MiFID II Choosing the Right Pricing. Costs, Implications, and selections for Your MiFID Products. Many years back, the European Union recognized the need for investment services across its member countries to have a standard regulation, higher competition, and better investor protection. Thus, in 2007, the executive body created the Markets in Financial Instruments Directive (MiFID).
Under the 2007 MiFID rules, banks and wealth managers could choose what costs or charges they disclose to clients using their investment products and services. This made it easy for these investment firms to recommend products that have low service fees but high charges, thereby generating high margins for themselves.
All that came to an end on January 3, 2018. On that day, the EU replaced MiFID with a new directive MiFID II to increase transparency and standardize regulatory disclosures in its financial markets.
With the new rules, no longer would there be blurry pricing. Fund managers, advisers, and platforms are required to send clients a yearly statement showing all charges associated with their investments during the previous year. This includes custody fees, advisory fees, brokerage fees, management fees, entry or exit fees, and any other charges billed to a client’s portfolio.
Now, since costs are stated both in percentages and actual values, clients can plainly see the gross performance of their investment. They know exactly what they are paying for each financial service and product and whether their net investment is gaining or losing.
Implications of MiFID II for Investment Service Providers
MiFID II might have come as a welcome relief for investors, but the implications for fund managers are enormous. For one, channels through which some players in the sector have been making lots of money, like charging less transparent all-in fees, are no longer feasible. Also, firms cannot migrate customers into discretionary mandates without giving detailed accountability afterward like they do in the post-MiFID II days.
All these comprehensive annual breakdown of portfolio costs have increased investors’ demand for lower charges and reduced the number of people going for high-margin investment products. Another new directive is the 10% rule, which mandates that clients be notified when their portfolio value goes down by 10% or more within a 3-month period.
Let’s not forget the pre-trade and post-trade transparency rules in MiFID II. While the pre-trade transparency directs firms to make the 5 best pricing levels for both buying and selling sides known to customers, post-trade ensures firms release data pertaining to shares’ prices, volume, and time of sale even if they’re not transacted in an open market.
Of all the MiFID II regulations, the one that has impacted the investment management sector the most is the unbundling of research costs from trade execution fees. However, the impact is not the same for all operators in the field. The buy-side (the users of research), for example, have had to struggle with the additional compliance costs.
Research conducted by the CFA Institute, the international organization for investment professionals, found that smaller funds – mainly independent research providers – from the buy-side have taken the greatest hit as a result of aggressive low ball pricing offered by larger investment firms (e.g. banks).
The CFA survey, which involved 12,633 participants, revealed that 57% of respondents from the buy-side sourced less research after the implementation of MiFID II. Overall, research results suggest that although one of the aims of MiFID II, which is increased competition, was achieved, larger firms with bigger resources benefited more than boutique operators. Other major findings of the survey include:
- Reduction of research budgets by an average of 6.3% by fund managers. Very large managers, especially those with assets worth over €250 billion, were found to have made the biggest budget cut at an average of 11%. On the other hand, groups managing assets between €1billion and €250 billion slashed their research spending by 5.5% on average. And for firms with less than €1 billion in assets, their research spending remains largely unchanged.
- Differing views on the quality of research and coverage provided under MiFID II. While a larger percentage of buy-side professionals maintained that research quality did not change. 44% of sell-side respondents in the survey believed the quality of research after MiFID II had declined significantly. In general, about 50% of both buy-side and sell-side respondents agree that research quality and coverage under the regulation have decreased, while less than 10% think it has increased.
Every new dos and don’ts have added pressure to the formerly-profitable revenue streams of investment service providers and decreased their total margins. To retain and attract clients, there is now a greater need for better value communication.
How to Price Your MiFID II Products Right
When pricing your MiFID products, the best model to adopt is value-based pricing. As clients become more aware and can compare charges of investment firms, lower-priced products like ETFs and index funds are gaining increasing acceptance. To save costs which tend to add up to a significant sum in the long-term, most clients found it easier to opt for these cheaper products and services over the more expensive ones.
Clearly, when clients make choices like this, the impact will be reduced profitability for a fund manager. That is why right from the get-go, instead of focusing on price when selling to clients, talk more about the value of the product and service you’re recommending.
While there’s no avoiding discussing fees, tell them about the costs upfront. More importantly, consider which channel will yield the highest returns for your client. And if that route is pricey, address the issue proactively with good explanations and intelligent arguments. Research has shown that what investors want at the end of the day is not really bargain-priced products but a vehicle that will bring them the greatest profit.
Clients are also concerned about how fair you are, your brand image, and whether your service is convenient or not. If you can prove and have past records to show you can deliver on all these, you’ll have little to no problem convincing clients to go with your higher-margin recommendations.
MiFID II Choosing the Right Pricing
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