I hope you enjoyed reading Part 1 of the series on MiFID II for ManCos. Now it is time for Part 2. In this article, we will dig deeper into the world of markets for financial instruments with a focus on investor protection.
Investor protection: pile it on
Even more investor protection... you might be wondering if there isn't enough protection already for all the investors out there? After all, we have prospectuses, KIIDS, and extra laws and regulations to ensure ongoing compliance. There are also auditors like me, plus regulators, plus AIFMs, plus PRIIPs KIDs coming soon (assuming no further delay).
But it's still not enough!
...is the point of view of the European Union, as we can see with MiFID II and the requirement of defining a "target market" (more info on that in the next section).
What we currently have are regulatory items of increased complexity, coming from different sources of regulation, and often governing the same product. In a perfect world, we might have one single source of regulation, like a rulebook on investor protection. But this is simply not going to happen anytime soon—just the opposite, as complexity seems to be on the rise.
PRIIPs for example will be applicable for investment funds sold to private investors only (the "R" in PRIIPs standing for "retail").1 MiFID II, on the other hand will protect all investors, private and institutional, regardless of whether it's wanted or not.
Target market
The new aspect of investor protection introduced by MiFID II is that you must define what your target market is. From my point of view, however, the expression "target market" could be a little bit misleading. What you're meant to ask yourself is actually whether your investment fund is suitable to be sold to a certain type of investor—thus, a clearer expression might be "target investor".
No matter what your preferred expression is, your definition will have to be ready by the start of 2018.
ESMA has come up with six categories to consider when defining the target market—check out the list here.
Coming back to the scope of MiFID II: let's assume your ManCo has no additional MiFID license as will probably be the case for many Luxembourg ManCos. Who is ultimately responsible for defining the target market? Probably the distributor, as he/she is in scope of MiFID II.
Information asymmetry
However... if the distributor is meant to define the target market, then it begs another question: does he or she have all the necessary information?
The ManCo will know more about the product while the distributor knows more about the investor. Thus, ManCos will have to be prepared to answer questions from distributors about the product, for example what the risks and rewards of the investment fund might be.
One more thing to know: in MiFID II terminology the ManCo is called manufacturer—although this expression might not be associated directly with the fund industry, it is the term used in the directive. Anyway, there is an information asymmetry between the fund manufacturer and the distributor, as a result of which communication will have to be enhanced between these parties: distributors will need information from ManCos in order to define target markets, while ManCos will need information from the distributor on to whom the investment fund has been sold (for ongoing monitoring).
Communication, big data, and a competitive edge
It's easy enough to talk about increased exchange of information and reporting between ManCos and distributors, but what will it actually look like in practice? One thing that's for sure is that the shift will be massive. To my thinking, there look to be three vying solutions for this manufacturer-distributor communication:
- Blockchain
- Data repository
- Industry reporting standard
There's no question that blockchain technology could make this communication extremely efficient. If, for example, the target market definition has been validated by both ManCo and distributor then this definition might be usable for other distributors as well. Furthermore, the report to the ManCo could be done via distributed ledger technology.
Another solution in the same direction would be a data repository for information relevant to fund manufacturers and distributors. Unlike the decentralised blockchain solution, a repository would store information at a central location, which would arguably have some advantages. Questions to think about might include who would run such a data repository.
A last possibility could be the definition of an industry reporting standard. We have seen such an industry solution in the insurance sector where the industry came up with a tripartite reporting template for Solvency II. So why not a template for MiFID II communication and reporting? The fact is, however, such a template would need to come from the industry because we currently do not expect ESMA to propose one.
Ultimately, the only certainty we currently have on the industry norm is that it's still uncertain. The precise balance required between ManCos and distributors is not yet crystal clear, so it will be important to anticipate the definition of a market standard.
Looking forward to hearing from you—and stick around for my next article on MiFID II for ManCos.
Footnotes
1 This is certainly true in theory, though in practice PRIIPs might affect basically all funds.
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.
