At the risk of teaching grannies to suck eggs, January 3rd 2018 sees the introduction of MiFID II to European Financial Markets and the implementation of the various new regulatory obligations it comes with. Major changes that the readers will be familiar with include, the unbundling of research costs, a significant increase in transaction reporting demands, regulating more off-exchange activity and tougher general standards across the industry.
The new implications have meant a lot of effort across the industry in changes to processes, technology systems and in some cases investment philosophies. Despite the legislation containing a remarkable 1.4m paragraphs of rules we feel at Vertem we are just about ready for MiFID II. But whilst the industry is hopefully now prepared and ready for it, the question is, are clients and the investor base ready?
MiFID II does not affect just industry participants but also the frequency and the way that clients are reported to. Quarterly reporting and review periods are already commonplace to some clients and probably palatable to those who prefer less frequent review. The requirement that we fear might create chaos is the infamous 10% rule.
Advisers and managers are required to notify clients if their portfolio declines 10% at any point since the last reporting period. Obviously intra-period drawdowns could easily exceed full review period losses and are more likely to occur than if the obligation was if a portfolio suffered a 10% drawdown over the full period. Thankfully this potential scenario should not be too common and should only affect clients at the higher end of the risk spectrum, however in extreme environments when many assets suddenly correlate to 1 even lower to medium risk clients could be affected.
Our first worry, with any client, is that such a notification or warning of portfolio decline could trigger short term fear by the client that prompt an instruction to withdraw funds from the market, even if such a decline should have been within their comfort zone. This is especially relevant if they wouldn’t ordinarily notice such intra-period movements and end up missing out on any upside if markets subsequently recover.
Therefore we think it is important, in advance of the new regulations that clients are made aware of these potential notifications and are using it as an opportunity to re-present the implied risk dynamics of their portfolios to them. This means a recalculation of risk data to make it relevant to reporting period frequency as well as over the longer term. In turn this fuels the creation of simple, easy to understand visual representations of what we expect from their portfolio, alongside what the portfolio has realised. This is to both set expectations going forward and to challenge whether their prescribed or desired risk level is genuinely within their comfort zone.
Hopefully we can use these tools to ensure that not only is Vertem ready for MiFID II but our client base is too.