• To understand what steps are needed before Mifid II comes into force.

  • To learn how product governance will work under the new directive.

  • To understand whose responsibility various aspects of Mifid II compliance will be.

    By CTO Ronan Brennan, this article originally appeared in FT Adviser.

    The Markets in Financial Instruments Directive II (Mifid II) is one of the most far reaching and demanding pieces of regulation yet for the wealth and investment management industries.

    However, worryingly, there are still quite a few steps to be taken (and therefore opportunities for failure) before the rules come into force.

    Without doubt, the mandatory repapering of agreements throughout the distribution chain to ensure end-to-end product governance will be a challenge for most firms, regardless of their size and scale.

    However, this should, for the most part, be a one-off requirement, within reasonably well-bound parameters – albeit with a very high volume of legal work to get through in a very limited time frame.

    The Mifid II directive effectively forces the product manufacturer to engage with all parties in the chain to ensure end-to-end oversight is achieved, leaving those non-Mifid firms little choice but to engage and facilitate the request.

    The implication here is that non-Mifid firms, such as pure Ucits management companies and alternative investment fund managers (AIFMs), who sit outside the general thrust of the Mifid II directive will still find themselves drawn into the Mifid II product-governance regime.

    That is because distributors in the chain who are Mifid II bound will be forced into an exercise to ensure all their product manufacturers adhere to the product governance principles.

    Additionally many regulators are indicating that MiFID II product governance will be considered a best practice approach to the governance of investment products, regardless of the MiFID designation of the entity in question.

    So a firm would need very good, and indeed well documented reasons as to why they would not follow said guidance in order to stay on the right side of the regulator.

    Product governance

    Of even more concern to firms are the hurdles presented by product governance when it comes to communication of target market data from point of manufacture to the point of investment/discretion.

    As part of the product governance process, a manufacturer must assess each product and assign it a target market that clearly defines the type of investors the product is aimed at, and the allowable distribution strategies for that product.

    This data then needs to be communicated throughout the chain right down to the adviser community, thus ensuring each point of distribution/redistribution has a clear view on how the product should be sold, and to whom it can be sold.

    Each distributor in the chain, including the end adviser, is in turn obliged to operate their own product governance process and to set out and document their own specific views on the applicable target market and distribution strategy for each of the products in their arsenal.

    The distributors are, in fact, expected to have an even more granular and refined approach to the process, the reason being that they are closer to the end investor and thus expected to demonstrate their knowledge of the client through a more targeted and specific market assessment.

    This requirement is dampened for products on the simpler side of the complexity spectrum, and obviously heightened for the more complex products.

    The target market and distribution strategy data is not particularly sensitive and many firms would have no qualms about publishing it on a publicly accessible web site, and to this end it is likely much of it will be deemed ‘market data’ and freely exchanged with market data vendors (MDVs) and data aggregators alike.

    The challenge will be simply how this data will be made available to tens, if not hundreds, of intermediaries in the chain. Giving the data to an MDV will not solve the broader problem; many intermediaries cannot reasonably be expected to sign up to any specific MDV, or indeed, a range of different vendors.

    What firms really need is a single point of distribution/collection where each intermediary can receive/pick up the data.

    The industry has come together in working groups to facilitate standards to ease the exchange of this data along with cost and charges information, right the way from product manufacturer down to distributor, and on the whole, there appears to be broad consensus on this communication of target market data.

    However, it is important to note that adherence to the standards will not always be consistent and there may be many versions in play as various different interest groups establish their own interpretations of these standards.

    Unfortunately, this is actually the easy part. Product governance within MiFID II also requires distributors to send target market sales exception data back upstream to the original manufacturer. This could include data on sales outside the target market, as well as data related to sales into the negative target market.

    Essentially distributors, including advisers and wealth managers will be obliged to monitor all investment placement and analyse how it aligns to the product manufacturers’ designated target market.

    What is highly sensitive data?

    The industry has not yet settled on the exact nature of the data to be sent back upstream, with some distributors wanting to post full sales reports, thus placing the onus on the asset manager to deduce the outside of target market and negative market allocations, while others want to send exceptions only

    What it is definitive though is that this is not market data and is not suitable for public view. In fact this is potentially highly sensitive data, and certainly not data a firm would like placed in an MDV data feed, which to many is equivalent to a public domain.

    We strongly advise therefore that the exchange of sales/exception data cannot happen via MDV channels as it is simply too sensitive (imagine a news source getting its hands on details of potentially mis-sold investments).

    Even with the obfuscation of the end investors’ details, the data itself is sensitive to both the distributor and the manufacturer and they will want to ensure it is limited to as few eyes as possible.

    Just as the investment managers will need to communicate target market data to a large number of distributors, so too will the distributors need to communicate sales/exceptions data to a great many managers. To this end, the data aggregation exchanges have a key role to play, in particular those exchanges that support permissioned and secure exchange of data between parties.

    There is an important philosophical point to make here; within an exchange, the ownership of the data still rests with the submittor, while with an MDV, once submitted, the data is essentially ceded  in ownership terms to the MDV.

    This allows the MDV to licence access to, and use of, that data to any third party. There is little or no scope to arrange a non-disclosure agreement with an MDV, and at best an embargo period is about the best any firm can expect to negotiate.

    Looking back at this list of challenges, it is easy to fret. However, thanks to the sterling work already completed, and still ongoing across the industry, we are hopeful that all the data requirements will be able to be met.

    Indeed, the list of those working groups who have been liaising to agree an intra-industry standardisation includes a wealth of the key players, including:

    • Tax Incentivised Savings Association
    • Wealth Management Association
    • Investment Association
    • UK Platform Group
    • Association of British Insurers
    • British Bankers Association.

    With so many instrumental associations getting on board and focussed on working together to achieve the best results, we can hope that we are in a strong position to face this new regulation head on.

    The problem still to be faced is that there are still some in our industry who have been very slow to realise the importance of these daunting issues. Many see this as next year’s problems, rather than acknowledging that we are less than six months away from Mifid II inception and so there is a risk that these firms and individuals won’t seek a solution until the last moment.

    Unfortunately, there is a risk that this resulting hold up could blow a hole in the sale of investment funds in the early part of 2018. Who in the chain, after all, will want to sell a fund if they believe that the steps have not been put in place to ensure compliance with the news rules?

    Next steps

    Which leads us to consider what can be done. With regards to sending product governance information down the chain, that is obviously the responsibility of the asset managers and platforms.

    Just as managers need to document and distribute the target market data to the distributor, each distributor is also obliged to document their own view on target market and distribution strategy with a greater onus on the distributor to define the target market in a more granular fashion, based on their greater understanding of, and connection to, the market place.

    In relation to retrieving information to send back up again, the major work in aggregation takes place at the platform level and is then dealt with by asset managers. The only credible solution for the efficient exchange of this data is a secure exchange, which allows the entire chain to get information to where it is most needed.

    What the adviser community can do is put pressure on their partners in the chain to ask what steps have been taken to meet the Mifid II challenge.

    Only by all of the industry working together can we keep each other on our toes to make sure we meet a deadline that’s fast approaching.

    By CTO Ronan Brennan, this article originally appeared in FT Adviser.