The reforms to the Markets in Financial Instruments Directive (known as MiFID II) will introduce wide ranging changes applicable across the financial services industry. The new rules were to be applied by member states by 3 January 2017, however, a delay to implementation now appears to be imminent.
One of the changes under MiFID II is a ban on the receipt of benefits from third parties for discretionary investment managers and independent advisers. This note sets out observations, suggestions and further detail on the proposed ban.
WHAT IS THE CURRENT POSITION UNDER UK LAW?
Under current UK law, all advisers (both independent and restricted) can only be remunerated for personal recommendations on retail investment products through adviser charges. The rules in this regard are set out in the FCA's Conduct of Business Sourcebook (COBS) at COBS 6.1A. "Retail investment products" include units in collective investment schemes, life policies, securities in investment trusts and structured capital-at-risk products. "Adviser charges" are charges payable by the client and agreed between the client and the adviser in advance of advice being provided.
For other firms (including discretionary investment managers and for investment advisers when they are not advising in relation to retail investment products), the general inducement rules under COBS 2.3.1R apply, which state that the receipt of a benefit is permitted where the benefit:
- does not impair compliance with the firm's duty to act honestly, fairly and professionally in accordance with the client's best interests;
- is disclosed to the client; and
- is designed to enhance the quality of the service to the client.
CHANGES TO THE RULES AROUND RECEIPT OF MONETARY AND NON-MONETARY BENEFITS
As mentioned above, MiFID II includes a ban on the receipt of monetary and non-monetary benefits from third parties (other than "minor non-monetary benefits") for both independent advisers and discretionary investment managers. This ban applies in relation to investment services carried on for both retail and professional clients. The ban on receipt of benefits under MiFID II for discretionary investment managers (and independent advisers that are not advising on retail investment products) is stricter than the current UK position.
It is understood that the European Commission will introduce a list of "minor non-monetary benefits", based on ESMA's technical advice to the Commission (in December 2014) which sets out some examples, including:
- generic information relating to a product or service;
- participation in conferences and training events on the benefits of a particular product or service; and
- hospitality of a reasonable de minimis value (e.g. food or drink during a business meeting).
Clearly, the intention at European level is for the scope of "minor-non monetary benefits" to be limited.
Other types of firms (i.e. those that are not independent advisers or discretionary investment managers) will under MiFID II remain subject to the general inducement provisions in COBS 2.3.1R.
ESMA's technical advice in December 2014 listed the circumstances in which an inducement will be deemed not to meet the quality enhancement test set out at limb (c) of COBS 2.3.1R, for example:
- where an on-going inducement is not justified by the provision of an on-going benefit to a client; or
- the inducement directly benefits the firm without any tangible benefit to the relevant client.
If this advice is accepted by the European Commission, this will appear in the MiFID II implementing measures, which means that the position for other firms will also be somewhat strengthened.
CONFLICT WITH CURRENT UK LAW
The MiFID II requirements differentiate between independent and restricted advice whereby under MiFID II restricted advisers are permitted to accept and pay benefits in accordance with COBS 2.3.1R. This conflicts with the UK position at COBS 6.1A where the FCA applies the same inducement standards to restricted advisers as to those providing independent advice.
The FCA have suggested in their March 2015 Discussion Paper that they intend to apply the MiFID II ban to both independent and restricted advisers. The FCA were concerned that it would cause confusion and permit firms to undermine the retail distribution review (RDR) if they allowed restricted firms greater flexibility than independent firms over the payments or benefits they can accept from providers and other third parties.
MiFID II also allows third party benefits to be accepted by discretionary investment managers if they are rebated back to the client. However, this conflicts with the current position under UK RDR Rules. In its March 2015 Discussion Paper, the FCA considered whether rebating should be banned for discretionary investment managers as well in the UK. The FCA's view is that there would still be a bias to accept commission-paying products, as the commission gives the impression of a discounted charge when it is rebated back to the client. The FCA may therefore ban cash rebates through discretionary investment managers, however it may allow unit rebates to be paid as these are currently allowed via platforms.
WHAT TO EXPECT ON IMPLEMENTATION
Firms should be aware that their benefit structures may need to be dismantled once MiFID II is finally implemented. It is not clear at this stage whether sunset clauses will be introduced (which would mean that benefits for discretionary investment managers and advisers (when they are not advising on retail investment products) would be allowed to continue until a certain specified date). If benefits are to cease immediately on implementation, agreements facilitating such arrangements will need to be revisited in advance to remove the relevant clauses.
It is likely that the FCA will introduce a total ban on benefits for all advisers as well as discretionary investment managers in order to align the regime with the rules introduced by RDR. However, while this will streamline the position in the UK, this will be inconsistent with the position in Europe where many member states may well apply the ban only to independent (and not restricted) advisers. If this is the case, it is likely that European advisers will define themselves as "restricted" in order to maintain their commission stream. Product providers may also find themselves facing different benefit regimes when dealing with advisers inside and outside of the UK, which may cause some confusion.
Regardless of the likely delay to MiFID II, the FCA's advice to firms is to proceed as if a delay is not taking effect. On that basis:
- firms should begin to consider their benefits arrangements and establish which of these will not longer be permitted under MiFID II.
- Firms should also take steps to identify the contracts which may require review and amendment with a view to renegotiating the arrangements in the new year.