Lost in translation

It seems odd that five small letters could cause such a commotion. Mifid (Markets in Financial Instruments Directive) II has not yet even been finalised by the European Commission. Nonetheless, it is already triggering plenty of unease amongst Europe’s asset management industry. To make matters even more difficult, the exact date on which the new directive will finally commence is anything but certain. 

 

Originally set to kick in on January 2015, European parliamentarian Markus Ferber now envisions the start at the beginning of 2017 as a more likely time frame. That has not, however, stopped some European countries from implementing new legislation on their own account – ahead of a directive that, amongst others, aims to bring more transparency into the European fund industry and its distribution networks. The UK has already received its share of regulation with the new RDR (Retail Distribution Review) at the beginning of 2013.

 

Mifid II

The Markets in Financial Instruments Directive was enacted in 2007. This directive has now been recast with the main objectives to increase transparency and better protect investors. The key points comprise: l improved investor protection (enhanced advisory documentation and the introduction of the option of fee-based ‘independent advice’) l the obligation to record telephone and email correspondence with clients, if it could lead to an order execution l further restrictions to avoid conflicts of interest (prohibition of inducements for independent advice and portfolio management)  l increased transparency of financial markets (extension of ‘systematic internalisation’ requirements to all financial instruments, obligation for ‘on-venue trading’ of liquid instruments rather than OTC trading). Mifid II and the corresponding regulation MiFIR is expected to be published in the second quarter of 2014 and is to be implemented into national law 30 months later. Barbara Lang from PWC concludes: “The application of Mifid II will therefore start in 2017.”

Now Dutch market authorities are causing an upheaval in their own fund industry business, as distributors have been forbidden from receiving retrocessions since 1 Jan, 2014 (the Dutch regulator has granted a transition until the end of the year). Any distributors receiving retroces¬sions during this time must pass them on to their clients). 

That leaves Europe’s fund industry realising that it may end up having to adopt a costly country-by-country share-class model, in order to accommodate national interpretations of the upcoming EU-directive in different member states. 

The Dutch example may well be a good indicator of what will lie in store for Europe’s fund industry: fund groups have had to issue retail share classes without retrocessions specifically tailored to the Netherlands.

That obviously applies to all fund companies wanting to do business in the Netherlands, including foreign asset managers. 

 

At least Dutch companies will not have to worry about losing market share to international fund companies, notes Martine Snoek, head of product management at Robeco. Indeed, she finds the change in management fee levels beneficial. “We are no longer required to deduct the distribution fee from our performance,” she says. “Fund outperformance can be visibly 35 to 75 basis points higher than before.”

 

Most fund companies are now offering clean shares with a reduced management fee by the amount of the retrocessions, which on average had accounted for 50% of the total fee. Industry participants see a greater chance of competing with a fast growing ETF market. However, industry consultant and managing director of GUIA Advisory Jeroen Vetter cautions: “Some asset managers have not fully passed on this cost advantage and simply lowered management fees by less.” 

In addition, not all fund companies will be replicating their entire product range. In particular, many international fund companies do not want to take on the extra costs of issuing clean share classes for funds that are encountering very little demand in the first place. 

Paul van Olst, head of distribution, Benelux at Fidelity Worldwide Investment explains: “We will be switching roughly 95% of our funds for the Dutch market to clean share classes our so-called Y-shares – so as to accommodate our client’s needs.” 

 

However, he notes funds are not being excluded because of costs associated with this change, adding: “Funds holding hardly any assets for Dutch investors will not be switched. Even though Y-shares require higher minimum investments, we are in a position to waive the minimum investment amount for our clients”. These share are widely available for the Dutch market, both on plat-forms and via online brokers. 

At the start of this year, ING Invest¬ment Management took an extra step of launching its own fund platform ‘FitVermogen’ for Dutch retail clients. Roughly translated, it refers to the idea of getting one’s wealth in shape, and aims to offer an alternative to purchasing funds via intermediaries. In addition, all Dutch retail share classes have now been transformed into so called zero rebate shares. 

 

Paul van Eynde, international head at Institutional Clients Europe says: “We have also registered some of our Sicav funds in the Netherlands. So there are now parallel, rebate-free shares for Dutch clients alongside existing retail shares.” Obviously, there are also costs associated with launching paral¬lel share classes, highlights Van Eynde. “But it wasn’t really a matter of choice, besides the fact that costs involved for new classes are more or less marginal on a total scale,” van Eynde explains. 

 

He adds that the change in the distribution landscape will be a more pressing issue. 

“This is an important period in history as the retrocession encompasses every distributor in the Netherlands, whether dependent or independent. Some will come out on top, others will lose out.” 

That in turn throws up the question over the future road map for distribution fees throughout the rest of Europe. Snoek is convinced that “when Mifid II comes in force, there will be more restrictions on retrocessions on a European scale as well”. With the conversion with the Dutch market, she sees the company “well positioned for future European legislation”. 

 

However, not all fund houses quite share this optimism. Sergio Trezzi, head of European retail at Invesco, is convinced that “Mifid II will actually add to the complexity of the way business is done. That is because we will be dealing with a European directive, not a regulation”. What Trezzi means by this is that Mifid II only offers a framework for local regulators to build on. “That leaves plenty of leeway for local interpretations,” he says. “If instead it were a regulation, then at least all countries would need to transpose the same rules.” That could lead to a heterogeneous approach in Europe, with some countries banning retrocessions and others not. 

 

“In markets such as the UK, where you have an established IFA industry, it makes sense to make business more transparent by banning retrocessions, as it also does for the Netherlands,” he says. “There are many small Dutch banks without their own asset management business.” But in countries such as Germany, Italy, France and Austria, where historically distribution and asset management is controlled by the banks, it could be difficult to impose a ban on retrocessions. In fact, Trezzi actually sees the distribution business in these countries potentially endangered if a ban were to be imposed, as is may well then choke off the markets. 

 

Frédérique Bompaire, head of public affairs at Amundi, adds: “These countries have never been faced with those conflicts of interest that led for instance the FCA in the UK to take drastic measures in this respect with the RDR regulation.” 

So once the new directive does go into effect, asset management companies will not only have to accommodate new share classes for the Netherlands, but for all member nations on a case-by-case basis. To make matters even more complicated, there is talk in Germsny as well as in Austria of applying a retrocession ban only to IFAs while permitting banks to continue selling shares including rebates. 

“Doing business in Europe will certainly become more expensive in the future. Either you are a big asset manager and can benefit from economies of scale, or you will be incurring large costs,” Trezzi concludes. And that in turn will make it particularly hard for small fund companies to distribute across the EU.