. He, too, admitted that because “Mifid II is probably the biggest piece of financial market legislation there has been so our approach at the outset was to prioritise the functioning of markets” the regulator was “balancing getting it introduced with markets functioning effectively, giving some time for things to settle down because we had to deal with a few things on the run in the early days and weeks”. However, he also said that the FCA had “a programme of supervision that is underway and of course after a while we will. No firm should say it’s not compliant and frankly if it is not compliant it ought to [ensure it is]”.

With this is mind it will be interesting what the German regulator finds in its latest review and even more so, what the concrete consequences in case of shortcomings will be.

 

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