Which regulations will impact private banking?

Peter Ipkovich

Head of Group Private Banking CEE, Erste Group Bank AG

MiFID aims to provide private investors with the protective processes enjoyed by institutions

The changes based on MiFID II (Markets in Financial Instruments Directive) framework will significantly impact the banking market and the private banking business in particular. Banks will have to completely review their business and pricing models.

Due to increased financial product complexity combined with higher risks in a difficult market environment, EU politicians started to call for tighter regulations. The MiFID framework aims to create more efficient and robust market structures by improving investors’ protection and increasing transparency. While MiFID I provided room for local deviations, MiFID II with the support of ESMA will limit the space for interpretation by the individual countries.

One of the changes with a major impact on the retail and private banking business is related to the advisory service. In the future, private clients will have to decide whether they want to be advised dependently or independently.

Independent advisory service implies that the financial adviser shall not be influenced in the product selection process by the interest of his investment firm.

The customer shall be provided a fair and appropriate comparison of a large scale of financial instruments based on a detailed analysis of the offered products. Any limitation to instruments with close links to the investment firm or the distributor must be avoided. In order to guarantee independence, any inducements or kickbacks  are banned.

We are observing new forms of advisory models appearing on the market but will have to wait and see whether the approach will be accepted by clients.

In case of dependent advisory the product range does not need to be that diverse, and a focus on self-issued products is permitted. Inducements are allowed if they enhance the quality of service.

I expect stand-alone private banking providers will opt for the independent advisory model whereas universal banks will, at least at the beginning, merely decide for dependent advisory. It is good news that, contrary to the initial intent, it will be possible for banks to offer a combination of both models so that distributors will be able to offer both advisory models under one brand.

Since the turn of the millennium, products that were initially designed for institutional investors were offered to private clients while neglecting the corresponding protective processes that were developed for professional investors. MiFID II requests these processes will become standard for private investors as well.

Tracking, recording and reviewing of any advisory service will have to be intensified. That means for example, that every telephone conversation between a client and an adviser has to be recorded. This will become a real technical and logistic challenge for financial institutions. Only those players with the capacity and the will to implement the new rules will remain which will further boost the concentration of private banking service providers in Europe.

Simpler products and more structured and standardised advisory services should protect private investors from ‘black sheep’. For financial institutions, MiFID II and other regulatory requirements might result in a diminution of potential revenues accompanied by high implementation cost. However, if it leads to greater trust and enhances the financial industry’s reputation, it will be worth it. 

Aymeric Lechartier

Director, Carne Group

There are worries AIFMD may lead to a narrower choice of investments, but the opposite is true

Private wealth managers strive to offer a broad range of investment products covering the full gamut of asset classes. With the introduction of the Alternative Investment Fund Managers Directive (AIFMD), there has been a concern the choice of investment products might become more limited. Most of the fund products traditionally on offer followed the Ucits format, but this excluded many alternative investment strategies that used more illiquid assets or commodities.

Historically, asset managers used the private placement regimes in many countries to be able to distribute their products into the private wealth sector, but this will become increasingly difficult moving forward, and is already almost prohibitive in some markets.

Even under the private placement regime, it has been quite cumbersome for wealth managers to effectively distribute offshore, non-Ucits funds. This conflicts with the significant interest from private clients for hard assets that can withstand the pressures of time and crises, such as real estate, farmland, infrastructure and natural resources.

AIFMD is intended to facilitate the marketing of alternative products via cross-border registration in Europe. It means managers can openly market European domiciled alternative investment (AIFs) as long as the investor is suitable. This will enable HNW investors to allocate as broadly as institutions and include a much wider alternative segment in their allocation.

The concern for many managers of illiquid strategies located outside the EU has been that the AIFMD’s requirements are simply too onerous for them to look at private wealth channels in Europe as a distribution option. This can simply boil down to worries about the cost of acquiring adequate substance, additional red tape, or increased marketing restrictions. There also exist concerns the directive will somehow confer invasive oversight from European regulators into the day-to-day business activities of non-EU managers.

Part of the challenge for firms is one of educating asset managers unfamiliar with AIFMD about the market access it offers rather than the obstacles. AIFMD represents an opportunity for asset managers on a global basis, including managers of real assets such as real estate and infrastructure, to make their strategies available on European private wealth platforms in a regulated wrapper.

Solutions exist to assist such efforts in a cost-effective manner while maintaining robust governance, oversight and risk management. While the perception in some quarters of the asset management industry has been that AIFMD has erected an insurmountable barrier around the EU market for all but the biggest alternative managers, this is far from the case.

Fund managers that already have solid distribution networks within the private wealth sector are starting to switch over to AIFMD in order to continue to be able to market to the industry. For others that have traditionally used private placement, it is critical that they revisit AIFMD and their current marketing arrangements, as private placement for the non-Ucits fund is a door that is rapidly closing. 

John Soler

Senior associate partner, Sarasin Asset Management

FATCA’s reporting requirements are complex and costly meaning many financial institutions are pulling out of the US

The Foreign Account Tax Compliance Act (FATCA) is an American law passed in 2010 which has recently come into effect (1 July 2014). It has far reaching consequences for the global wealth management industry and for US taxpayers.

The primary aim of FATCA is to increase tax compliance by US taxpayers who have financial assets held outside the US. The act was primarily a response to the 2009 UBS off-shore banking scandal which revealed some Americans were maintaining unreported and untaxed bank accounts. The FATCA legislation imposes on all foreign financial institutions a legal mandate to determine who among their clients are “US persons” and report, either indirectly (via intergovernmental agreement) or directly, to the IRS specific information on those accounts.

Severe penalties are imposed for non compliance in the form of 30 per cent withholding tax on all US-sourced payments including the gross sale proceeds of US securities. Because US financial assets are so widely owned globally, virtually all financial firms receive substantial US payments. Having 30 per cent of all these payments withheld regardless of whether you have any US clients or not is not a good option. Most financial firms are expected to be compliant to avoid the withholding.

The implications for the global financial services industry are huge. Almost every conceivable kind of financial institution outside the US is caught by FATCA. Banks, brokerage firms, custodians, insurance companies, and fund managers are all in scope. Even private entities such as trusts, corporations and partnerships are required to declare their status. Each has to follow extensive criteria to identify and report their “US persons” which includes US citizens, US residents and green card holders, as well as trusts with US connections. 

For financial institutions the reporting requirements are complex and costly. It is no surprise that many are choosing to close and prevent future accounts with US persons in order to lessen their compliance burden. For those that choose to remain open to US clients, extensive FATCA reporting is but only one important consideration. Other critical factors include maintaining registration with the US SEC, knowledge of US tax rules and US tax reporting capabilities. No wonder so many firms are deciding it is too costly to look after US-connected accounts. Any firm that remains open to US clients must be fully committed.

For US clients, not only do many face the shock of account termination letters and the need to find new fully US-compliant firms, but there is also a pressing need to take inventory of all their financial accounts and consider which ones will be subject to FATCA reporting by a financial institution. Previously unenforceable rules will now become enforceable as FATCA is implemented globally and the penalties are severe. Good intentions and a casual tax compliance attitude are no longer enough.

The global FATCA reporting regime paves the way for stricter enforcement. For example, existing requirements for US clients to report foreign bank accounts (FBARs), to report holdings in passive foreign investment companies (PFICs) (which includes most non-US domiciled mutual funds and ETFs) will be more easily enforced.

It is the right time for US persons and trustees to review their accounts and ensure they are using financial firms who are fully committed to US clients.