Old Mutual Wealth: Getting to the bottom of negative transaction costs

Jeremy Mugridge is head of platform proposition at Old Mutual Wealth
Old Mutual Wealth‘s Jeremy Mugridge explains why some transaction costs appear as a negative figure on a platform, following a Money Marketing article this week

The regulatory regime brought in by Mifid II and Priips is beginning to bed in, and some of the more bizarre implications of the vast legislation are beginning to pop up.

One of these is negative transaction costs, which sounds like a contradiction and leaves people inside and outside the industry scratching their heads. However, as strange as it may seem, it is a requirement of the legislation and it may well be ironed out as the regulation develops.

The issue stems from a fund manager’s need to calculate transactional costs in keeping with the prescribed regulation. These costs are incurred in buying, selling, or switching underlying investments in the fund. Since there are many factors which contribute to these costs, the calculation is not straightforward.

The first thing to point out is these costs are based on the past three years of costs.

This is an issue in itself since cost of transactions over the past few years do not necessarily correspond to future costs. The number and nature of transactions will shift as markets and asset allocations shift.

Using that three year history, companies are required to follow rules to calculate the cost. One of these rules is to allow for the “delay cost” that takes the difference between the mid-market price of an asset immediately before the order is placed in the market and the price at which the deal is struck.

How does the calculation work?

Say, for example, an asset manager had to sell a notional £1m of a certain stock. He hits a bid from a broker to sell the stock at £100 per share. However, by the time the sale settles, the stock’s share price has gone up and is worth £102. This would result in a positive additional return of £20,000 and so the fund would show a negative transaction costs.

This is undeniably confusing as customers may start to think that the fund is discounted, so it is understandable to instead say transaction costs are zero.

However, in regulatory guidance for Priips, it explicitly says the cost cannot be shown as zero.

The regulation says: “If the prescribed methodology for transaction costs results in obtaining negative transaction costs, should the transactions costs be reflected as negatives, or should the implicit costs portion be shown as 0 instead? The result of the estimate from the methodology specified in the Commission Delegated Regulation should be included (i.e. it should not be 0, if negative).”

One of the central purposes of the regulation is to help advisers and customers more easily compare providers and be able to explain the cost of funds across different providers. To go against the legislation is to defeat one of the central purposes, and indeed almost all providers are showing these negative costs.

This is all part of a wider issue with the new regulation – with huge amounts of data being analysed by many different players, costs and charges will show up differently in different places.

This can be confusing for clients and makes advice crucial. They will need a guiding hand to navigate the sometimes counter-intuitive numbers.

We are hopeful that these stranger things are just the teething pains of the new legislation. During the next 12 to 18 months, the industry and the regulator’s thinking on best practice will evolve, in what we hope will align with common sense thinking.

Jeremy Mugridge is head of platform proposition at Old Mutual Wealth



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There are 2 comments at the moment, we would love to hear your opinion too.

  1. “This can be confusing for clients and makes advice crucial. They will need a guiding hand to navigate the sometimes counter-intuitive numbers.”

    Firstly, what about clients dealing execution only? On their own presumably, good luck to them.

    Secondly, it cannot be the responsibility of advisers to ‘correct’ a client’s understanding of a document mandated by regulation. Indeed, it would be dangerous to do so. What happens if that ‘correction’ turns out to be wrong or have gone too far? Passing the buck to advisers for poor regulation is frankly outrageous.

    Excellent article by the way, the above comments are not a reflection on the author or providers in general.

  2. Andrew Macintyre 23rd March 2018 at 4:26 pm

    Yet another example of something that gets dreamed up by well-intentioned academics and theorists but just does not work in the real world.

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