While agreement might finally have been reached between the European Commission, Council of the European Union and the European Parliament on MiFID II, major implementation challenges lie ahead. Paul Golden and Valentina Romeo speak to some of the industry’s leading experts.
Three years after the European Commission revealed its plans to amend and extend the Markets in Financial Instruments Directive or MiFID, the proposals for its successor MiFID II have been accepted.
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It might seem as though the European Securities and Markets Authority (ESMA) and the other European authorities who need to develop implementing measures to detail some of the requirements set out in MiFID II have plenty of time, given that the legislation will not come into effect before 2017. However, a number of areas of concern remain.
For example, though MiFID II is EU-wide in scope, its implementation will be undertaken in conjunction with other national, pan-European and global regulatory proposals. Therefore, global institutions operating out of traditional global financial centres like the UK can be expected to be those most affected by yet more mandated requirements.
That is the view of Matt Sauer, research manager global securities and investment strategies at IDC Financial Insights, who adds that implementation within each member state (and Norway, Iceland and Liechtenstein)will depend on the eventual interpretation of ESMA technical guidelines by each national body.
"There is some scepticism around ESMA’s ability to monitor compliance with MiFID II. Doubts surrounding the lack of resources available to the authority were not quashed when its chairman recently described difficulties it was having raising funds to meet its ever growing requirements. There are many within the industry who expect that ESMA will firstly need to continue to expand on its headcount if it is to effectively meet its requirements to draw up technical standards for a multitude of regulatory proposals."
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By GlobalDataData doubts
Sauer refers to recent conversations where questions and doubts have been raised about the amount of data that is to be reported to ESMA and whether ithas the human resources – and more specifically the technological power and competency – to understand and action data to ensure specifications are being adhered to.
"The full implications of any national differences, however, remain to be seen with each member state given 24 months to translate ESMA specifications(expected before the end of the year, although this is optimistic) into working legislation."
Citisoft CEO Steve Young says the jury is out on ESMA’s effectiveness in fully implementing the reforms as they were originally intended. "However worthy the regulation is and regardless of the end benefits to investors, regulation of the markets is more of a political issue than anything else. If ESMA continues to be in the middle of this political battle, it is hard to see how it can get the support from all the necessary parties to be truly effective."
As the full impact of the regulation becomes apparent, he believes many firms will need to revisit their budgets and plans. "I strongly suspect that much of this additional spend will come from downstream changes required to ensure the directive is fully implemented. Areas such as suitability and transparency will have impacts throughout the operation. Many firms will have started to look at these issues already, but if they have not fully appraised the complete impact on their entire operating model, then costs will be under estimated."
Compliance costs
There are two schools of thought on whether the cost of compliance with the directive will be higher than originally envisaged. The first is that based on recent experiences, institutions have no reason to expect anything other than spiralling compliance costs. Over the last three years, compliance spending has dominated IT investment and IDC Financial Insights forecasts that it will continue to outgrow overall IT spend right across the financial services over the next five years. A recent informal poll of senior technology managers suggested that regulatory-related spend is accounting for approximately 40-50% of overall spend in 2014.
The second (and more optimistic) view is that as the second version of MiFID doesn’t differentiate too significantly from its 2007 iteration, firms can simply build on the capabilities they have already put in place. "Holders of both views concur that the sums that will have to be directed to MiFID II compliance will be anything but insignificant, putting more pressure on current operating models and cost cutting initiatives," adds Sauer.
A report on MiFIDII and its agenda published by PwC in 2012 reported that retail and private banks appeared to have a good understanding of the proposed requirements. It showed that more than half of respondents (57%) had raised MiFID II awareness internally, while 62% had carried out (or planned to carry out) a high-level impact assessment.
Fluid environment
"MiFID II will make sure that the competitive environment is fluid, considering that the regulation differs by every European jurisdiction," says Ian Woodhouse, director PwC. "Some of these jurisdictions have an advantage, probably the UK and the Netherlands. Even if some time away, people should get it into place, because it does require significant change to the business model in terms of client segmentation, market distribution documentation, product service line approach, pricing and last but not least, the cultural change of the advisors. All this shouldn’t be underestimated."
In 2011, the European Commission estimated initial MiFID II implementation costs to be 512-732m, with ongoing compliance costs in the region of 312-586m. These figures are significantly lower than the overall 2bn implementation cost of MiFID I, Ernst & Young reports in its latest documentation.
"I think it is difficult to know the exact figures on costs for private banks," Woodhouse admits, "but the cost of regulation can be managed intelligently by the increasing use of process and technology management in conjunction with the advisor."
Already playing a big role in reshaping the business model, new technologies are increasingly allowing automation to help advisors achieve compliance and favour document processes. "When you take MiFID and all the other regulations, the cost of regulation is the cost of doing business. What is going to be more costly will be cross- border activity, because it has more regulation."
John Kersten, senior manager investment banking Ernst & Young explains that the cost of compliance could be substantial because MiFID II impacts firms that were previously exempt from MiFID requirements.
"Those firms that don’t have the infrastructure in place could be very heavily hit. For private banks the whole process of distribution to clients needs to be reviewed. Previously, asset managers said they didn’t care about the design of the products. Products now need to be aligned with the target audience. Funds and banks need to look at how MiFIDII will change the market landscape and how business models and distribution models and the trading engagement change as a result of that – it is much more than a compliance exercise."
Tangible opportunities
Banks will need to react to business opportunities and market changes, he continues."If they are able to do that they might minimise the negative impact, while at the same time leveraging opportunities. MiFIDII creates tangible business opportunities, but those organisations that don’t investigate and are lazy about looking at the market opportunities will be heavily hit."
Risk rating and understanding of risk tolerance will need to be constantly monitored, depending on the experience of the investor. As appropriateness and suitability with the product and transaction are the core focus of the new regulation, advisors will need to be clearer on the risk prospects of each client’s fund.
The directive will also require a ‘re-assessment of business models’ according to Ernst & Young and will lead to a culture change in the advisory model. Advisors will have to acquire greater skills in managing clients, whether they are retail or institutional, but whatever happens the number of advisors in Europe is expected to go down sharply.
Sauer reckons that as compliance costs continue to escalate and banks remain determined to minimise operational costs, sustained outsourcing and endeavours in the cloud computing environment will become more prominent.
Given the magnitude of commercial and operational impacts, successful implementation will require early involvement of relevant business lines and key functions such as IT and operations, warns Woodhouse.
"The absolute worst thing a bank can do is put its head in the sand over MiFIDII and say it is too far away because it is going to move quite fast. MiFID II is going to help the industry demonstrate and create value and it will educate clients (especially retail clients) on the relationship between risk and return."
MiFIDII will shake up the industry, but it won’t be its ultimate challenge, he concludes."There is a lot of consolidation on the way. As private banking is at an inflection point you will get people recapitalising from that, so you will have a combination of existing players alongside new, electronic-enabled entrants, such as Nutmeg and a lot of private equity firms."
