David Green: Miffed over MiFID

MiFID 2 is the European Union’s second Markets in Financial Instruments Directive. My spell checker keeps changing “MiFID” to “miffed”, which is mildly annoying. You might be miffed too if the European Commission gets its way in regulating your treasury management.  They’ve seen plenty of stories about poor investment decisions by local authorities across Europe and they want to protect you from the financial whizz kids in London and Frankfurt. To do this, they are looking to reclassify all local authorities as retail clients.

This would mean that all financial services firms like banks, brokers, advisers and fund managers will have to treat local authorities the same way they do individuals and small businesses. That includes ensuring that investment products are suitable for the customer’s needs, and that all the risks and features have been fully explained.

Now that might be a welcome change for some, but it also involves lots more paperwork for both the firm and the client, to prove to the regulator that all the steps have been taken, and as evidence in case of alleged mis-selling.

Some of the more ill-informed things I’ve read on this topic suggest that many firms will stop dealing with local authorities if they become retail clients. One widely circulated advice note even said that banks will refuse to lend to or accept deposits from retail clients.

But of course, most of the clients of banks and fund managers are individuals and small businesses who are already classed as retail.  Dealing with new retail clients in the form of local authorities won’t be a problem for most service providers.

There are a few firms that only deal with professional clients at the minute, including some wholesale money market brokers and treasury advisers. They will need to decide whether the extra regulation and paperwork is too much bother, although those whose business is mostly local authority focused may have little choice. But if a couple of firms do exit the market, there are plenty of retail alternatives – stockbrokers sell bonds and funds as well as shares, for example.

It is reasonable to assume that costs will rise though, which may be reflected in either higher fees or lower investment returns.  Having said that, the best firms already take their duty of care to customers seriously, and go beyond the current requirements before recommending a product to local authorities. Their fees shouldn’t increase as much.

MiFID does include an option for certain retail clients to opt for professional status, losing some of the protections in return for a simpler investment process.  The British negotiating team gained an exemption in MiFID 2 allowing the Financial Conduct Authority (FCA) to set its own criteria for deciding which local authorities should be allowed to do so.

Now, UK local authorities come in all shapes and sizes. I think everyone would agree that the parish council with a few thousand pounds to invest and one part-time clerk probably needs treating the same as my Mum and Dad before being sold an investment. And there seems little argument that the largest local authorities with over a billion pounds of financial instruments should be treated as professional clients, just like similarly sized companies. The question is where to draw the line.

At Arlingclose, we favour a solution that permits, but does not require, all district, unitary and county councils to opt up to professional status. We believe this is best achieved by applying the FCA’s large undertakings criteria, outlined as option C in their recent discussion paper.

For investments that fall within the more restricted scope of MiFID 1, the FCA already requires firms to check that local authorities meet these criteria before treating them as professional clients, so this should cause the minimum fuss. We expect the FCA to launch a more formal consultation paper later this year.

Assuming that a pragmatic approach is finally adopted, this just leaves the question of whether local authorities should exercise their option or not. The decision can be made on a firm-by-firm and an instrument-by-instrument basis. So you can select to be a professional client when dealing in markets you are more familiar with, such as for wholesale deposits via money brokers, and be a retail client in the more arcane instruments, such as structured loans.

Finally, it’s worth pointing out that none of this will affect your dealings with the firms you already have arrangements with.  Under the “grandfathering” rules, your current service providers will continue to treat you as a professional client.  But when you start a new business relationship after January 2017, you may well have a careful choice to make between lower fees and higher protection.  Choose wisely.

David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.