All change on information as Mifid comes in

When the Markets in Financial Instruments Directive (MiFID) comes into force on November 1, it could mark a revolution in the amount and type of information that wealth managers will need to disclose to their clients. The question is, how prepared are these firms for the operational challenges presented by the directive, and what effects will they have on day-to-day business? When it was formulated at the European Commission, MiFID was designed to provide increased protection to retail clients and open up competition in the European Union by breaking down the monopolies that have dominated the capital markets landscape across the continent. Concentration rules will be removed from stock exchanges and financial services firms will be required to provide a great deal more information on their internal workings to both regulators and clients, as well as amassing an enormous amount of data on their customers so as to protect them from misselling financial products. Best execution One of the more technical requirements is the notorious “best execution” stipulation, included in Article 21 of the directive. From November, firms transmitting or executing client orders will be required to prove that they have taken “all reasonable steps” to ensure that they have achieved the best possible result for their customers. This will involve formulating a best execution policy, obtaining clients’ approval, then providing documentation to those clients and to the regulators to demonstrate that the policy has been adhered to by disclosing execution venues, prices, costs and fees, giving an unprecedented level of transparency to the business of wealth management. Lack of clarity A major challenge, according to Alain Lesjongard, international head of compliance at the Bank of New York Mellon, has been finding out exactly what the requirements are. The Committee of European Securities Regulators (CESR) and the Financial Services Authority (FSA) in London have been criticised in the run up to the deadline for failing to provide enough guidance to firms which will need to comply. The lack of clarity over which firms are eventually responsible for achieving best execution and the way that it must be documented and monitored create complexity and operational issues, Mr Lesjongard says. This means that the onus at the moment is on achieving the very basics of compliance, Mr Lesjongard believes. “At the moment, most of the firms are plodding along and trying to get out what they think is a practical and meaningful best execution policy to be sent out to their clients, getting the concept of how they intend to achieve best execution,” he says. Achieving that best result is another challenge, and proof is reliant on the availability of data and suitability of market structures. In the UK and Europe’s more developed markets this is unlikely to be a major barrier, but in some emerging markets it is a more difficult prospect. Consequently, Mr Lesjongard says: “I think [compliance] is going to be on a best effort basis.” Making a statement The Bank of New York Mellon is looking at possible ways to include best execution information into its statements, and has begun the process of sending policies out to its customers for review. So far, none have taken issue with the firm’s approach to meeting the requirement, according to Mr Lesjongard. Once the policy is in place and the documentation process under control, that information then needs to be transmitted to clients. The difficulty then is that those clients may not be suitably qualified to understand the intricacies of the trading process. It is vital that clients are not overwhelmed by an avalanche of information that is not relevant or appropriate to their business. “I’m not sure how much some of the regulators appreciate that providing information is always a double-edged sword, it’s important not to confuse the client,” Mr Lesjongard says. “The process of education is the responsibility of the regulators as well as the investment firms,” he adds. This is also where the best execution reporting requirements start to overlap with other areas of the directive. MiFID demands that clients be assessed on their knowledge of the financial instruments so that they are only sold products that meet their investment objectives. To this end, Fortis Private Banking Belgium is currently meeting with all of its clients in order to assess their financial situation, investment objectives and their knowledge and experience of financial instruments, according to Xavier Declève, senior executive director at the bank. This process is unlikely to be completed until some time in the first quarter of 2008. Following these meetings, clients will be expected to sign off on the suitability documents that are compiled and the bank will also use a computer-based “appropriateness test”. “We would like to create a mindset that when we meet a client or prospect, we try to know as much as we can about them,” Mr Declève says. Mission impossible Even with this understanding of clients’ requirements, tailoring the best execution policy for individual customers is likely to be next to impossible, Mr Declève says. In early discussions within the industry, the possibility that Article 21 would require bespoke execution policies, depending on the client’s objective at the time of order, was raised. Realistically, a single policy focusing on the best cost may be sufficient. Fortis’ private banking division is working with its capital markets arm to offer best execution. Fortis Global Markets will come up with the best execution policy, which will then be distributed to clients. The bank will also publish benchmarks to help their clients understand best execution in the context of the rest of the market, Mr Declève says. Kleinwort Benson also regards MiFID as being more of a customer relationship exercise than a compliance one. “We’re not looking at it from the standpoint of a specific compliance exercise, we’re looking at it as a front-of-house exercise,” says Robert Taylor, the bank’s chief executive officer. Kleinwort Benson is training its bankers to educate clients and glean information about their level of understanding of instruments, Mr Taylor says. “If you look at private equity as an asset class, clearly a lot of our entrepreneurs will have a good understanding of the essence of what running a business is all about, and likewise, a lot of people have worked in property of some sort,” he notes. But the derivative instruments used by hedge funds may be less widely known, even among Kleinwort Benson’s client base, which is traditionally drawn from financial services industry participants. Kleinwort Benson’s bankers will themselves be assessed on their ability to advise and rate clients. Those that do not meet the firm’s standards on November 1 will be asked not to see clients until they can get up to scratch. Point in the road This level of consultation and data collection is far from new, Mr Taylor notes. In fact, it is merely a formalisation of practices that have been prevalent in the industry for some time. “We’ve always had a policy of profiling clients quite thoroughly, so in terms of the information that we have, our recommendations are generally based on our understanding of their financial picture, their attitudes towards risk and also their overall assets and needs.” The change is a refinement of those discussions rather than a total reworking of practices. In fact, MiFID marks a waypoint on a long road to better client service that the industry has been on for more than a decade, Mr Taylor says. “We in Britain have seen this industry shift so much as a result of trying to do things that are better and clearer for clients, so it really shouldn’t come as a big shock to us in that sense. “I believe what we’re seeing is a professionalisation of our business that has been going on for 10 to 15 years,” he adds. “With or without MiFID itself, in the UK we’ve been trying to become increasingly transparent and increasingly aware of how we are offering our products and services to clients. MiFID is just sharpening up that approach.” Whether it comes procedurally or suddenly at the beginning of November, more transparency is likely to mean more robust discussions with clients over pricing, as after sifting through transaction reports they find themselves with more ammunition. “I’m not anticipating, at least from our clients, that they’re going to change their behaviour that much based on this information, because again we have a fairly sophisticated client base,” says Mr Taylor. But then, clients with sophisticated financial knowledge have always looked that much more closely at the information they are given. Looking at the wider industry, Mr Taylor says: “I hope what it does do is give clients the opportunity to question more where they might not quite understand what the situation is in terms of what they’re investing in or question a bit more in terms of the pricing.” This will enhance competition between wealth managers across Europe and may increase client portability between firms, Mr Taylor hopes. But wealth management has always been a client-centred business. And if the message is that if you fail to advise your clients properly they will vote with their feet, November 1 is hardly likely to signify the start of a paradigm shift.

‘I’m not sure how much some of the regulators appreciate that providing information is always a double-edged sword’ - Alain Lesjongard, BNY Mellon