The MiFID II revolution: improving client experience to safeguard margins
The clock is ticking now with MiFID II coming into force in January 2018. The industry is still actively working to adapt its business model to the most transforming regulation for years. Most players are still struggling to anticipate the target distribution model for financial instruments.
In the near future, clients will have to pay for investment advice when this service is currently free of charge in most cases. In return, the cost of products should be reduced thanks to a sharp decrease in inducements. With a clear price put on the service and no hidden costs anymore, clients will be much more demanding and will request a dramatically improved service level. Proactive advice will become the norm and advisors will be more client-centric.
The adaptation to this new model will not be easy and banks should:
- Heavily invest in technology to assist advisors in the investment decision with robo-advisors, robo-allocators and streamlined reporting tools.
- Simplify their product range and focus on low cost products (ETFs) or best in class financial instruments with a strong track-record.
The 6 key post-MiFID II trends distributors will have to cope with
A gradual transition to a fee-based model especially for Private Banking
Over the long run, inducements should be replaced by a transparent fee-based model for advice and services. This evolution could decide clients reluctant to pay additional fees to switch to low cost “execution only” offers.
Nevertheless, the transition to a fee-based model should be gradual with a faster path in Private Banking and in Northern Europe. In a recent survey from the Fund Platform Group more than 60% of respondents (distributors, AM, platforms) see inducements as the dominant compensation model for the 3 next years
Regarding Retail banking, inducements remain a good pricing model to provide clients with basic investment advice and avoid the so-called “advisory gap” (this is why the FCA may re-authorise inducements in the UK). Over the short term, we do not expect that Retail banking will get rid inducements.
A crystal clear offer to justify inducements or additional fees
A better value proposition and a more transparent pricing model are needed to maintain market shares and preserve margins.
- Improve the quality of investment advice è Build a best in class service for advised client to justify fees/inducements and keep a commercial edge compared to “execution-only” offers.
- Introduce advisory fees è Switch slowly from inducements to advisory fees and transfer as many clients as possible to advisory service or in DPM. After the inducement ban, NL and UK distributors applied advisory fees between 50 and 100 bps of client’s AUM.
- Make clients pay the real cost of service èIntroduce administration fees (platform fees, custody fees…) especially for clients not willing to pay for advice. This solution was favoured by distributors in NL after the inducement-ban.
MiFID II is a major opportunity to reinforce the partnership between agile manufacturers able to design a full suite of value-added, mostly digitized, service for their distributors. Indeed, distributors need assistance from their manufacturers to reinforce the quality of advice and preserve their revenues.
The rise of packaged asset allocations, Funds of Funds and robo-advisors
Packaged allocations (model portfolios, robo-advisors, funds of funds) adapted to each category of investor profile should quickly rise for Private and Retail banking as they offer turnkey solution to:
- Provide standard advice for each client profile and limit regulatory risks.
- Address the need for a simpler core offer that can be easily marketed. Nevertheless, these packaged products should be complemented by diversification products covering specific needs.
- Ease the transfer of execution-only clients to Advisory with a standard and industrialized offer.
- Switch clients’ assets from low margin saving accounts to packaged products generating more revenues for both distributors and manufacturers.
The rise of Funds of Funds is also a major trend in Europe with a yearly growth rate higher than 20% according to Ignites. This product, tailored to client investment profile, has several advantages:
- It is a packaged Portfolio Management-like product for smaller clients with one fund per profile (conservative, balanced, growth…).
- Operational costs are lower compared to DPM.
- It is a way to simplify the suitability assessment for the end-client.
The adaptation of no-rebate shares to safeguard the non-independent distribution model
MiFID II bans inducements for Portfolio Management and Independent Advice that is why Asset-Managers are creating or revamping their no-rebate shares offer to cover this need. Asset Managers should restrict the conditions to access no-rebate shares to avoid the contagion to activities keeping inducements.
Distributors are also concerned about the potential competition from online brokers offering no-rebate shares. At this stage, this threat is not yet certain as inducements are needed to maintain an aggressive pricing (no custody fees, reduced brokerage fees…). At this stage we identify three strategies:
- Maintain inducements and keep the low cost offer as-is.
- Stop the sale of funds as there is no business plan without inducements.
- Build a more disruptive strategy with for instance a copycat of the successful Vanguard Personal Advisor Service. This offer proposes a low-cost advisory service priced at 0,3% a year, mixing robo-advisory and advisors available remotely.
A reinforced oversight of investment advice to ensure suitability
MiFID II also reinforces suitability checks with a mandatory suitability statement justifying any advice. So, it is crucial to make sure that Relationship Managers have a good knowledge of financial instruments. Two market trends can be anticipated.
- Create a specialized salesforce with investment specialists in charge of investment advice. This setup is being deployed for instance by UK players such as Santander (225 financial planning managers).
- Develop Robo-Advisor within the distributors to automate and bounder investment advice provided by Relationship Managers. Digital tools are here crucial to ensure the suitability of advice and preserve the distribution of financial instruments.
A simplified Investment Universe at Distributor level
With the evolution of appropriateness and suitability frameworks, the definition of suitable investment recommendations for each client profile requires an extension of due diligences on financial instruments and an ongoing review of the recommended Investment Universe. As a consequence, a large investment Universe triggers higher costs and more risk of complaints.
A simplification of Investment Universe should happen with distributors deploying several strategies:
- Reduce the number of product providers to the detriment of smaller product manufacturers. This is a recurrent feedback from distributors.
- Request assistance from fund selection specialists to manage and follow investment Universe.
- Narrow the range of complex financial instruments distributed.
- Increase investment in ETFs (12% of AUM in Europe today) to reduce the cost of investment for end-clients.
- Focus on internal products for standard strategies and benefit from a close partnership between internal manufacturer and distributors.
What could be the key post MiFID II trends for distributors?