Communicating with clients: New marketing and reporting requirements under MiFID II
Published: 30 January, 2018
Amongst the many changes introduced by the second Markets in Financial Instruments Directive (MiFID II) are those impacting on how firms communicate with their clients, prospective clients and the wider public. The two key areas in which MiFID II introduces new or enhanced requirements in this respect concern the content of financial promotions and marketing material, and the disclosure of fees and charges to clients.
Although these subjects have not received perhaps the same degree of attention from industry commentators and trade bodies as some of the other areas covered by MiFID II – for example, transaction reporting or payment for research – they nevertheless have the potential to create significant challenges for firms if they are not addressed in a timely and comprehensive manner.
What are the key changes?
The changes in respect of financial promotions and marketing material stem from Article 44 of the Delegated Regulation (Organisational Requirements). They introduce new and enhanced obligations on the part of firms approving the content of such material. The changes are explained in more detail below, but in summary these changes will narrow the gap in standards required for retail and professional investors considerably. Arguably, in terms of the letter of the requirements at least, there will be very little difference going forwards.
The new requirements regarding the disclosure of fees and charges can be found in Article 50 of the same Delegated Regulation. Firms will be required to disclose substantially more information than is required under the current regime, both at the point of sale and on an ongoing basis.
Both changes aim to improve the quality of information communicated to clients and potential clients, and as such can be traced back to one of the key drivers behind MiFID II, namely increased investor protection.
Whilst the new requirements will apply in respect of any client or potential client for whom a firm undertakes MiFID business, we consider below whether firms may wish, for operational simplicity, to apply uniform standards across all areas of their business.
The changes introduced by MiFID II in respect of information to clients can be broken down into two areas:
The introduction of specific additional requirements regarding information that must be included within financial promotions, marketing material and product collateral; and
An enhanced emphasis on the overriding requirement for such material to meet the test of being “fair, clear and not misleading”, applicable to all information and communications with clients.
Specific requirements
The specific requirements introduced by MiFID II include:
Risk warnings: Always providing a fair and prominent indication of relevant risks when referencing anybenefits of a service or financial instrument – previously the requirement to provide an indication of risks was only required where potential benefits were emphasised;
Formatting: Ensuring both the layout and font size of risk warnings give them equal prominence to the remainder of the communication;
Forward-looking statements: Including details on future performance based on relevant scenarios in both positive and negative market conditions.
Fair, clear and not misleading
On the face of it, little changes under the new regime in this respect. MiFID introduced the requirement that all communications with clients should be “fair, clear and not misleading” (albeit that the requirement reflected pre-existing standards in UK regulation), with no distinction between retail and professional clients. However the increased emphasis on prescriptive requirements regarding information provided to professional clients is likely to have a knock-on effect in terms of raising regulatory expectations as to what exactly constitutes “fair, clear and not misleading” in the context of such communications.
In our view, the FCA is likely to retain a degree of pragmatism and proportionality when considering the content of material aimed at professional investors – for instance, by recognising that pre-existing knowledge levels on the part of the investor will generally be higher than in the retail space. Nonetheless, firms will need to consider carefully the manner in which they communicate with professional clients and apply a higher threshold than might previously have been the case.
Comparison with SEC requirements
The anticipated changes put forth by MiFID II draw many similarities to the current SEC requirements for marketing materials under the Investment Advisers Act of 1940 and accompanying No Action Letter guidance. Generally, the SEC prohibits the use of any marketing material which contains any untrue statement of a material fact or which is otherwise false or misleading, similar to MiFID II’s requirement for communications to be fair, clear and not misleading. Additionally, the SEC requires fulsome disclosure language within marketing documents describing the various risks an investor faces in terms of the potential loss of profit and warning the investor that past performance is not indicative of future performance. Further, the SEC expects disclosures to be prominent and legible and has cited deficiencies for advisers who chose a small or unreadable font size or style.
Finally, the SEC pays particular attention to the use of performance in marketing materials and has a large number of requirements dictating the proper method to utilise performance along with the requisite disclosures in using performance figures. While there do still appear to be some areas of divergence between the SEC’s requirements and MiFID II’s proposed changes to the content of marketing communications, the new requirements exhibit many overlaps with the SEC’s current expectations in terms of marketing materials and the use of performance.
What should firms be doing?
There are a number of practical steps firms can and should be taking now in order to ensure both that they remain compliant post January 2018, but also that they are able to keep the costs of remaining compliant to a minimum.
One set of standards or two?
The specific new requirements only apply to a firm’s MiFID business, meaning those who conduct both MiFID and non-MiFID business will need to consider whether it is preferable to maintain two sets of approval processes, communications guidelines and standards, etc. In practical terms, many firms may consider that the benefits of having a consistent set of standards and processes in this respect far outweigh any related issues, particularly given that the overriding requirement for communications to be “fair, clear and not misleading” will continue to apply to all material.
Plan ahead
Depending on the nature of the firm and the volume of existing collateral it utilises, the task of updating existing material to bring it into line with the new requirements could be one of the most significant challenges, potentially placing considerable strain on approvals processes and the individuals within a firm who are responsible for either the production or sign-off of material. This in turn could lead to delays, errors or inconsistencies if not managed appropriately, which could mean drawing upon additional external resource. Further, proper planning of changes to existing materials can ensure that stocks of printed material are run down as best they can be, thereby minimising costs resulting from wastage.
Consider the approval process
At a minimum, approval checklists will require updating to reflect the specific MiFID II requirements. However, additional changes to firms’ approval processes may also be necessary, notably in respect of the records that the firm keeps, showing the audit trail leading to the approval of an item. The question of what is “fair, clear and not misleading” is one requiring significant judgement, and the ability to demonstrate clearly why an item was felt to meet this standard can be crucial in managing regulatory risk in this area.
Education, education, education
Staff involved in both the creation and approval of communications material will need to be fully conversant with the new requirements. In some cases, this will be a relatively straightforward task, involving an explanation of specific additional wording that must be included within communications material. However, in other areas, staff will be called on to exercise additional judgement and potentially to change the “mindset” they adopt when producing or approving materials. These changes are likely to be most effective if they are given time to bed-in.
Think strategically
The FCA has frequently noted that the choice of marketing strategy can have a bearing on firms’ ability to produce compliant financial promotions, marketing material and product collateral. Where and how firms advertise can play a role both in terms of setting tone and communication style, as well has having a significant bearing on the ability to demonstrate that material is most likely to be received by its intended target audience.
Further, the practice of testing the understanding of material – for instance, through customer research, focus groups and similar – can be invaluable in identifying non-compliant collateral, whilst also delivering potential commercial benefits by ensuring messages are delivered in a manner that is most likely to appeal to their intended recipients. Such research has previously tended to be commonplace only in the retail space. However, the subjective nature of the “fair, clear and not misleading” requirement is such that some firms may wish to adopt this approach in order to provide robust evidence to support their judgements, particularly in the early days of the new regime.
Indeed, this last point crosses over into the area of product governance, another key area of change under MiFID II, and one which will likely cause many firms to engage in similar internal discussion and debate regarding their strategy, processes and procedures.
Fees and charges disclosure
It is clear that the new regime regarding the disclosure of fees and charges will impose significant additional obligations on firms insofar as both the initial disclosure (e.g., those typically provided within the IMA for our clients) and particularly ongoing disclosure of fees, costs and charges are concerned.
In summary, the new regime will require firms to disclose, on at least an annual basis, an aggregated value – in both actual and percentage terms – for all costs incurred during the year; this includes one-off charges, ongoing charges, transaction costs, costs relating to ancillary services and incidental costs. The impact of these aggregated costs on the value of the assets must also be shown. In addition, firms will be required to provide clients, on request, with an itemised breakdown of these costs. All such disclosures must be personalised, taking into account any purchases and sales of funds made by the client during the course of the year.
There is no currently agreed upon template for how this information must be displayed, although relevant trade associations have been consulting on various proposals.
Key impacts
The impact of this change will vary considerably across firms and will depend on a number of factors, not least the nature of the business undertaken by the firm and how its systems are set up. Some of the Article 50 requirements may already be satisfied through existing reporting, but it is likely that for many firms, the new requirements will go significantly further than their existing client disclosures.
For firms with multiple funds and/or clients, the impact of the new requirements could be particularly onerous, potentially requiring major systems development to enable all relevant fee information to be extracted and aggregated so as to show the cumulative impact on the value of investments. Although firms with, for example, only a small number of managed accounts are likely to face a less onerous task, it will still be important to ensure that the new requirements are factored into relevant communications with clients.
Certain charges that will be incurred by a fund or portfolio will be known in advance, and as such, there is unlikely to be any significant difference between the contribution these charges make to the aggregate value of charges in ex-ante versus ex-post disclosure. However, other charges may be considerably more difficult to predict with any degree of certainty. For example, charges relating to a property fund will vary depending on the volume and value of transactions undertaken by the fund in any given period, whilst charges impacting on a multi-manager fund may vary as a result of entry and exit fees, performance fees and other factors. The new regime will require firms to provide an explanation where ex-post charges differ significantly from those disclosed on an ex-ante basis. Firms will need to be ready and able to provide such an explanation and should expect potential challenge – from clients, regulators or both – if ex-post charges frequently show significant variance from ex-ante charge disclosure.
What should firms be doing?
Notwithstanding that there are points of detail that remain to be resolved in this area, firms can begin the process of planning for the new requirements now. Steps firms can be taking include:
Plan for systems changes
For many firms, the task of collating the necessary information required in order to comply with the new requirements will involve systems changes, and this is likely to be the area presenting the greatest challenges, partly due to the inherent complexity of systems changes, but also given that systems changes arising from other requirements under MiFID II are likely to lead to significant pressure on IT resources in the latter half of 2017.
Identifying the different systems that will need to be included within an automated solution – this could include, for example, booking systems, accounting systems, client relationship management systems and others. The earlier firms understand what may be involved in developing an automated solution to collate required information from different systems, the more likely this automated response can be developed and implemented by January 2018.
Consider how to communicate
As noted above, a standard template has not yet been agreed upon for disclosure required under the new regime. As greater clarity emerges in this respect, firms will need to consider if they develop their own approach or how they can best utilise the template to provide information in a manner consistent with other material communicated to their clients. Further, and regardless of the format or template to be used for disclosure, firms can and should consider whether required disclosure should form part of existing communication cycles with their clients or should represent a standalone communication.
Firms will also need to consider the most appropriate format for providing itemised breakdowns to clients on request, and define a process by which such information can be extracted and provided to clients.
Training
Client-facing staff will need to be aware of the new requirements and be capable of discussing both ex-ante and ex-post disclosure statements with clients, including explaining how and why any variances have arisen (see above).
Strategic thinking
Increased visibility of fees and charges, particularly when shown by reference to their impact on the value of investments, has the potential to create additional competitive pressures as clients seek to maximise their returns by identifying where charges may not represent good value and/or may be reduced by switching to alternative funds or managers.
