In the wake of MiFID 2, the industry navigates the changed landscape and adjusts to the brave new world.
On 3 January, EU markets entered the brave new world of MiFID 2 (Markets in Financial Instruments Directive). Its sweeping scope has major implications across the European marketplace and beyond. However, it will take a while before the precise impact, both intended and unintended, becomes clear.
Here are four key issues to watch:
1. Trading Transparency Could Drive Tailwind for EU ETFs
The rise of the global Exchange-Traded Fund (ETF) industry has been one of the key trends over the last decade. While the growth of the EU ETF industry has lagged behind the US market, two elements of MiFID 2 may change this.
The first is the focus on trading transparency. Historically the market was opaque with approximately 70% of European ETFs are traded over-the-counter. However, firms are now required to report transaction details such as trade volume and price. The increased transparency will aid in price discovery and improve liquidity. It may also drive more ETF trading on exchanges. This could make it easier to lend ETFs and make them more acceptable as collateral, which could boost demand.
The second is that payment of commissions to independent advisors for fund sales is now prohibited. The ban on fund commissions is part of a larger global trend, which has seen similar initiatives proposed or implemented in various countries, including the UK, the Netherlands, and the US. Some in the industry have speculated that the shift away from commission-based sales will boost the attractiveness of low-cost products such as ETFs and passive index funds.
While it will not be overnight, MiFID 2 may prove to be the shot in the arm the EU ETF industry needs.
2. Stricter Product Governs Leads to Distribution Disruption
Asset managers and distributors are now subject to far more rigorous product governance requirements. Under the new rules, asset managers must identify the appropriate target market for the fund and define the suitability requirements for the end investor. This is an ongoing commitment, and asset managers must work closely with their distributors to ensure the product remains suitable for all their end investors. There is also an onus on fund distributors and platforms to monitor the target market, and provide much more information to asset managers.
To reduce the oversight workload, distributors and platforms may reduce the number of funds they offer. Likewise, asset managers may limit the number of distributors and platforms they use to sell their funds. In either case, the end result could be more restricted sales architectures and reduced choice for EU investors.
Another possible outcome is that asset managers may seek to disintermediate some of their distributors and go direct to customers. This could lead to more asset managers launching robo-advisors across the EU.
Either way, MiFID 2 could have long-term implications for the distribution of funds in Europe.
3. MiFID 2 Equivalence will Remain a Theoretical Concept
MiFID 2 introduced a third-country (i.e. non-EU) equivalence regime, allowing the European Commission to deem non-EU jurisdictions as having equivalent regulations to MiFID 2. If a third country is granted equivalence, financial firms from that country could provide investment services or activities to EU investors (although the regime only covers professional investors and counterparties).
There are two key challenges to the Commission granting third-country equivalence: one technical, the other political. The technical issue is that there are few countries with equivalent rules to MiFID 2. The political issue is Brexit. As the EU and UK engage in the Brexit negotiations, there will be political pressure to ensure the UK does not appear to benefit from exiting the EU. Therefore, despite the UK fully implementing MiFID 2, it still may not be granted equivalence. Brexit has also made EU policymakers reconsider the idea of equivalence, which may lead to delays extending equivalence to other jurisdictions.
Overall, at least for this year, it seems likely MiFID 2 equivalence will remain more a theoretical concept than a practical one.
4. Expect Technical Adjustments
With a piece of regulation as large and complex as MiFID 2, it is inevitable some elements of the rules will need to be fine-tuned. For example, the asset management industry would love to see the cost disclosures under MiFID 2, the Undertakings for Collective Investment in Transferable Securities, and Packaged Retail Investment and Insurance Products harmonized. At the moment, the same basic information needs to be reported in three different ways. However, neither the industry nor policymakers have the desire to embark upon another nearly decade-long legislative process to implement a MiFID 3.
What is more likely is that the Commission and European Securities and Markets Authority make technical adjustments to MiFID 2 where possible. This will eliminate the need for a protracted debate over the changes, and allow the EU to be nimbler in addressing potential issues. If issues do require legislative work, it will probably be more tactical in nature. So while there could be changes to MiFID 2 in the coming years, they are more likely to be in the form of a MiFID 2.1 than a MiFID 3.
Written by Sean Tuffy, Head of Market and Regulatory Intelligence, EMEA, Custody & Fund Services, Citi.