Earlier this summer, we held a workshop with Stephen Hanks from the FCA’s markets policy team. He answered a wide range of questions posed directly by our clients. This is a summary of the main discussion points addressed by Mr Hanks, to give you insight into his thoughts on some of the key challenges faced by the industry in relation to MiFID II.

FCA expects "reasonable efforts to comply"

Introducing the talk, Mr Hanks updated the forum that domestically, the FCA has now done the bulk of the policy work on MiFID II with the publication of July’s second policy statement. (PDF)

He stated that the FCA's role is primarily about turning the EU legislation into domestic rules and regulation and not, for example, providing extensive commentary on the way the rules are interpreted. He said most of the interpretative work has to be focused at the European Markets and Securities Authority (ESMA) level, where the UK regulator is fully represented, to ensure consistency across the EU. He noted that the next significant set of Q&A from ESMA is due to be published at the end of September, likely to be under the heading of investor protection on costs and charges. 

The FCA cannot publish its own Q&As without this becoming guidance, which would require a consultation, so its approach will involve more informal contact and communications with the industry. The FCA continues to meet with firms and trade bodies and Mr Hanks suggested that, following implementation, the regulator is likely to do thematic work, looking at how firms have dealt with implementation of the new regulations.

The core of what the regulator will do remains the same, with the focus on quality of investment advice, product governance and smarter communications -- and these are likely to be supervisory priorities next year. He added, "That will drive what we do in terms of thematic work. We are not going to be knocking down doors on the 4th January to look at how people have done particular bits. We will be doing work in the course of next year to look at areas that are of concern to us, linked to what we perceive as the risks to our objectives."

Concerns about the start date

The majority of concerns raised by firms about readiness relate to transaction reporting, product governance, costs and charges and investment research. Some firms had expressed their frustration about the 3rd of January implementation date, but Mr Hanks said it was determined by EU processes, meaning implementation was scheduled just over 18 months after the legislation was adopted and published. 

Transaction reporting, cancellations and LEIs

Responding to a question, Mr Hanks advised that firms could not start submitting MIFIR transaction reports before the implementation date, because the FCA systems would not have changed over.

Attendees were very interested to hear the regulator’s thoughts on how to report certain scenarios of the cancelled and rebooked transactions. 

"Where there is a cancellation and reversal of a trade, in making an error and reversing it, you have to report all of that. There has been a transaction and therefore that requires a report," he said.

On the subject of legal entity identifiers (LEIs), Mr Hanks suggested that where a client's LEI had not been renewed, the original would suffice.

He noted that by and large where a firm was dealing with, for example, a SIPP provider, it was the SIPP's LEI that was needed, not the underlying client LEI, unless there were specific reasons for the firm having knowledge of and working with the underlying client.

Asked about reporting of transactions, where a transaction might involve two different business units, one perhaps taking the order, another buying the stock, Mr Hanks said it was likely to represent just one transaction report for that legal entity, although how a trade was conducted would impact data required. 

Attendees asked how this wealth of data would be used by the regulators and Mr Hanks said that, among other things, the FCA uses a software package to run over the top of transaction data to identify market abuse. It also helps the FCA understand the behaviour of firms in general and individually, to analyse trends in the market and informs work on financial stability with the Bank of England.

Client reporting and suitability

Attendees were keen to understand what exactly MiFID II required in terms of providing periodic reports and get clarity about where these reports sit alongside suitability reports, given the related update to COBS 16. 

"If you are reviewing suitability, it seems sensible to align that at some level with the periodic report. So if you only review suitability on a six monthly basis and produce the periodic report on a quarterly basis, you would simply add it to the six monthly report," he said.

Hanks said that, in general, communications around suitability were meant to incorporate a consideration of whether a client’s circumstances had changed and thus that the product remained suitable. 

Product governance

Firms acting as product distributors were also keen to understand just how much information they have to provide to product manufacturers as part of their new responsibilities.

Hanks said: "The information is supposed to enable the manufacturer to judge whether the product is being distributed in the correct target market, so it only needs to be as granular as is required to determine whether that is the case. The granularity will depend on the assessment of the target market -- the more vanilla the product, the more vanilla the information that has to come back."

Asked about how frequently to review target market criteria for products which change their underlying investments on a frequent basis, he advised that the assessment should be on "the kind of mandate it has to invest. It applies if that mandate changes or another change affects the inherent characteristics of the product -- rather than a fund has bought one share and sold another." 

Costs and Charges disclosure

Managers were worried about which firm had to disclose what information on charges, where an end investor might be serviced by multiple IFAs, fund managers, wealth managers, custodians and other service providers.

Mr Hanks said there might be variations in practice between firms about what is disclosed, though he thought it would be odd if information provided by a fund manager, for example, on portfolio turnover was not then passed to the client by a firm. He suggested that some variation in practice was likely to be expected. He added: "We may do some thematic work and say: 'this is what we think is good practice and poor practice.' The main concern we have on costs and charges is that people attempt to make aggressive assumptions to make their costs look lower than a person doing very similar business next door."

When asked specifically about how to report FX charges where they may be embedded in the spread, Mr Hanks said further clarification might have to await ESMA’s look at how such issues impacted on wholesale markets.

In response to some firms’ worries that clients might believe charges had increased dramatically under the new regime, he said it was up to firms to communicate with clients and put the changes in context.