Caught in the EU FINREG WAKE

Citi Custody & Fund Services – Caught in the EU FinReg Wake 15 14 platforms to monitor the target market, and provide much more information to asset managers. To reduce the oversight workload, distributors and platforms may reduce the number of funds they offer. Likewise, asset managers may limit the number of distributors and platforms they use to sell their funds. In either case, the end result could be more restricted sales architectures and reduced choice for EU investors. Another possible outcome is that asset managers may seek to disintermediate some of their distributors and go direct to customers. This could lead to more asset managers launching robo-advisors across the EU. Either way, MiFID 2 could have long-term implications for the distribution of funds in Europe. MIFID 2 EQUIVALENCE WILL REMAIN A THEORETICAL CONCEPT MiFID 2 introduced a third-country (i.e. non-EU) equivalence regime, allowing the European Commission to deem non-EU jurisdictions as having equivalent regulations to MiFID 2. If a third country is granted equivalence, financial firms from that country could provide investment services or activities to EU investors (although the regime only covers professional investors and counterparties). There are two key challenges to the Commission granting third-country equivalence: one technical, the other political. The technical issue is that there are few countries with equivalent rules to MiFID 2. The political issue is Brexit. As the EU and UK engage in the Brexit negotiations, there will be political pressure to ensure the UK does not appear to benefit from exiting the EU. Therefore, despite the UK fully implementing MiFID 2, it still may not be granted equivalence. Brexit has also made EU policymakers reconsider the idea of equivalence, which may delay extending equivalence to other jurisdictions. Overall, at least for this year, it seems likely MiFID 2 equivalence will remain more a theoretical concept than a practical one. EXPECT TECHNICAL ADJUSTMENTS With a piece of regulation as large and complex as MiFID 2, it is inevitable some elements of the rules will need to be fine-tuned. For example, the asset management industry would love to see the cost disclosures under MiFID 2, the Undertakings for Collective Investment in Transferable Securities, and Packaged Retail Investment and Insurance-based Products (PRIIPs) harmonized. At the moment, the same basic information needs to be reported in three different ways. However, neither the industry nor policymakers have the desire to embark upon another nearly decade-long legislative process to implement a MiFID 3. What is more likely, is that the Commission and European Securities and Markets Authority make technical adjustments to MiFID 2 where possible. This will eliminate the need for a protracted debate over the changes, and allow the EU to be nimbler in addressing potential issues. If issues do require legislative work, it will probably be more tactical in nature. So while there could be changes to MiFID 2 in the coming years, they are more likely to be in the form of a MiFID 2.1 than a MiFID 3. While the implementation of the MiFID 2 has gathered all the attention, the EU’s new PRIIPs regulation is proving to be a headache for the industry. At issue are some of the calculations in the new Key Investment Document (KID). Designed to be a standardized document, the KID is supposed to let retail investors easily compare investment products from asset managers, banks, or insurers. However, many feel that the calculations are undermining this goal by giving investors misleading information. A key area of concern is the transaction cost methodology prescribed by PRIIPs. The new rules require transaction costs to be calculated using an arrival price, which is the midpoint price at the time a trade order is submitted. The market movements between the arrival price and trade execution price are factored into the transaction costs. Under certain circumstances this can result in a fund reporting negative transaction costs. Another concern is the future performance scenario calculations. The KID contains four potential future performance scenarios, ranging from stressed to favorable, calculated based on past performance. Asset managers have raised concerns that the inclusion of past performance data in the calculations is causing overly optimistic forecasts. The European Securities and Market Authority is reviewing the matter and is expected to produce further guidance to help clear things up. In the meantime, asset managers must continue to press ahead with the KID as is and work to explain any potentially misleading information to their clients and distributors. 3 4 PRIIPS: THE KIDS AREN’T ALRIGHT