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Let the seller beware

New requirements around target markets mean asset managers and fund distributors must be a little more mindful, says Fundsquare’s Paolo Brignardello

Do you know who is buying your funds? From next year, the second Markets in Financial Instruments Directive (MiFID II) will require asset managers and fund distributors to ensure that clients are not being sold inappropriate investment products. Exactly what this entails is still in the air, but for sure it will require even greater quantities of data to flow back and forth along the fund distribution chain. Centralised utilities could be the way to cut complexity.

Target-market analysis is becoming an important part of the retail fund business. Already part of MiFID I, suitability and appropriateness tests have been ramped up in MiFID II. At the point of sale, more effort will need to be made to assess the client’s investment knowledge and experience, and what objectives they have. Then, each investment product will need to be assessed to gauge how it matches, in the words of the directive, the “needs of an identified target market of end clients”. This on an ongoing basis.

What does a target market mean?

These simple words belie the complexity of this task. The European Securities and Markets Authority has published guidelines in an attempt to define some of these concepts, but many grey areas persist. Industry working groups are seeking to provide more clarity, but this ongoing dialogue will take time. Where once investment advice was often based on a somewhat subjective assessment made by a financial advisor or client, it will now need to follow a clearlydefined path, supported by relevant documentary evidence.

Manufacturers and distributors will have to work closely together. Sharing information about the client market and how portfolios are constructed. However, the asset manager might only set this out at a high level of detail, giving theoretical attributes of the suitable investor. They can also take a view on the appropriate broad target market and the distribution channel to be used. It will be the task of the client advisor to make sure there is a more granular assessment of the nature of the implicit risk-reward and liquidity in each product and how this fits client needs. There will also need to be ongoing post-sale updates of product and client profiles.

Communication along the chain

The manufacturer will need to ensure that marketing and sales are being conducted according to principles they feel comfortable with. The regulator might decide that the financial advisor, wealth manager, bank, and so on, is mainly at fault from any misselling, but they might rule that the asset manager had been negligent too. Concerns about this have led some retailers to consider reducing the number of third-party funds they provide. Only by offering in-house funds can they guarantee a consistent approach, they argue. However, so far, the industry consensus remains that fund vendors are likely to continue as now.

Yet, this discussion underlines the need for ongoing, bi-directional monitoring along the many links of the fund production and distribution chain. Moreover, financial organisations are generally large and complex organisations. This is complicated further when dealing cross-border in different languages and different market cultures. Also, documentary evidence about who proposed what and to whom will be vital if allegations of misselling emerge. Terms will need to be defined and agreed upon. What precisely do expressions such as ‘medium-term time investment horizon’ or of an investor having a ‘high level of knowledge and experience’ mean? There will also need to be agreement about interpretations of how each country has transposed the EU directive into national law.

Clear, standardised communication

Utilities would do much to streamline this process, encouraging standardisation and automation. Rather than communicating pointto-point with dozens of retailers, asset managers could keep an upto-date description of each of their funds in a central repository. Thus, all participants in the distribution chain would have a single, reliable source of information about how each fund house sees its products. There will be no way a retailer could argue that they were unable to access the data. Retailers will then have a clear basis on which to communicate information to asset managers on how their market segments are changing.

MiFID II has reversed the traditional idea of ‘buyer beware’, replacing it with a firm principle of ‘seller beware’. The responsibility is with asset managers, distributors and retailers to make sure clients know the risks they are taking. A central data repository would streamline data flows, thus ensuring the entire distribution chain is on the same page.

 

Asset Servicing Times, issue 177

 

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