Articles and opinion
This whitepaper was first published by the Institute for the Fiduciary Standard on 22 April 2019.
‘United wishes and good will cannot overcome brute facts,’ Churchill wrote in his War Memoirs. ‘Truth is incontrovertible. Panic may resent it. Ignorance may deride it. Malice may distort it. But there it is.’
Summary of the requirements
MIFID II directive (2014/65/EU) article 24.4 and supporting Delegated Regulation 25.4.2016 Article 50 and 59.9 requires providers of investment services to disclose all costs and charges related to the financial instrument and ancillary services, including the cost of advice, and where relevant, the cost of the financial instrument recommended or marketed to the client and how the client may pay for it, including any third party payments.
Third party payments received by investment firms in connection with the investment service provided to a client must be itemised separately and the aggregated costs and charges shall be totalled and expressed both as a cash amount and as a percentage.
Where any part of the total costs and charges is to be paid in or represents an amount of foreign currency, investment firms must provide an indication of the currency involved and the applicable currency conversion rates and costs.
Investments firms must also inform about the arrangements for payment or other performance. The information must be disclosed on both a forecast and actual costs incurred basis. Finally, the client must be provided with an illustration showing the effect of the overall cost and charges on the return of investment. This must occur on a forecast and actual basis (the latter occurring regularly and at least annually during the life of the investment).
Scope of the requirements
The costs and charges disclosure requirement would apply to financial planners, wealth managers, asset managers, discretionary investment managers and stock brokers acting on behalf of retail investors in the EEA.
Investment firms providing investment services to professional clients are able to agree a limited application of the detail requirements set out in the Delegated Regulation but not where the services of investment advice or portfolio management are provided or when, irrespective of the investment service provided, the financial instruments concern embed a derivative.
Similarly, investment firms providing investment services to eligible counterparties have the right to agree to a limited application of the detail requirements set out in the Delegated Regulation, except when, irrespective of the investment service provided, the financial instrument concerned embed a derivative and the eligible counterparty intends to offer them to this clients.
Impact of the requirements
The requirements have been in place since 3rd January 2018. In practice this has meant disclosure for all forecast costs for new MIFID investment sales since 3rd January 2018. There has been more variance of disclosure for actual costs with many investment firms counting a year since year –end valuation on 31 December 2018 meaning that many clients received the actual costs disclosure for the first time by 31 January 2019.
Investment firms have had to base these on simulated models which aim to show the potential indicative running costs of a portfolio and/or investment advice. This means that assumptions are made about transaction volumes, asset choices and portfolio performance.
It can be a challenge obtaining and reporting actual costs in a consistent manner from the range of parties involved i.e. product manufacturers, execution venues and investment advisers.
Providers of investment services have to provide clients with an aggregated overview of all the service costs and charges, as well as any recommended solutions.
Illustrating the cumulative effect of costs on return should not be seen as a separate disclosure but instead a continuation of the aggregated costs and charges disclosure.
Unfortunately, there is not a standardised format for demonstrating the cumulative effects. Firms have used graphs, tables and text.
Not all product manufacturers have disclosed ongoing charges in MIFID II compliant manner. It has not been easy to source the required MIFID II costs including transaction costs and borrowing costs for UCITS funds as they are not currently reflected within UCITS Key investor information documents and the new Packaged Retail and Insurance- based Investment Product Regulation ( “PRIIIPS”) is not yet in place.
Also, there are discrepancies between the calculation of transaction costs between MIFID II and PRIIPS. Fund managers calculating under MIFID II use a bid and offer spread whereas PRIIPs methodology allow the inclusion of slippage i.e. the difference between the price at which a trade is executed and the 'arrival price' when the order to trade is transmitted to the market. .. . which can yield a zero transaction cost.
Non-European Union providers are not obliged to comply with MIFID II methodologies and as such MIFID ii firms have to obtain that data on a “best endeavours” basis.
How are firms responding?
The UK Financial Conduct Authority published in January 2019 a review of 50 MIFID investment firms providing investment services to retail clients and concluded that:
- Firms knew about their obligations for disclosing costs and charges but were interpreting rules in a variety of ways.
- Firms were better at disclosing the costs of their own services than at disclosing relevant third party costs and charges.
- A number of firms had not shared their costs and charges with each other to meet their obligations to provide aggregated figures to clients.
- Firms needed to work on producing estimates where they could not obtain data in items such as transaction and incidental costs and not merely report them as zero.
- Firms need to ensure that costs and charges disclosures in advertising materials where consistent with what was reported to clients.
- Firms need to take reasonable steps to minimise the effort required for a client to request an itemised breakdown.
- ESMA suggests that best practice for disclosing costs and charges online would be to enable a client to get this information through hyperlinks.
- Firms should use example numbers based on customer actual experience as opposed to numbers that were easy to calculate
To view the full article on the Institute for the Fiduciary Standard's website, please click here.