17 December 2018
By Manjit Singh, Asset Management and Insurance Practice Leader, PwC Malaysia and Lum Kar Hoe, Senior Manager, PwC Malaysia
The Markets in Financial Instruments Directive 2, or MiFID 2 in short, is a legislative framework introduced by the European Securities & Markets Authority. Since its implementation on 3 January 2018, MiFID 2 has been billed as one of the EU’s most progressive financial reforms. This is despite opposition from certain quarters such as French financial markets regulator AMF due to application of new market rules made complicated by Brexit.
MiFID 2 aims to strengthen investor protection and improve the efficiency, resilience and transparency of financial markets. To achieve these goals, we need to consider the impact, both immediate and long term, that may reframe how we view competition in this dynamic marketplace.
Immediate impact: A clearer look at investment decisions
One of the key features of MiFID 2 is the unbundling of research reports from trading fees. Up until now, research and trading fees have been built into a brokerage services package provided to fund managers for the execution of client trades.
In Malaysia, the Securities Commission’s (SC) Guidelines on Unit Trust Funds require that the investment committee of a fund manager prescribe a limit in terms of proportion of dealings, in percentage form, to be executed with each broker or dealer, taking into account their capabilities and services. Typically, some of the factors taken into consideration include brokerage rates, quality of research reports provided, timeliness of execution and efficiency of trade settlement.
The subjective nature of these factors often makes it difficult to benchmark the brokerage fee charged by each broker. As a result, there is rarely a clear distinction between the allocations made, and this is compounded by the fact that fund managers are not obliged to publicly disclose the basis of these allocations made.
Because of these subjective considerations and the lack of transparency, brokers and dealers may get a bigger share of allocation despite charging a higher brokerage fee. With the unbundling of research reports from trading fees, this removes at least one subjective element involved in allocation decisions, resulting in fairer allocation of trades.
Impact to the fund management industry in Malaysia - we’re not as insulated as you might think
While there is no direct impact to industry players in Malaysia as MiFID 2 is a European directive, foreign brokers who are subjected to this new framework may adopt a streamlined approach globally to reduce operational complexities, costs and compliance risks. As such, there could be indirect effects to the local fund management industry in these ways:
i) Fund managers may be asked to assist on its counterparty compliance efforts with MiFID 2, such as assisting in data collection activities.
ii) Fund managers subscribing to services of foreign brokers under the purview of MiFID 2 may receive fewer research reports on global equities unless they have sizeable dealings. However, we note that most fund managers are now committing to absorb these research costs, putting a further strain on their profitability. This is at a time when the industry is hit by a shift to passive investing, competition posed by robo-advisors, changes in tax laws and an unrelenting pressure to reduce management fees.
We anticipate that as management fees continue their downward march and as investors continue to move towards lower cost products, total expense ratios will fall by more than 22%, to reach 0.53% globally by 2025 (see figure below).
iii) The outcome of MiFID 2 - an efficient, resilient and transparent financial market - is welcomed by institutional players. But you have your work cut out for you, given that it may take several years before you fully feel the impact of these changes. We expect that large sovereign wealth funds will require fund managers to disclose where they add value, allowing them to more aggressively negotiate for lower fees to achieve specific outcomes while allowing retail investors to benefit from fee competition.
What does the implementation of MiFID 2 mean for fund managers going forward? Work needs to start right now including a rethink of your research strategy, given the far-reaching effects of MiFID 2.
Greater pressure on profitability is the most obvious impact that we anticipate. But consolidation may also be on the horizon as a result of increased research costs, process changes and transparency requirements brought about by this new legislation.
As a fund manager, are you thinking strategically about your positioning plan? Are you future proofing your business by replacing silo-ed working groups with cohesive multi-skilled teams? Explore our recommendations in our publication Asset & Wealth Management Revolution - Pressure on profitability.
What’s clear is that in this buyers’ market, industry players will need to push efficiencies while balancing costs, knowing what works for the investors as well as their pain points. Adopt a ‘fit for growth’ mindset by investing in your areas of strength to build long term stakeholder trust. Get this equation right, and half the battle will be won.