UK: Fund Distribution Under MiFID II | Building The Optimal Model

Last Updated: 15 February 2016
Article by Joy Kershaw and Kateryna Bobrova

Most Read Contributor in UK, August 2017

New investor protection rules under MiFID II are set to reshape investment managers' product and distribution strategies in Europe. As the impact of the changes will vary across countries and distribution channels, there is no single optimal approach for firms to adopt. Investment managers distributing funds across the EU will need to think carefully about their strategy in each market. Innovative solutions around online platforms and robo-advice may offer some answers. While the final details of the rules are still pending, policymakers are considering a potential delay of the MiFID II go-live date until 2018. But firms still need to prepare now to be ready in time.

What are the key changes to the investor protection rules under MiFID II?

  • Product governance: Product providers will need to ensure that products and distribution strategies are aligned to and sold to their target markets. Firms will face increased costs due to the need to renegotiate agreements and maintain ongoing exchange of information with their distributors.
  • Appropriateness test: A wider range of products, including structured UCITS and AIFs, will be deemed complex and subject to the pre-sale appropriateness test to ensure investors have sufficient knowledge and experience to buy these products.
  • Inducements: Independent advisers and portfolio managers will be banned from receiving most third-party inducements. While other firms can continue to receive inducements, they will need to show that these are designed to enhance the quality of service to the client. The rules on what constitutes enhancing the quality of service are expected to be stricter than under MiFID I.
  • Disclosures to investors: MiFID II introduces an EU-wide definition of independent investment advice and requires firms to disclose to clients whether they provide such advice. MiFID II will also require more detailed disclosure of costs and charges.

Further detail on these requirements will be fleshed out in the MiFID II Delegated Acts, which are expected to be adopted by the European Commission in the coming weeks.

How are funds distributed currently across the EU?

Despite some similarities, there are substantial differences across EU countries in how funds are distributed. Different supervisory regimes, historic distribution structures and consumer preferences are just some of the factors contributing to the variety of distribution landscapes.

In many EU countries, banks are the biggest distributors of retail funds. By contrast, in the UK most distribution of funds to the retail market is done via platforms, independent financial advisers, or a combination of the two. In the Netherlands, the local regulator banned third-party inducements in 2014 and the share of distribution via platforms has grown since then. In other EU countries, platforms are slowly taking off but the market share of retail clients buying directly is still relatively low. Some countries have seen investment managers setting up their own direct-to-client platforms.

Independent advice makes up only a small proportion of retail distribution in many EU countries and is more common for high net worth clients. A small but growing number of platforms offer "robo-advice".

When it comes to the choice of products, in many EU countries, retail investors are sold AIFs as well as UCITS. The types of AIF sold to retail investors include funds compliant with local retail fund regimes (such as UK Non-UCITS Retail Schemes) and closed-ended funds. Investment via life insurance products is popular among retail investors in some countries, such as France. In some countries, including Belgium and Italy, local supervisors have taken action to reduce the sales of complex products to retail clients.

How will MiFID II affect distribution in the EU?

Overall, MiFID II will increase the cost of distribution, and could shift the balance of power from investment managers to distributors, which may lead some investment managers to set up their own distribution channels. This may reinforce an existing trend towards lower cost solutions such as digital distribution and robo-advice.

More specifically, the impacts of MiFID II may include:

  • Distributors becoming more selective and a rise in direct-to-client offerings: Distributors selling funds from a wide range of investment managers may look to reduce the number of investment managers whose funds they sell as costs increase under the product governance rules. As a result, some investment managers could look to build direct-to-client solutions.
  • New add-on services from banks: Banks receiving inducements to distribute funds will need to ensure that the inducements they receive sufficiently enhance the quality of service to the client. This may involve providing more ongoing services, such as market insight or personalised reporting.
  • Reduced product complexity: Distributors currently selling AIFs and structured UCITS on an execution-only basis will need to incorporate the appropriateness test into their sales processes because these products will in future be deemed "complex". Fund managers may consider moving towards products which are deemed "non-complex" where this can be achieved without significantly altering the fund's investment strategy.
  • Moving to non-independent advice: Where no local regulatory definition of independent advice exists, standalone financial advisers may currently label their services as "independent". Many of these will likely re-label their advice as "non-independent" under MiFID II to avoid the stricter rules on inducements for independent advisers. However, in the UK and the Netherlands, both independent and non-independent advisers are already prohibited from receiving inducements under local rules.
  • New opportunities for independent advice: In many EU countries where independent advice is not currently defined, MiFID II may provide a new opportunity for some firms to provide this service to high net worth clients.
  • Lower cost solutions: As MiFID II will increase distribution costs, increase the transparency of costs and charges, and widen the scope of products deemed "complex", investment managers will need to make strategic decisions about their offering. This may include moving to lower cost, less complex and passive funds and/or developing robo-advice solutions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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