It has been over six months since MiFID II became EU law, and accompanying it has been a series of new, occasionally laborious obligations, which have been imposed on the investment fund industry. Chief among them was a consumer protection requirement requiring manufacturers to perform Distribution Oversight and ensure their funds are being sold to the correct target market audience. Manufacturers must now regularly monitor the activities and practices of their underlying distributors to prevent product mis-selling.
Validating client suitability was previously the role of distributors and intermediaries. But with manufacturers now shouldering responsibility as well, many are being forced to implement changes to their business operating models. The reform process has, however, been slow with 83% of market participants telling an industry study in September 2017 that they were less than halfway ready to meeting the requirements to provide data on target client groups. Even today, many firms are still yet to build proper target market solutions.
Not as easy as it sounds
So what do investment managers need to do in order to avoid falling foul of MiFID II’s target market requirements? Firstly, manufacturers need to properly define who the target market is for their various fund ranges and share those findings with their distribution partners. The next step then will be for manufacturers and distributors to develop data exchange channels, so the latter can impart target market information with managers, and flag instances where mis-selling may have occurred.
The TISA best practice guide goes into more detail on this topic when it comes to responsibility and risk ignoring the feedback of data from the distributor. They state that “Certain distributors may believe that it is easier to provide a manufacturer with more information as this means they can just take a data download from their systems with no additional manipulation or filtering, and at the same time are passing on all of the risk of identifying potential issues to the manufacturer.”
TISA go on to say that “Whatever information Manufacturers receive, they must be able to digest, aggregate, analyse and act on it, as well as retaining evidence that they have done so. Information may be received from a very large number of distributors across multiple jurisdictions, across different timeframes and reporting periods.” “Opinions are divided amongst distributors and manufacturers between the preference for full reporting or exceptions-based reporting. And they are divided for different reasons as well. In essence, this comes down to a trade-off between doing the work and taking the risk.”
As manufacturers typically use multiple providers across Europe to distribute their products, the standard of target market data distributors receive is inconsistent, and may actually be of very poor quality in some circumstances and hence increasing the risk. Certain distributors, for example, may only communicate intermittently with manufacturers or merely when they observe a negative target market event. Such disclosure time-lags could delay manufacturers’ responses to mis-selling incidents, potentially leading to regulatory fines.
To date, the European authorities have adopted a pragmatic and flexible approach towards MiFID II compliance, conscious that the rules are highly complex, and taxing on an industry, which has dealt with its fair share of intricate regulations over the last 10 years. Nonetheless, a failure to implement a thorough Distribution Oversight policy could prove costly for manufacturers especially if esoteric or higher-risk products find themselves in the portfolios of unassuming retail investors.
MiFID II has an upside!
Very few regulations have commercial upsides to them, although MiFID II appears to buck this trend. In an environment where managers are continuously trying to acquire a competitive edge over their rivals by wading through vast swathes of alternative data sets, the collation, collection and analysis of target market data by distributors will provide manufacturers with enhanced transparency and understanding about their end clients, which could prove advantageous in future asset raising efforts.
If target market data is granular and delivered on a frequent basis, managers will be well-placed to introduce material changes to their distribution processes. Well-packaged, comprehensive target market data can help managers identify investor and geographical trends and localised risk appetites, allowing manufacturers to build products that are more aligned and tailored to their customers’ preferences. In short, this will enable managers to customise their sales strategies which should support AuM growth.
Making it work
Managing MiFID II compliance and leveraging its potential commercial opportunities requires manufacturers and distributors to embrace automation more enthusiastically, and disentangle themselves from antiquated manual processes.
At KNEIP, we offer a single operating platform underpinned by the latest digital technology, which is capable of facilitating frequent target market information sharing between distributors and manufacturers, allowing managers to benefit from richer data analytics. Our Distribution Oversight product can help you to set up and manage intermediaries and their documentation. The platform also reduces your financial risk with integrated business rules to help ensure accuracy, enhance your sales, compliance, product, and financial reporting to benefit both manufacturers and distributors.
By Raymond Groen int Woud