The UK has historically led the way on financial services regulation, but Europe is now seeking to go further than FCA legislation in key areas such as cost disclosure and dealing commission.
What is more, experts have argued that the European interpretation of certain essential aspects of financial services regulation, such as the definition of independence, are actually much improved on the FCA’s rules. Some have gone so far as to suggest the FCA could be forced to revisit its stance on independence in light of what’s coming from Europe.
Yet the idea that Europe is winning the regulatory race is not clear-cut. Regulatory lawyers say some of the European rules which go further than FCA legislation could cause a “nightmare” for UK advisers.
A consultation on the Markets in Financial Instruments Directive II, published by the European Securities and Markets Authority, proposes that advisers must disclose to clients all costs related to products themselves and not just advice, which experts say will be near impossible.
Countries have until 1 August to respond to the consultation, and final Mifid II rules will be implemented on 1 January 2017.
Experts say some advisers may be caught out if they assume the UK will always be ahead of the regulatory curve.
Independent regulatory consultant Richard Hobbs says: “As a result of globalisation, in the last decade, continental Europe has become much more like North America and the UK in terms of financial products. Therefore Europe has little choice but to develop regulation that looks increasingly like UK regulation.
“But where Europe is going further than the FCA, the regulator is likely to shrug its shoulders and fall in line. It is hardly going to be the industry champion against tougher consumer protection coming out of Europe, even if that is impractical at a UK level, or brings costs which outweigh the benefit to consumers.”
Clarke Willmott partner Philippa Hann says: “The FCA has been far ahead of the curve, particularly in areas like consumer protection and suitability.
“But advisers must keep abreast of what is happening in Europe and cannot rely on the assumption that regulation is always tougher in the UK.”
Europe takes the lead
So where is Europe going further than the FCA?
The Esma consultation proposes that advisers must disclose to clients all costs relating to the product itself as well as the advice, and the cumulative effect of this on returns.
Wealth Management Association deputy chief executive John Barrass says: “Cost disclosure is the biggest issue for our members. It is not clear how this will work in practice at all.”
Law firm King & Wood Mallesons SJ Berwin partner Tim Dolan says greater clarity is needed to avoid widespread confusion.
He says: “This confuses two fundamentally different things: the cost of advice and the cost of the product. It is like mixing up the cost of getting your car serviced with the cost of petrol.”
City law firm Reynolds Porter Chamberlain associate Sam Bishop says the requirements will be “onerous” for advisers.
“Firms will be aware of costs like trail commission, but there will be other underlying provider costs which they are not aware of,” he says.
“It will be a challenge for firms to obtain all of that information and incorporate it into a single figure.”
Hobbs adds: “How can advisers disclose information which they do not have access to? This could involve enormous costs and will be a nightmare for firms.”
Esma also proposes banning the use of dealing commission for any form of privileged access to research analysts including face-to-face meetings or conference calls.
It also prohibits the use of dealing commission to buy any bespoke reports or analytical models, investor field trips, or corporate access and market data services.
The proposed rules go further than FCA rules which came into force earlier this month by banning any form of bespoke research and access to analysts.
FCA rules have banned the use of dealing commission money to gain face time with company management. Deals that offer rebates on research to fund houses for putting trades through the brokerage businesses were also stamped out by the FCA.
Barrass says: “We need to be very careful of the impact of the Mifid II rules on the research market, particularly for smaller stocks. The risk of the research market being killed off is a concern for us and one we will be drawing attention to in negotiations.”
Mifid II is also set to introduce stricter rules on execution-only. Mifid I effectively banned execution-only sales for “complex” products, and Mifid II seeks to further clarify which products are complex.
EY executive director Anthony Kirby says: “Under Mifid I it was very difficult to get a consensus on what a complex product was, but nations such as France and Spain are very keen to formalise the definition.
“Under Mifid II unregulated collective investment schemes are set to be reclassified from a non-complex to a complex product – this is a big issue as it bans execution-only sales for certain products.”
One area where the consultation does not go as far as FCA rules and which is likely to be welcomed by advisers, is its alternative definition of independence. The consultation says recommendations by independent advisers must be based on a “sufficient range” of providers’ products, and not the whole market. Independent advisers are also banned from receiving commission, although this is still allowed for non-independent advisers. It says: “The range of financial instruments should not be limited to those provided by entities with close links to the adviser firm.”
The FCA rules define independent advice as “based on a comprehensive and fair analysis of the relevant market, and unbiased and unrestricted”.
Apfa director general Chris Hannant says: “Esma’s proposed definition is more sensible and is much closer to what consumers would understand by the word independent.”
Barrass adds: “Esma’s definition is clearer for consumers and better suited to the way the UK market works.”
As Mifid II is a directive and not a regulation, member states can apply for exemptions where they believe there is a need to diverge from the rules. Experts say it is therefore unclear whether the FCA will keep its existing definition of independence or whether Mifid II will prompt the regulator to revise it.
The FCA declined to comment on an open consultation.
Hannant says: “There is an expectation that national regulators will follow the rules unless they can provide justification for doing otherwise. I would not be surprised if the FCA looked again at the advice labels, given all the problems the market has had with them.”
Bishop says the FCA will face strong pressure from the industry to change its definition.
He says: “At the same time the FCA is embedding the RDR, the European regulator has given its own definition of independence which is a lot closer to what firms and consumers would understand by the term.
“This will have to be implemented into UK law so it will be very interesting to see what happens to the existing RDR rules. Firms are going to say: ‘If we are regulated as if we are providing cross-border services, why can we not comply with the European standards’?”
But not all advisers support a change in the independence definition. Plan Money director Peter Chadborn says: “This sounds like the old multi-tied definition and that did not work as it was too open to abuse.”
Mifid II does also not go as far as the FCA on inducements and commission. While under the RDR inducements from product providers to advisers linked to securing product sales are banned (including “extravagant” provider hospitality), under Mifid II advisers must merely disclose any third-party payments to clients. Commission is also only banned for independent advisers.
Deloitte insurance partner Andrew Power says it will be up to national regulators to decide whether they want to go as far as the FCA on commission and inducements, and that many will wait to see the full impact of the RDR before they do so. “The EC seems to be comfortable with where the FCA has gone on inducements,” he says. “But other European countries will be watching the advice gap closely to see if the negative effects of the RDR outweigh the positive.”
So while the UK’s RDR rules mean it remains the regulatory guinea pig of Europe in many respects, advisers must also be vigilant of where the continent is seeking to overtake the FCA and what this means for their business.
Mifid II: Q&A
What is Mifid I?
Mifid I has been in force since November 2007. It aimed to increase competition by creating a single market for investment services, and harmonised protection for consumers across member states.
So how is Mifid II different?
In October 2011, the European Commission tabled proposals to revise the directive and create Mifid II. Mifid II aims to extend and tighten up the rules of Mifid I, particularly in areas such as disclosure and inducements.
How does Mifid II relate to other EU legislation such as Priips?
Mifid II has been introduced alongside the packaged retail and insurance-based investment products regulation, and the insurance mediation directive II. These three pieces of legislation cover different product types and either the sales or disclosure process, but there is a degree of overlap between them.
Priips, which is due to be implemented in summer 2016, addresses disclosure requirements for investment and insurance-based investment products. IMD II, set to be introduced next year, covers sales and disclosure rules for insurance products, and sales rules for insurance-based investment products. Mifid II covers sales and disclosure rules for investment products. Priips has brought some non-investment products, such as structured products, under the Mifid II regime.
UK financial services regulation has historically always been in front of the rest of Europe. But there are now a number of areas where Europe is pressing ahead. One of the biggest is execution-only. Under the FCA’s Cobs rules, if a client decides to buy a product on an execution-only basis, it is treated as their decision and there could be no suitability comeback on the adviser.
But Mifid I introduced a requirement for execution-only sales to be appropriate, which goes against the legal approach that would be applied to someone who has taken responsibility for their decision. Mifid II looks at that in further detail, and changes some of the exemptions. Non-complex products were exempt from the Mifid I rule, and unregulated collective investment schemes were previously classed as a non-complex product. But under Mifid II, Ucis will be classed
as a complex product.
Another area is the proposed requirement under Mifid II for advisers to disclose all costs related to the product as well as the advice. This is a welcome step forward for transparency because a lot of the issues I come across result from clients not truly understanding what they have invested in. Clients understand the relationship between risk and reward but they would believe an investment bond with a return of 3 per cent to carry the same risk as a deposit account paying 3 per cent. If they understood that the 3 per cent return has had 5 per cent in costs taken out of it, then they would understand it is much more risky than a deposit account paying the same rate.
Advisers must keep abreast of what is happening in Europe or risk falling foul of the rules. They cannot simply rely on the assumption that regulation is always tougher in the UK.
Philippa Hann is a partner at Clarke Willmott
Lee Robertson, chief executive, Investment Quorum
Europe going further than the UK seems to be the direction of travel. What the industry has not done well is disclosure of costs and instead of the UK leading on this and doing it properly as it should have done, Europe is now forcing additional rules upon us. The trouble with what Mifid II is proposing is that it is very difficult to get the full breakdown of costs from providers.
Philip Milton, managing director, Philip J Milton & Company
Regulation coming out of Europe and the FCA has gone too far and is placing ludicrous demands on advisers. Having said that, if Mifid II prompts the FCA to look again at its independence definition, that would be a positive thing.