Private banks sweat on MiFID’s arrival

There will be sleepless nights in the private banking community as the November deadline for the implementation of the Markets in Financials Instruments Directive (MiFID) looms. In several recent research assignments undertaken by Scorpio Partnership, MiFID has been highlighted as a key concern in part because firms are unclear on what the rules will mean in practice. So what does MiFID promise? First, it should provide significant economic benefits when it integrates the EU financial market. In the post-MiFID environment, there will most likely be increased scope for pan-European banking consolidation which may pave the way for a wealth management industry to rival the US in scale and efficiency. However, until such time, there is the inevitable fear that fragmented implementation across Europe may place a few bumps on the otherwise level playing field. So far, only the UK, Ireland and Romania have signed the directive into law. Unsurprisingly, banks in these countries fear they will face higher costs to implement the directive on the back of the new legislation. For example, it is expected that banks in the City of London will spend more than £1bn (?1.4bn) on implementation. The expenditure is linked mainly to systems that can cope with the sheer volume of data that firms will be required to maintain. While there is a plethora of changes heralded by the directive, three areas stand out as being of key interest to the private banking community. One of the four high-level imperatives that MiFID introduces requires banks to understand their customers and communicate their products and services transparently. While ‘know your client’ practices are already commonplace at private banks, the client classifications presented by MiFID will create a new set of challenges for the industry. Under MiFID, the classification of clients will be either retail, professional or eligible counterparties linked to how frequently they trade. In some countries this marks a change in regulatory terminology and approach. In other countries, this may signal a change from marketing designations to regulatory requirements. The major concern for private banks with the new classification system relates to client portfolios where there is little trading activity, notably execution-only and advisory clients. These clients may be regarded as retail clients as a consequence and be denied access to more complex instruments such as contracts for difference (CFDs), covered warrants, hedge funds and products with embedded derivatives. To add to the confusion, the classification of clients will not be static and may vary, depending on trading levels. Client classification could prove to be one of the areas of greatest expense. A client can theoretically change their classification on a trade-by-trade basis and system-based parameters will need to be implemented to deal with this potentially frequent change. Following the changes to client classifications, the next major area of concern relates to the levels of transparency required. Chief among these is the need for fee transparency and next-day transaction and client reporting. With many private banks operating on creaking back office systems, there is the expectation of significant potential effort required to solve some of the legacy problems ahead of the deadline. However, what MiFID promises to deliver is a more standardised approach to reporting, which will undoubtedly be welcomed by private clients. With respect to best execution, many private banks believe that there is a particular issue relating to structured products. The regulation demands that all products are accurately priced, risk profiled to be suitable for the client and sourced from a number of providers. This may bring to an end the policy at many private banks of ‘pushing’ their investment bank’s own range of structured products exclusively. Banks are reliant on teams that are responsible for the best execution for clients although it is common practice to favour in-house solutions. With greater transparency this may no longer be acceptable. However, few private banks can see a practical way to achieve market-wide transparency without the creation of a formal market for structured products. What is expected as a result of these high level changes is a stronger drive toward outsourcing, particularly in the back office as private banks seek to cope not only with the enhanced transparency requirements but also the growing volume of data management required by the new directive. With the deadline for implementation looming shortly after the summer months, it seems that the traditionally quiet period may face a frenzy of activity, particularly for the back office solution providers. Ted Wilson is managing partner at wealth management strategy think-tank, Scorpio Partnership