How financial advice regulation is changing: some insight into Mifid

The client has always been the key element in delivering financial and banking regulation since he avails himself of services to satisfy a wide range of needs, as receiving funding and financial advice.

The knowledge of the features and the costs of the operations, the comparison of the various offers on the market, and the opportunity to make informed and targeted choices depend on available information and transparency, read as the possibility for the client to access evaluation data to make investment decisions.

Financial advisory service is therefore essential. It is to provide advices in the form of personalised recommendation to a client in respect of financial instruments. This is the main area impacted by the Markets in Financial Instruments Directive, known as MiFID. MiFID includes a series of provisions in favour of client protection to improve the quality of the financial services provided by banks.

And what would that be, exactly? Let’s go deeper.

MiFID I is a directive implemented in 2007, which recognized the importance of financial advisory in efficiently allocating savings. This directive highlights that the development of strategy based on a “customer service” is a crucial point for the strengthening of the norms ensuring a reduction of preference errors because they may lead to significant behavioural abnormalities.

Then, the need for implementing amendments to enlarge the scope of MiFID I has been identified. Thus, on 15 May 2014 the Directive 2014/65/UE and the Regulation (EU) No 600/2014, known respectively as MiFID II and MiFIR, were issued. Both MiFID II and MiFIR are set to take effect in January 2018.

The key objectives and core measures of MiFID II are:

• external controls: developments in the market, products and technology have outpaced provisions of the original directive, with activities such as high frequency trading (HTF) strategies
• internal controls: exposure of weaknesses in the regulation and transparency of non-equity financial instruments
• Market structure: creation of a level playing field between market participants since the envisioned benefits of increased competition have not always been passed on to end investors, retail or wholesale clients
• Market transparency for trading environment
• Investor protection that was not enough in front of the rapid innovation and growing complexity in financial instruments and had resulted in mis-selling

 Also, the consulting field was affected by the development of the legislation and its structure has changed in the time frame between MiFID I and MiFID II:

• Simple consulting: it was very popular when MiFID I was in force. It is based on personal recommendations to a client, either upon its request or at the initiative of the investment firm, in respect of one or more transactions relating to financial instruments.
• Upgraded consulting: it is usually based on customisable model trading books for each asset class and a wide number of services characterised by a higher degree of competence can be added. In this case, the monitoring takes place on a regular basis and is combined with reports, even if they are not always complete and detailed.
• Cum-fee consulting: it has been introduced by MiFID II Directive and occurs against the payment of a fee, characterised by a high degree of personalisation. It aims at a greater depth of needs analysis and three different kinds of advisory can be pointed out: “Fee on top”, “Fee only”, and “Independent consultancy”.

 To what extent does the independent consultancy depart from the traditional models?

• Before the amendments to the Directive were introduced, a mere financial product was offered. Instead the new regulatory framework seeks to offer a complete service;
• Broader range of products, differentiated based on the clients’ needs;
• Greater customisation;
• Processes that were manually managed are now centrally operated;
• In addition to client profiling, the analysis of assets and needs of its relational core.

 Phases in which it articulates:

1. Client’s diagnosis: it consists in analysing its needs and objectives and in filling out a categorising questionnaire comprising different parts aiming at:
   • Ensuring that the client understands the risks inherent in investment transactions he is about to take;
   • Gathering information on its intentions (e.g. duration, risk preferences, …);
   • Ascertaining the availability of resources and assessing the possible investors consistency of revenues.
2. Needs planning, e.g. setting up a liquidity reserve to cover potential and unexpected losses;
3. Due diligence of the portfolio, meaning that the overall risk profile resulting from the embedded financial instruments should be identified, also considering the expected return for each instrument.
4. Investment proposal: formulation and validation of the proposal delivering the reporting.
5. Monitoring of the portfolio, consisting in investments monitoring and reviewing the strategic asset allocation accordingly to the client needs.

Given the high degree of refinement reached by the new regulation, we can reasonably expect a significant step forward in the quality of the financial products offered by banks, especially with regard to their suitability with respect to the needs of the client. Obviously, this would result in a greater customer satisfaction.

The assumptions here would seem excellent and the changes made by MiFID II look truly improving and developed. Now there is little else to do but wait the entry into force in January 2018. After a few months, we will be able to monitor its impact on the markets and make sure that the expectations which it raised are fulfilled.