What is this about?
On 10 December 2019 the Dutch Authority for the Financial Markets (AFM) published a report about its investigation at 10 investment firms that provide investment services to professional clients and eligible counterparties (ECPs). The AFM analysed the compliance with MiFID2 requirements regarding cost transparency, product governance, inducements and fiduciary management. The examination covers the period from the implementation date of MiFID2 on 3 January 2018 until early July 2018.
Which parties should care?
The report is relevant for firms providing investment services to professional investors and ECPs, including investment firms, banks, AIFMs and UCITS management companies.
What should they do?
These firms should consider the outcomes of the investigation. The report shows that, according to the AFM, the relevant investment firms still need to take steps to fully comply with MiFID2.
Cost transparency
In relation to cost transparency, the AFM distinguishes three non-compliant groups.
The first group does provide information on costs prior to the
provision of investment services, but this information does not meet
the MiFID2 requirements.The second group does not provide any information on costs prior to
the provision of investment services.The third group asserts that it does not need to comply with the cost
transparency requirements because no (new) investment service is
provided. The AFM has recommended the third group to comply with the
cost transparency requirements going forward, as the AFM could asses
from the available policies and procedures that these firms were
ultimately not going to be able to be compliant with these
requirements.
Product governance
In relation to product governance, again three non-compliant groups are distinguished.
The first group (i) has procedures and measures in place dealing with
product governance and (ii) identifies a target market (for the five
financial instruments that were selected by the AFM). However, these
procedures and measures do not provide enough detail. For instance,
they do not specify the procedure to identify a target market.The second group also has procedures and measures in place that do
not meet the requirements, but in addition does not identify a target
market at all (for the financial instruments selected by the AFM).The third group does not have procedures and measures in place at
all. This group asserts that no target market assessment is required
to be made by them because they do not qualify as distributors. The
AFM stresses that this view is incorrect and that the definition of
‘distributor’ should be interpreted broadly. In any case, it covers
the reception and transmission of orders, execution of orders,
portfolio management and investment advice.
Inducements
In relation to inducements, the investment firms state that they do not receive inducements from third parties, but rather minor non-monetary benefits. However, the AFM concludes quite the contrary, stating that they do receive inducements because minor non-monetary benefits qualify as such.
In relation to such minor non-monetary benefits, the AFM states that some investment firms apply a definition that is too broad and not aligned with the MiFID2 inducement rules. For instance, software provided by a broker or a bottle of wine should not fall within the definition of minor non-monetary benefits. As such, we believe that the AFM seems to apply a narrower definition than the market does.
Furthermore, in respect of research, the report shows that all investigated investment firms pay for the research they receive and have processes in place to prevent research from being received free of charge. However, there is not enough awareness regarding orally provided information, for instance in the form of calls in which brokers provide insight in the expected developments over the coming trading day. According to the AFM, investment firms must assess whether this type of information qualifies as research or as a minor non-monetary benefit. Also in other situations the AFM finds that investment firms apply a definition of research that is too narrow.
Fiduciary management
The AFM notes that several investment firms offer fiduciary management to their clients, which covers a range of (investment) services. The research shows that investment firms qualify the services they provide under fiduciary management differently. When a combination of the investment services portfolio management, investment advice, execution of orders and reception and transmission of orders is provided, the firm should be licensed for each separate investment service. Some market participants take the view that when providing portfolio management services for a client, and a specific transaction is being suggested by the firm and subsequently discussed with the client, this does not necessarily amount to the provision of investment advice. However, the AFM asserts that portfolio management implies a discretionary mandate. If the specific transaction requires the client’s approval, the service provided presumably amounts to investment advice. As such, we believe that the AFM again takes a different view than the market.
Any further thoughts?
Although is advisable to take note of the report, we note that the report covers only 10 investment firms and only the first six months of MiFID2. It may therefore not be entirely representative of the current situation, as the AFM acknowledges. Nonetheless, the report shows that it is a major challenge to achieve full compliance with MiFID2, especially where the AFM takes different views as to the requirements than the market.
