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MiFID II, Costs and Charges

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Transparency is the holy grail to which MiFID II aspires. Not just transparency in the markets, but also transparency in the costs and charges paid by the underlying investors in funds, or those with discretionary agreements. Regulators are aiming to make the investment management industry as transparent as a 3-star Michelin chef's consommé. They want the ability not just to see the direct costs, but now, also the cost of investing in the markets, through the use of Transaction Cost Analysis.

Whilst much has been made of the transparency in the markets, this article seeks to look at the transparency of costs and charges to the end investor, be they explicit, or implicit. Like the gas bill that hits your doormat every quarter, are the costs and charges easy to understand, can you make sense of them, do they add up, and are you able to see what you're really paying for? Under MiFID II, the costs and charges regime will bring more transparency, clarity, and granularity to the underlying investor. Will this give them more information to use when exercising their "buying power", and perhaps will it influence the firms/instruments that they choose to invest with/in. And with the increased depth and breadth of the costs and charges disclosure, how can Asset Managers be certain of the accuracy, integrity, and consistency of the data they must now supply to their clients and investors?

When defining of projects required to deal with MiFID II in the run up to the January 2018 deadline the subject of Costs and Charges has tended to be pushed to one side, due in part to the lack of clarity from the regulators but also bigger fish to fry in the MiFID II project scope. With less than a year to go, now is the time to start looking at Costs and Charges in more detail.

Who does MiFID II apply to?

MiFID II applies to any discretionary funds manager and will apply to UCITS management companies and AIFMs where they manage separate discretionary portfolios. MiFID II will also indirectly affect UCITS firms and AIFMs where they delegate funds to MiFID II fund manager. Some EU country regulators are also likely to gold-plate their requirements to apply MiFID style regulations to companies outside the scope of MiFID II.

What do we know?

The regulation's requirements are still not entirely clear. However, we know that they are likely to be in line with other similar existing costs and charges regimes, therefore, we need to seek guidance from other regulations and requirements coming into effect over the next few years, namely:

  • PRIIPS (Packaged Retail Insurance-Based Investment Products)
  • Cost disclosure requirements for Department of Work and Pensions
  • Local Government Pension Schemes

Although there is no guarantee the MiFID II requirements will follow these there are indications that the regulations will be along these lines.

Scope of the requirements

MiFID II Costs and Charges requirements are expected to cover Retail funds, Private clients and Institutional funds with disclosure requirements for Ex-Ante, before the client invests and Ex-Post, periodic reporting after the client has invested into a fund, with the requirements for both these being enhanced from their current levels. Many of the expected components of the costs to be disclosed including AMC, Custody Fees, Performance Fees will almost certainly be known to the fund manager although probably not collated and stored in as granular level as will be required to meet MiFID II. The costs that will be new as far as disclosure is concerned and that will require some effort on the part of the fund manager to calculate the Transaction costs.

The regulations split transactions costs into two parts, Explicit and Implicit costs:

Explicit costs are costs charged to and paid directly by the fund and include Brokers Commission, Research Commissions, Transaction Taxes and Fees these should all be known or easily identifiable by the investment managers order management and transaction cost analysis systems.

Implicit Costs are more contentious in that they are not an actual discrete cost charged to a fund or probably a cost that would ever have been calculated before by the fund manager or even viewed as a cost. Implicit costs relate to the cost differential between the mid-market price of an asset immediately before the order is placed in the market and the price that the deal is struck at. It represents the cost of taking an asset into a fund. The implicit cost could be either positive or negative and could vary greatly dependent on the liquidity of the stock being invested in, with smaller cap stocks having a larger bid-offer spread the dealing costs for these and the overall cost for small cap funds will be larger than those of a large cap fund investing in more liquid assets. Many companies will already have the information to calculate this cost for equities from trade cost analysis, gathering the same for bond transactions will be more difficult and asset managers are lobbying hard to get this fact acknowledged by the regulator.

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The MiFID II requirements for the disclosure of these costs including implicit costs vary from current disclosure requirements.

Ex Ante requirements

  • A disclosure of the cost per £1,000 (or relevant currency) investment at share class level.
  • The disclosure needs to show the impact of costs and charges on performance (e.g. 1, 3, 5 years).
  • If any part of the costs and charges is paid in a foreign currency the disclosure needs to provide an indication of the exchange rate used.

These disclosures for segregated clients should be relatively easy to add into the transaction flow with the requirement for these to be disclosed prior to an investment being made. Consideration will need to be made as to where these costs are disclosed to the retail client particularly in automated fund supermarket scenarios as the existing KIID can't be changed so some form of enhanced disclosure will need to be delivered during the transaction flow. The retail client will also need to be informed that the figures shown in the KIID do not disclose the full costs on the fund.

Ex Post requirements

Costs and charges will need to be disclosed to the client at least annually

  • Companies will be expected to provide a personalised disclosure of the costs and charges impacting the client.
  • The cumulative effect of costs and charges on performance needs to be disclosed.
  • Details of significant future changes to the costs and charges of the fund must be included.
  • Where the fund has invested into another fund those underlying costs also need to be included in those disclosed.
  • A detailed breakdown of costs and charges needs to be provided if requested by the client.
  • An explanation of the costs and charges must be clear and simple for the client to understand.

For segregated funds this should be relatively easy to create but for retail investors into pooled funds this will mean apportioning the costs of a fund over the holdings of that client for a year, a slightly more complex process than just sending out a standard report to all clients especially where the client invests actively, has a monthly savings plan and holds several of your funds. The possibility of the client requesting a detailed breakdown of the figures provided for them implies the need for an auditable database to store the figures and control over how the figures are produced with signoff, sending a detailed breakdown with a different bottom line to the original figures would raise embarrassing questions!

The accurate and timely production of consistent costs and charges data will be a significant challenge to Asset Management firms under MiFID II, whether it be the annual disclosure, or responding to a client request. Client facing staff are also likely to face detailed questions from their clients about the specifics of the costs and charges on their invoices, and will need tools to be well equipped to deal with these.

The time is now to take action. How prepared are you for the new costs and charges regime under MiFID II? Think you've got plenty of time? Think again. With only just over 9 months remaining, and with everything else that has to be done under MiFID II, do you have the right ingredients for a clear and transparent costs and charges consommé for your firm?

ISC has worked with many large and small asset management companies on the implementation of regulatory requirements including Solvency II, AIFMD and MiFID II. Our regulatory compliance pages hold more information about the support we can offer. ISC Regulatory Compliance.

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