The Markets in Financial Instruments Directive (MiFID) II comes into effect on 3 January 2018, seeking to further harmonise securities trading, financial services legislation and improve investor protection across all member states of the European Economic Area.

At the start of July, the Financial Conduct Authority (FCA) published its second policy statement (PS17/14), which set out final rules for implementing the directive in the UK. The good news is many of the rules that affect advisory firms have already been addressed comprehensively by the Retail Distribution Review (RDR) – notably the ban on commission and other inducements for independent advisers, which the FCA now plans to extend to restricted advice and portfolio management. Nonetheless, there are a number of other aspects of MiFID II that may require UK adviser firms and manufacturers to take action.

Demands on adviser firms

Here are the key areas adviser firms need to be aware of:

Defining independence

For the first time ever, MiFID II will introduce a European-wide standard for independent advice, requiring firms that call themselves independent to assess a range of financial instruments, not limited to entities to which the firm is linked.

Any UK independent adviser that’s already compliant with RDR should notice little difference, apart from an increased scope of investments. However, there are two developments worth noting. First, a firm will be able to offer both non-independent and independent advice, provided there is a clear separation between the two (for example, the same adviser cannot offer both independent and non-independent advice on MiFID products). Also, the FCA has indicated that a firm will be able to call itself independent even if it only offers advice on a certain area of the market, provided its marketing makes this clear.

Implication 

Could make it more attractive for independent firms to specialise in a particular area of the market. Firms may want to reorganise into dual independent and non-independent operations for different areas of financial planning.

Complex products

Investment products will be defined as complex or non-complex, with only the latter available to private investors without any advice or suitability checks.

The MiFID II definition of complex currently covers non-UCITS retail schemes (NURS) and any structured UCITS fund that embeds a derivative. However, as a directive, interpretation of the rules is ultimately left to each national regulator and the FCA has chosen not to classify either NURS nor investment trusts automatically as complex products. Instead, the FCA says the complex designation should be made case by case.

Implication

Could create a greater opportunity for firms to advise on more complex products. Or it could encourage product providers to reduce the range and complexity of products they offer.

Suitability

Before recommending a product or a particular transaction (including selling, holding as well as buying instruments), a firm must make suitability checks to ascertain a retail client’s relevant knowledge and experience, their objectives, situation and ability to bear losses. A suitability report must then be provided.

Suitability is already addressed in the FCA’s Conduct of Business Handbook. But MiFID II additionally stipulates that where advice or discretionary management is provided wholly or partly through an automated system, a firm still remains responsible for assessing suitability. Further rules apply on keeping suitability information up to date if a client is being provided with ongoing advice.

Implication

Both European and UK regulators are intent on making suitability requirements as tight as possible. Any firm that has not got a clear procedure in place for assessing, recording and periodically updating client suitability needs to revisit their processes and systems urgently before January.

Telephone calls

MiFID II requires ‘recording of conversations and communications with all clients where these relate to or intend to lead to the conclusion of a transaction, even where the transaction is not concluded.’ The FCA comments: “anything communicated from either the client or the adviser that could influence the client’s decision should be captured.'

Implication

Firms will need to introduce clear procedures for documenting ALL client conversations leading to an investment decision, including where advisers are using their personal mobile phones.

Execution-only investing

MiFID II will allow private investors to self direct but execution-only investing will only be automatically available for non-complex financial instruments (see above).

Complex products will require execution-only services to conduct appropriate tests regarding an investor’s knowledge and experience. Appropriateness tests are likely to vary according to how complex the product is.

Implication

Firms offering any form of self-directed service will need to check what products it includes and how these will be defined under MiFID II. Where complex products are included, systems will need to be put in place to assess appropriateness before a client can trade.

Clearly, there’s plenty for firms to address and before 2018.  The FCA has acknowledged that parts of the regulation are still being resolved but expects firm to take ‘reasonable steps’ to comply with the rules by the January deadline.

This being the case, making sure that robust processes are in place to ascertain and record suitability of advice, appropriateness of products and disclosure of all costs should be top of any advisory firm’s to-do list.

Demands on advisers and manufacturers

There are two key areas both advisers and manufacturers (defined as ‘a firm which creates, develops, issues and/or designs investment products’) need to be aware of:

Target markets

In addition to the suitability rules, manufacturers and distributors will be required to define their target investor markets and take steps to ensure that products only end up in the hands of the intended market. This will demand extensive two-way information-sharing and ongoing assessment of both products and clients.

Total costs disclosure

Distributors will be required to disclose a single figure for all costs of investing in a product – including advice and platform charges – against the expected return. Total costs will need to be disclosed pre-sale and then annually thereafter. The FCA is not setting out a standardised format in which point-of-sale and post-sale information should be presented but says it will engage with any industry-led format.

With these key areas of focus in mind, we’re considering the implications and will provide an update on Aegon’s response soon.