07 October 2011

Ian Williams: MiFID Review and Retail Products

Introduction

The long-awaited European Commission response to the MiFID Review is due for publication on 19 October 2011. The Review, which looks at the operation of MiFID, introduced in 2007, takes into account the fiscal, political and technological developments which have accompanied the financial crisis. It presented a serious political opportunity to influence the markets’ functioning and organisation through this major piece of EU regulatory architecture. 

In light of the financial crisis, the Commission emphasised the need to address further the question of investor confidence and protection. This briefing focuses on that part of the MiFID universe which targets EU policy-making on the retail consumer.

Investor Protection in the EU - MiFID’s retail role

The decisions reached in the MiFID Review will profoundly influence the parallel work being carried out by the Commission on PRIPs and IMD 2. In the case of selling practices, MiFID has been identified by market participants and regulators as providing the clear benchmark, as it contains comprehensive rules covering key aspects of avoidance and management of conflicts of interest (including inducements), and a firms’ conduct of business (assessment of suitability and appropriateness). These rules will be further developed as a result of the Review. In the context of the review of the IMD, the Commission will propose rules on sales of insurance PRIPs that are consistent with those in MiFID.

From a retail perspective, MiFID remains a critical part of the regulatory platform that seeks to improve confidence in the retail investment sector. The key issues for retail products and distribution include:

i) Product approval process; Authorisation and organisational requirements - With ESMA now established, the mechanism is in place to provide a more interventionist EU approach to retail market regulation. The orientation of the Review explicitly seeks to strengthen and codify firms' organisational requirements in relation to the provision of services to investors. The appropriate design of distribution and sales policies, and the adoption of adequate firms' internal controls around products and services development, are crucial to avoid detrimental practices towards customers. The Commission suggests that the involvement of senior management in the design of distribution policies and the adoption of adequate internal controls should receive a specific focus in legislation. This would be particularly relevant in the case of the launch of new products, operations and services.

ii) “Execution only” - key business model - MiFID originally liberalised the “execution only” market in the EU by allowing investment firms to provide investors with a means to buy and sell certain financial instruments without undergoing any assessment of the appropriateness of the given product - that is, the assessment against knowledge and experience of the investor. These "execution-only" services are only available when certain conditions are fulfilled, namely when it involves so-called 'non-complex financial instruments'. Non-complex instruments under MiFID are:

1. shares admitted to trading on RMs;
2. money market instruments;
3. bonds and other securitised debt (with no embedded derivative);
4. UCITS; and
5. other non-complex financial instruments.

There is concern that the Review could allow the Commission to claw back this freedom by abolishing “Execution only”, on the basis that investments services are intrinsically complex.

iii) “Inducements” - Impact on the advice market - The Commission wants to go further in dealing with inducements, that is “any payments likely to influence the choice of service or financial instrument”. They raise the possibility of banning inducements in the case of portfolio management and in the case of advice provided on an independent basis, or alternatively to ban in the case of all investment services. The latter may be considered a step too far for most Member States to adapt to.

The lack of strict definitions has led respondents to raise a series of concerns including the nature of benefits and group ownership. The most public concern has been raised in the UK about how the new MiFID could impact the far-reaching, and in policy terms the UK ‘flagship’, RDR reforms due to be rolled out in the UK in 2013.

Of particular significance to the UK is that it is not clear whether investment advice that does not comply with the definition of ‘independent and fair’ advice would remain available to investors. Is the Commission seeking to single out independent advisers to prevent them obtaining inducements? RDR does allow so-called ‘restricted’ advice, that is, advice under conflicts of interest, to be offered as an alternative to independent advice. The FSA in its submission calls on the EU to catch-up with the forthcoming regime by getting the (proposed) Directive to go further and “stop product providers from setting the remuneration of all investment advisers and not just those who provide advice on the basis of an independent and fair analysis; investment advice should be provided without any potential for bias.”

There is currently press speculation in the UK that the failure of the EU to ban all commissions will leave the UK in a difficult non-compliance position, in that its regime will go further than those in the other EU Member States. MiFID is a maximum harmonisation Directive which is aimed at removing Member States’ ability to impose additional rules on domestic market participants. The removal of the Member States to plead special circumstances and retain additional local rules, despite the MiFID ‘Article 4’ gold-plating ban, is  a very sensitive policy issue for the Commission. Previously, the UK made an application to the EU (which was approved) to maintain its specific disclosure and conflict of interest rules which are additional to the MiFID regime, but which were said to reflect the particular risks of the UK’s retail marketplace. It is not clear whether the Commission would once again grant an exemption.

MiFID, along with PRIPs and the IMD Review, will offer an interesting insight into the evolving policy dynamics between the new institutions and the Commission’s commitment to improving investor protection at the retail level through greater intervention, a single rule book based on maximum harmonisation. The original MiFID project became to be dominated by the sophisticated organisation and representation of market/supply-side interests. It remains to be seen whether the new MiFID is able to reflect genuine consumer interests better, and restore trust in the retail sector for long-term savings and investments.

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© Ian Williams