Finally, on January 3rd 2018, MIFID II has entered into force and as one of the novelties, the explicit ex-ante disclosure of all costs & charges in connection with a transaction is from now on a must.
This covers both information on costs and charges associated with the manufacturing and managing of the financial instruments (i.e. product costs) and with the provision of investment or ancillary services (i.e. service costs). Also third party payments to investment firms in connection with the investment service (like trailer fees) shall be highlighted. Costs and charges shall be aggregated and expressed in both cash amount and as a percentage.
Why all this hype about cost reporting?
These costs existed already before the MIFID II regime, but what makes the big difference is that they now are clearly recognizable. This means also that on the one hand clients can already in advance of taking an investment risk compare the reported costs with gross performance and on the other hand even compare the costs with the ones charged by peers.
Implementation approaches
Turning theory into practice may be a real challenge, even if regulation allows a given level of flexibility, leaving open different approaches to compliance.
Taking a quick look at the Hungarian, Polish and Romanian market, various solutions can be found, like:
- illustrative cost disclosure on particular products within an asset class or on an asset class (sometimes even with examples attached),
- cost calculator engine/simulation with pre-fixed investment amount and period,
- cost calculator engine/simulation with freely selectable investment amounts,
- individual cost disclosure on the actually planned transaction.
Many firms have chosen to reserve the possibility to provide single cost & charges information for several financial instrument categories, in a standardized form. However at the same time stressing a strong investor protection, they assure the possibility for clients to request further, individualized information, even if this means an extra burden for the advisor. Thus, in practice, ex-ante reporting is based on representative, illustrative calculations, assuming a fix amount and period. By using this method, some disclose the costs & charges for sub-asset classes (e.g. real estate funds) or certain buckets of products (e.g. OTC FX forwards, government securities auctions), others even for each relevant financial instrument with help of a cost calculation engine.
There are also banks, who provide as a main rule personalized disclosure based on the client’s expected transactional business, and apply illustrative calculations only for products where this seems to be the more reasonable approach, like in case of FX forwards.
Disclosure in writing may significantly increase trade latency, thus investment firms seek to acquire client consent to be able to provide the information on website or in any durable medium like e-mail.
Cost disclosure is easier with professional and eligible counterparties, as – under certain conditions – the limited application of the rules can be agreed on.
In any case, information shall be available in good time before the given service is provided or the transaction is concluded. MIFID II leaves flexibility on the interpretation of “in good time” – we think that this shall represent a timeframe within which the client realistically can receive, read and comprehend the information.
However, practical considerations in line with client’s interest should also be taken into account, like quick changes in stock prices which require reasonably quick investment decisions.
Sticker shock?
Will investors be scared off by experiencing the cost disclosure as evidence for paying more than previously? Or will they be more conscious and take advantage of the sudden richness of information? Or will these reports be disregarded as clients suffer of information overload?
It’s too early to answer these questions but if the regulatory initiative achieves its aim, clients may be increasingly looking for more cost-efficient solutions. The increased comparability of different investment alternatives may in a long term result in a realignment of the market as the transparency may enhance the demand for lower-cost financial products. A typical case is – even if they differ in certain aspects – the decision between funds and ETFs, the latter being typically cheaper.
Investment firms may at the same time be under pressure to counterweight clients’ eventual negative cost perception and increase service level, strengthen image and communication, and work out smart cost and pricing strategies.
Truth will out…
.. when the first ex-post disclosure cost & charges reports will be sent to the clients, expected in the beginning of 2019. While ex-ante cost reports contain assumptions and estimates, ex-post reports will only contain real and actually charged elements and provide full accountability. The estimation method used in the ex-ante reports will be tested and eventual discrepancies may have substantial impacts on the credibility of an institution.
Sufficient disclaimers in the ex-ante reports may protect firms legally, however they may not serve as “remedy” for the disappointment of clients when they are facing such discrepancies. Disappointed clients may mean loss of trust and finally loss of the client itself.
Software solutions supporting compliance
Legal compliance can be turned into competitive advantage if supported by sound and valuable software solutions. Digital tools can help to make cost reporting customer friendly, easily understandable and informative, and have even the chance to be regarded as an added value tool. Well-designed cost and performance reports can even increase customer satisfaction and the information overload factor can be eliminated. On the other hand automated procedures can also improve advisors’ efficiency.
Last but not least attractive and easily understandable ex-ante cost reports can give rise to the customers challenging the products and the services thereby initiating the creation of overall better products and services.
