Reform in the retail sector - MiFID II and other EU initiatives

Ash Saluja

7 March 2012

Covering

1. MiFID II and MiFIR (Markets in Financial Instruments Directive and Regulation)

2. PRIPs (Packaged Retail Investment Products)

2

MiFID – brief reminder of impacts on retail sector

– Harmonised standards in EU

• common perimeter for service/activities in financial instruments and

easier cross border services passporting (home state COB rules only)

• new market infrastructure (regulated markets (RMs), multilateral trading

facilities (MTFs) and systematic internalisers (SIs))

• governance and systems and controls (including conflicts of interest)

• new conduct of business rules

– client categorisation (retail, professional and eligible counterparties)

– order execution and handling

– suitability and appropriateness

– inducements

– provision of information to clients (marketing, reporting etc)

3

MiFID II and MiFIR – why change?

– EU committed to minimise discretions available to MS in FS to reduce

differences between jurisdictions

– MiFID I => more competition between venues in the trading of financial

instruments and more choice for investors

– But benefits from increased competition have not flowed equally to all

market participants and have not always been passed onto end investors.

Market fragmentation resulting from competition has made the trading

environment more complex

– Market and technological developments have outpaced MiFID I,

undermining the level playing field

– The financial crisis has challenged previous assumptions that minimal

transparency, oversight and investor protection are conducive to market

efficiency

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5

MiFID II/MiFIR – an overview

– European Commission published legislative proposals to revise MiFID on 20 October 2011

– A new Directive (MiFID II)

• provision of investment services

• scope of exemptions, organisational

and conduct of business rules for

firms and trading venues

• powers for competent authorities

• sanctions

– A new Regulation (MiFIR)

• pre- and post-trade disclosure

• mandatory trading of derivatives on

organised venues

• authorisation and ongoing obligations

for data service providers

• supervisory actions

Legislative timetable

6

MiFIR – why a regulation?

– Regulation necessary to grant product intervention and trade transparency powers to ESMA because deviation at national level would

lead to market distortion and regulatory arbitrage.

– Central aim of proposal is to ensure that all organised trading is conducted

on a neutral, regulated trading venue

• Regulated market, MTF or OTF with

• Identical (but appropriately calibrated) pre- and post-trade transparency requirements

• Almost identical market organisation and surveillance requirements.

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MiFID II/MiFIR – major impacts

Market structure*

Transparency*

OTC derivatives*

Investorprotection**

Third countryaccess**

Commodities*

Corporate governance** Supervisory

powers & sanctions**

MiFID II/MiFIR

Key areas of impact for the retail sector

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MiFID perimeter changes

– Exemptions remaining

• UCITS/AIF managers

• Firms simply providing investment advice and receiving and transmitting orders in securities and units (not holding client money or assets)

– MiFID regime extended to

• Non EEA (third country) firms

• Credit institutions directly

– Changes to financial instruments/services

• Deposits with non-interest rate returns (i.e. structured deposits) likely to become financial instruments

• Safe custody becomes a “core” service

• Issuance and sale of financial instruments by investment firm or credit institution, with or without giving advice, may be an investment service

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Third country firms

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Suitability & appropriateness (1)

– Current requirement – firms providing investment advice or carrying out portfolio management must obtain necessary information regarding a client's knowledge and experience, financial situation and investment objectives to assess suitability on a transaction by transaction basis

– Proposed requirement – when providing investment advice, a firm must

• state if advice is independent & based broad or narrow market review

• if independent advice being provided

– Assess sufficiently large number of financial instruments

– not take 3rd party fees (but non-monetary benefits like training OK)

• state whether it provides ongoing assessment of suitability of the financial instrument recommended

• explain how advice meets the client’s personal characteristics

– No requirement to ensure suitability if not providing investment advice or carrying out portfolio management

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Suitability & appropriateness (2)

– Current requirement – firm providing non-investment advisory/portfolio management services must ask clients as to their knowledge and experience in order to understand the risks involved and whether the product and/or service is appropriate for the client

– Proposed requirement

• similar to existing requirement, no appropriateness checks required for execution/receiving and transmitting order services for liquid/non-complex financial instruments only

• Complex instruments include financial instruments embedding a derivative or which incorporate a structure that makes it difficult for the client to understand

• ESMA is tasked with developing guidelines for the assessment of financial instruments that incorporate a structure that makes it difficult for the client to understand - does not apply to shares or units in UCITS, with exception of “structured UCITS”

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Inducements

– Current requirement - prohibition on receiving “fees, commission or any other non-monetary benefits paid … by any third party” unless it (a) is disclosed to the client, (b) is designed to enhance quality of service to client and (c) does not impair duty to act in client’s best interests

– Proposed requirements

• prohibit 3rd party inducements in respect of portfolio management and for firms providing independent advice

• expected that Level 2 measures will enhance the disclosure requirements – current summary form and after the event disclosure is seen as inadequate

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Market landscape

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Order execution & handling

– Current requirement – firms executing orders on behalf of clients must take

all reasonable steps to obtain the best possible result taking into account the

execution factors such as price and costs, and the approach must be

detailed in a written order execution policy. Firms receiving and transmitting

orders or placing orders for execution need to act in “best interests” of client

– Proposed requirements

• approach to current policies inconsistent and most offer little value to

clients – need to explain clearly, in sufficient detail and in a way that can

be understood by clients, how orders will be executed by the firm for the

client.

• firms make public on an annual basis, for each class of financial

instruments, their top five execution venues (execution venues will also

publish more information)

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Miscellaneous

– Restrictions on cross-selling of products within firms

• when a service or product is offered together with another service or product as a package, firm must provide client with information about the costs and charges in respect of each component, and whether it is possible to buy the components separately

– Telephone and electronic communication recording

• new common obligation across EU to record client orders coveringthe services of receipt and transmission of orders and execution of orders and transactions concluded when dealing on own account in all financial instruments, with a minimum retention period of 3 years

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Product intervention

– Regulatory authorities (i.e. FCA)

• may prohibit or restrict any type of financial activity or the marketing,

distribution or sale of any financial instrument

• if reasonably satisfied that the activity or instrument gives rise to

significant investor protection concerns or poses a serious threat to the

orderly functioning and integrity of financial markets or the stability of the

financial system

• in coordination with ESMA

– ESMA

• similar powers, but can only prohibit or restrict “temporarily” (for three

months)

• although could potentially renew prohibition/restriction indefinitely

• scope of ESMA’s powers likely to be scrutinised carefully

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Changes to corporate governance

– Current requirement – firm’s senior management must be of sufficiently

good repute and sufficiently experienced as to ensure the sound and

prudent management of the firm.

– Proposed requirement means in addition that all board members must:

• have sufficient time to commit to the firm, and not combine more than (i) one ED with

two NED appointments, or (ii) four NED appointments

• must be inducted and trained

• have adequate collective knowledge to understand business & main risks

• have independence of mind to assess & challenge senior management decisions

• oversee senior management & ensure firm soundly managed

– ESMA to opine on standards for sufficient time commitment, diversity,

honesty and integrity, induction and training and collective knowledge of the

management body

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2. PRIPs review

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What are PRIPs?

“A PRIP is a product where the amount payable to the investor is

exposed to fluctuations in the market value of assets or

payouts from assets, through a combination or wrapping of

those assets, or other mechanisms than a direct holding”

– typically “manufactured”, combining different assets into a single product

– offer exposure to underlying financial assets, but in a modified way because of their packaged forms

– packaging in this way introduces additional layers of cost and risk and can disguise the complexity of the underlying investments

– will include funds, unit-linked life policy products, derivatives etc.

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Review of PRIPs - background

– EC review

– Key drivers

• “Patchwork of uncoordinated regulation” (MiFID, IMD, UCITS Directive)

• Conflicts of interest

• Improve investor protection

• Introduce level playing field for all investment products sold in the

European retail market, irrespective of their legal form

• Move away from the sectoral approach to regulation

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Review of PRIPs - key developments

– New, horizontal legislative approach to regulation

– Sales rules (for intermediaries and other distributors)

• direct sales by UCITS managers will be subject to the MiFID sales rules

• i.e. assessments of suitability and appropriateness; best execution/best

interests; conflicts of interest

– Product transparency

• mandatory pre-contractual product disclosure for all PRIPs sold in the

retail market: Key Investor Information Document (“KIID”)

• Responsibility - product manufacturers or distributors

– Timing for implementation

• latest paper awaited Q1 2012

How to deal with MiFID II/MiFIR and PRIPs

– Early stages but

• monitor developments

• lobby where necessary now (e.g. third country arrangements, commission

charging by non-independent advisers etc)

• start building project teams

– Don’t lose focus on

• more immediate changes both UK (e.g. RDR) and EU (e.g. AIFMD)

EU Reforms and the RDR

– Impact of changes under MiFID II and RDR likely to be similar overall but, some inconsistencies

• Scope of “financial instruments” wider than “retail investment products”

• Different definitions of “independent advice”

• Restrictions on commission (“independent” only in MiFID II vs all advisers in RDR)

– MiFID II intended to be “maximum harmonisation” Directive

– But FSA has stated that MiFID II will not restrict implementation of RDR (e.g. where RDR goes further than MiFID II on commission for all advisers)

– Amendments may be required soon after implementation of RDR, to reflect MiFID II

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Any further questions?

Retail Distribution Review – the final furlong

Paul Edmondson

7 March 2012

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The RDR: What’s it all about?

FSA’s retail objective

– Ensuring customers get a fair deal

Restrained by MiFID

– FSA wanted to go further

– Focus on suitability, not product regulation

– Difficulties in prescription

And in the new world?

– A future-proof project

– And the shape of things to come …

– FCA’s focus on efficiency, choice & competition

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Current aims of RDR

– Consumers offered a transparent and fair charging system for the advice

they receive

– Consumers are clear about the advice they receive

– Consumers receive advice from highly respected professionals

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A couple of aims which no longer seem important

– Viable firms

– An appropriate regulatory framework

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The RDR – who?

Regulated firms in the retail investment market:

– Providers of retail investment products (e.g. insurers, retail banks, building societies, fund managers, investment banking businesses)

– Distributors of retail investment products – main impact on financial advisers (independent/ tied)

Covers (personal) advice given to retail clients, but not

– Generic advice;

– Non-advised services; or

– Pure discretionary investment management business

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The RDR – what?

“Retail investment products”

New FSA Handbook definition – wider range of products

– Packaged products

– Unregulated collective investment schemes

– Investment in investment trusts

– Structured investment products

– Other investments that offer exposure to underlying assets, but in a packaged form, which modifies that exposure

– Stakeholder & personal pension schemes

FSA says, if in doubt, assume that the RDR rules do apply

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RIPs

“The definition of retail investment product is intentionally broad to

ensure that all comparable investment products sold to retail clients

on an advised basis, including those developed in the future, are

subject to the same relevant selling standards, for example the

requirement to be remunerated by adviser charges. To determine

whether a product is captured by the definition of ‘retail investment

product’, the characteristics of that particular product would need to

be considered. In general, we expect there to be very few types of

investment products sold to retail clients that would not fall within

the definition.”

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Independent advice – issue for advisers

– Independent advice is unbiased, unrestricted and based on a

comprehensive and fair analysis of the relevant market

– Restricted advice is non-independent advice – does not meet the

standard of independent advice (only certain products or limited range of

providers)

– NB: same suitability, adviser charging and professionalism requirements

apply to both

Independent advice – Relevant Market

– A relevant market should “comprise all retail investment products which are

capable of meeting the investment needs and objectives of a retail client”

(COBS 6.2A.11G)

– Defined and assessed on individual client basis

– Needs unpredictable so starting point for a firm = all types of RIP

– Can reduce this if

• Particular market irrelevant for all clients

• Firm only markets to and takes on appropriate clients

• Appropriate disclosure given

• Examples in GC 12/3

Independent advice

– “Based on a comprehensive and fair analysis of relevant market”

– “Unbiased and unrestricted”

– Exclude products

• Based on client needs (not firm’s)

• If not generally appropriate for retail

– Include

• Non-UK products

• Non-RIPs

– Adviser delivering advice must have skills necessary to ensure standards for independent advice are met

Independent advice – panels, platforms and model portfolios

– Panels and platforms

• Sufficiently broad

• Regularly reviewed

• Ability to advise off panel/platform

• Single platform unlikely to be sufficient

– Model portfolio

• Consider each product

• And for risk, portfolio as a whole

• Ability to advise outside model

Restricted advice

– Flexibility as to how to disclose scope of advice provided

– Should still consider existing products when determining suitability

– Can offer independent and restricted

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Adviser Charging – the policy

The policy

– Remuneration set by advisers, not providers

– Make adviser remuneration more transparent

– Address current conflicts of interest

– Enable clients to know exactly what they are paying for

In consequence

– Firms providing investment advisory services will have to agree their charges up

front with clients

– Any method, any tariff

– No more commission paid by product providers to advisers on new sales

Possible ways of avoiding RDR adviser charging rules under discussion within the industry

(e.g. replacement of product provider commission with a one-off “access fee” payable by

product provider / distributor to adviser) – but many likely to fall foul of RDR

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Adviser Charging – six rules for the adviser

Where:

– A firm makes a personal recommendation to a retail client

– In relation to a “retail investment product”

That firm may only be paid by adviser charge agreed with customer

1. Means any charge payable by or on behalf of retail client to a firm

2. Charging structure must be clear, appropriate and not excessive

3. May neither solicit nor accept any other benefit (even pass-through)

4. Nor share of product or platform charges or provider-set commission

5. Nor from a 3rd party if materially different period or basis from client

6. No recurring payment without ongoing services or regular investment

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Adviser Charging – four rules for the provider

When a retail customer is personally recommended a product you distribute, you

1. May not pay any firm unless

• Facilitates adviser charge

• Administration charges, for example for a platform

2. Must ensure your product charges distinguishable from adviser charge

3. Must not offer to invest >100%

4. If facilitating collection of adviser charge, must

• Validate instructions

• Offer flexible facilitation

• Only pay out as get in

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Adviser Charging - implications for product design

– Consider pricing models - how to facilitate the collection of adviser

charges

– e.g. fund managers:

• could choose to offer a reasonable range of different share classes, to

support different levels of ongoing adviser charges;

• could choose to rely on third parties, such as platforms, to help collect

adviser charges through consumer cash accounts; or

• could pursue other mechanisms, such as schemes to allow consumers

to sell units at regular intervals to release cash to pay their adviser

charges

– Consider post-sales service requirements

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Adviser Charging – ongoing trail commission

– Payment of trail commission on pre-31 Dec 2012 advised sales can continue post 30 Dec 2012, until product matures or terminates

– Payment of commission also permitted where firm gives advice very shortly before 31 Dec 2012, but the (initial or trail) commission is not actually paid by the provider until 2013

– Post 30 December 2012 any new advice to be paid for by adviser charge

– Reclassification of commission as adviser charge not permitted (but can rebate as part of new adviser charge)

– And more generally …..

Commission

“A firm may continue to accept a commission, remuneration or benefit of any

kind after 30 December 2012 if there is a clear link between the payment

and an investment in a retail investment product which was made by the

retail client following a personal recommendation made, or a transaction

executed, on or before 30 December 2012. This is the case even if the firm

makes a personal recommendation to the same retail client after 30

December 2012 to the extent that the continued payment can properly be

regarded as linked to the pre 31 December 2012 personal recommendation

or transaction, rather than the new personal recommendation.”

Trail commission – examples (assume advice given after 30/12/12)

– No change to product

– Reduction in contributions

– Fund switch in life policy

– Top-ups or switches

• Automatic

• “new”

– Re-registration of trail commission

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Key issues for platforms

Provider / distributor

– Ensure platform presents products without bias

– If platform receives fee, it must disclose and disregard when presenting product

– Adviser charging

– Platforms must meet the same standards as product providers if they facilitate payment of adviser charges

• Sight of client agreement

• Should use customer cash account – only cancel units if in best interests

• Ongoing charges for ongoing services (or for regular payment)

• Not need platform if not provide ongoing service

– And an adviser should only use a platform

– Must be suitable to use a platform

– And the platform

– And cannot rely on a single platform if independent

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And by the way …

Payments from product providers / distributors to platforms

– FSA in favour of banning payments by product providers / distributors to

platforms (as well as cash rebates to consumers) – but no final rules yet

– Providers should not pay standard rebate to client a/c on platform in

settlement of adviser charge because not agreed – favours unit rebates

Re-registration

– Nominee companies, including platforms, which hold products on behalf

of consumers, must offer to re-register a customer's assets to another

nominee company within a reasonable time

Fund information and voting rights

– Platforms and other nominees must pass on fund information to end

investors

So what now?

– Determine offering – done (nearly)

– Delivering against your chosen scope – well underway

– Increasing professionalism – well underway

– Remuneration – how much and how? – underway

– Documentation

• Clients

• Product providers

• Advisers

• Platforms

• Other third party providers

• Internal SYSC

• Done ??? Underway ???

Any questions?