Within this document, we have taken the opportunity to address some of the frequently asked questions we are receiving from professional advisers on the MiFID II. We note that there is still some ambiguity surrounding the interpretation of the new regulations and we therefore expect further guidance to be provided on a number of subjects in the coming months.

If you have any questions on the information contained within this document, or any other aspect of how Brooks Macdonald is approaching MiFID II, please contact your Brooks Macdonald representative.

What is MiFID II?

MiFID II (the updated Markets in Financial Instruments Directive) is European Union legislation that will apply to firms that provide services linked to financial instruments. It builds on MiFID, which was implemented in November 2007 to improve investor protection and transparency within the financial services industry. MiFID II comes into effect on the 3 January 2018 and its implementation presents one of the biggest regulatory challenges the UK wealth management industry has faced in recent years.

Does MiFID II apply to me?

Simply, yes. In the UK, the FCA is required to apply ‘at least analogous’ rules to exempt firms under MiFID II, as it did for MiFID.

The requirements of MiFID II are relevant to anyone giving investment advice, not just MiFID “Investment Firms”. One of its key objectives is to increase investor protection, so even if some of its elements do not directly impact advisers they will likely impact their clients.

What areas are impacted?

Broadly speaking, MiFID II impacts all parts of the financial advice and wealth management industry. For advisers, the key changes will relate to transaction reporting, client reporting and product governance.

What are the impacts on client reporting?

The changes mainly surround the frequency and transparency of disclosure to clients.

How will periodic client reporting be affected?

MiFID II requires valuation statements to be provided to clients at a minimum of quarterly intervals. This requirement impacts all portfolios and wrapper types.

Although we already provide quarterly reporting for our Bespoke Portfolio Service, the reporting frequency of our Managed Portfolio Service will increase to quarterly from bi-annual. We currently provide quarterly valuation reports in paper form, but we will start providing valuations electronically later in 2018. Electronic valuations will be distributed via email and clients will be able to access them through our secure online client portal.

What are my new responsibilities surrounding “depreciation reporting”?

MiFID II will require firms to notify clients when the overall value of their portfolio depreciates by 10%, and multiples of 10% thereafter, during a reporting period. Although this seems straightforward, a number of intricacies will complicate this process and professional advisers must ensure that these are addressed by the 3 January deadline. For further information, we have identified a number of issues firms could encounter during the provision of depreciation reporting, including that the regulations suggest firms should notify clients by the end of that business day.

MiFID II FAQ’s for professional advisers

MiFID II FAQ’s for professional advisers

For client investments held within a Brooks Macdonald nominee company, we will be responsible for providing depreciation reporting. Where mandates are managed on a platform, we will not necessarily have access to the client information needed to provide depreciation reporting; in these cases. Advisors that have utilised our services via platforms should ensure they have determined who will provide depreciation reporting; please assume that we will not be able to undertake reporting to clients as their information is only held by the platform and adviser.

We are engaging with adviser firms and investment platforms to ensure we all fulfil our depreciation reporting commitments. We strongly recommend that advisers make all necessary arrangements to ensure that depreciation reporting can be provided to their clients upon MiFID II’s implementation. Advisers who outsource to DFMs should state whether they wish to be informed when depreciations are reported to their clients. It is our intention to inform advisers as well as clients when we undertake depreciation reporting.

We plan to initially provide depreciation reporting in paper form, but we will start providing it electronically later in 2018.

How will client reporting responsibilities change for leveraged portfolios?

A number of MiFID II’s reporting requirements for leveraged portfolios are different, including the obligations relating to reporting frequency. We do not offer leveraged portfolios in any of our services.

How will MiFID II change the way costs relating to client investment activities are measured, borne and reported?

Under MiFID II, there will be significant changes to both the ex-ante (pre-sale) and ex-post (post-sale) costs and charges disclosures for clients. The new regulations are more prescriptive and we anticipate significant changes will be made to the information disclosed to clients. In particular, they oblige firms to provide increased transparency around costs and charges, in order to allow them to make informed decisions.

Although there will be no set template to follow, at the very minimum firms will be required to disclose:

• The costs of advice• The costs associated with any recommended investments• The costs associated with third-party services

Ex-ante costs will also need to be shown prior to the point of sale, alongside their potential cumulative effect on the investment’s return profile. Other costs, such as entry costs, exit costs and performance fees, will also have to be made available for different products. Furthermore, cost-based transaction analysis is likely to become more demanding under MiFID II and what is estimated in ex-ante reports should be closely reflected in ex-post charges.

We expect to break down ex-ante costs and charges into five distinctive areas:

• One -off costs: including initial charges or switching charges• On-going costs: including the annual management charge• Transaction costs: including underlying fund charges• Ancillary costs: including the costs associated with research• Incidental costs: such as performance fees

Ex-post, itemised breakdowns will need to be provided, at least annually, with total costs expressed as both cash amounts and in percentage terms. The deadline for implementing this change will be in 2019, but firms must begin capturing the data from 3 January 2018. We expect to provide our first annual reports in the first quarter of 2019.

Despite recent regulatory guidance, the reporting of costs and charges under MiFID II remains a grey area as no defined template has been agreed by the regulator or by industry. As such, reporting is likely to diverge across the industry and we expect regulatory guidance in this area to evolve further during 2018.

Advisers should consider how they will report costs and charges associated with the products they provide. We are available to discuss the methods we plan to use to provide information on ex-ante and ex-post costs and charges to clients.

How will the treatment of research costs change?

The regulations governing access to externally-produced research fall under the general heading of ‘Inducements’ under MiFID II. Firms will have to clearly define what they deem ‘research’ to be. This will include determining whether any research received implicitly or explicitly provides investment strategy or substantiated opinion as to the present or future value or price of investment instruments or assets.

Firms that utilise third-party research in the process of providing investment services will have various options as to how to pay for it. We have been able to absorb the costs associated with external research, rather than passing them on to clients; as such, there will be no research costs shown in our costs and charges disclosure document. Adviser firms that utilise paid-for, externally-produced research in undertaking their own investment services will have to decide whether they will absorb the costs associated with it themselves, or whether they will pass them on to clients.

We will not be able to distribute any paid-for research that incorporates implicit or explicit investment recommendations. However, the documentation we provide to advisers, including our Insights publications, market updates and investment lunch presentations, will all fall within the scope of non-monetary benefits.

More information on the treatment of research costs under MiFID II can be found here.

MiFID II FAQ’s for professional advisers

How is the treatment of transaction reporting changing?

One of the key purposes of transaction reporting is to assist in the identification and investigation of market abuse. Under MiFID II, transaction reporting will have to be provided to the FCA for a ‘reportable instrument’. Reportable instruments include any financial instruments or over-the-counter derivatives linked to equity or debt financial instruments that are admitted to trading on a regulated or prescribed market. This includes exchange-traded funds, investment trusts and shares.

Reporting details must include, but are not limited to, transaction details, identification of the underlying client, identification of the transaction decision maker and the executing party.

It should also be noted that securities traded on multi-lateral trading facilities are considered equivalent to those that are exchange traded for the purposes of transaction reporting.

What are Legal Entity Identifiers (LEIs) and who needs them?

Legal Entity Identifiers are unique 20-character, alphanumeric codes. Legal entities and structures, such as trusts, small self-administered schemes, charities and corporates, must obtain an LEI in order to transact after MiFID II’s implementation.

There are various intricacies surrounding which party’s LEI will have to be used during transactions, depending on the documentation in place. For example, if a DFM and professional adviser have an ‘agent as client’ agreement in place, it may mean the LEI used is that of the adviser. However, if the adviser outsources to a DFM which has a separate agreement in place with the underlying client, the LEI used will be that of the underlying client; we hold client agreements with each underlying client and therefore consider our services in this way.

We have offered a service to obtain LEIs on behalf of clients whose assets are held under our custody, providing a cheaper bulk rate that we have negotiated with the London Stock Exchange. Advisers should ensure that LEIs are obtained for relevant client accounts, whether through our service or otherwise.

Any entity or structure that requires a LEI and has not obtained one by 3 January 2018 will not be allowed to undertake any investment transactions until one has been obtained. From this date, not having an LEI could impact the suitability and performance of an entity’s investment portfolio after MiFID II’s implementation.

We will be informing clients and advisers that have not fulfilled their obligations to obtain an LEI of the stance we will take for these accounts in December 2017.

How will the process of client identification change?

We already obtain client identification information as part of our on-boarding process. As a result, there should be not significant impact on advisers or clients.

However, National Insurance Numbers (NINOs), dates of birth and nationality will become a mandatory requirement in the identification of UK nationals. For non-UK nationals, a national identifier or passport number will be needed instead of a NINO. In circumstances where the account owner is under the age of 18, we will require their name, country and date of birth.

Will I have to change any of my documentation?

We expect changes to be required to a number of documents describing our services and responsibilities to clients; for example, we have updated our Terms & Conditions to incorporate descriptions of our depreciation reporting processes. Further detail on how we intend to change our documentation can be found here.

Any updated documentation we issue will only be applicable to Brooks Macdonald. Advisers need to consider their own documentation in light of MiFID II’s changes.

How will product governance change under MiFID II?

There will be significant changes to product governance obligations and a clearer definition between what is required of product manufacturers and product distributors.

In broad terms, firms will have to clearly assess their target market. This will include identifying both the investor type, i.e. retail, professional or eligible counterparty, and also their knowledge and experience, i.e. basic, informed or advanced. There will also be a greater emphasis on capacity for loss within the assessment of a client’s risk tolerance and objectives. Furthermore, advisers will have to consider target market assessments in addition to suitability assessments.

The changes to product distribution will be more relevant for advisers, rather than the changes relating to manufacturing. Firms will have to identify suitable target markets for their products and distributors of those products will need to report to the product manufacturer if they distribute outside of these.

The changes to product governance will ensure that more information will have to be captured and shared between manufacturers and distributors. These requirements could be particularly onerous for firms that offer execution-only or advisory services.

MiFID II FAQ’s for professional advisers

How will suitability assessments change?

In the UK, the Retail Distribution Review’s (RDR) suitability requirements largely meet those of MiFID II. However, there are a few areas where advisers may want to reconsider their approach to suitability assessments.

Under MiFID II, additional suitability obligations will include the application of assessments when making recommendations to hold or sell investments. There will also be enhanced requirements to review and report on suitability on a continuing basis; in this regard, advisers may want to consider the implications of what ‘continuing’ means.

How will product classifications change under MiFID II?

Under MiFID II, all investment products will be defined as either “non-complex” or “complex”. These classifications will determine the conditions under which products can be distributed to different types of clients. Specifically, non-complex products are likely to be available to all types of clients, whereas the distribution of complex products (including all non-UCITS funds) is likely to be more restricted, with appropriateness tests being required, where relevant.

Is there any change regarding appropriateness?

Appropriateness tests are already required and are intended to support firms understanding of each client’s knowledge and experience, thereby enabling them to determine whether a particular complex product is appropriate. These tests are relevant to all complex products, particularly where the transaction is an execution-only order.

Under MiFID II, more products will be deemed as complex; for example, structured products. Therefore, it is likely that appropriateness tests will be required for a larger range of products.

What are the changes to the rules surrounding best execution?

Best execution obligations already exist and firms should already have published their own best execution policies. However, MiFID II will ensure that firms must provide greater disclosure surrounding costs, including information relating to the top five execution venues they use.

Firms that manage investments on a discretionary basis will have to be able to demonstrate that they have achieved best execution for client transactions. Such demonstrations should be easy for certain investments, such as liquid, large-cap equities; however, for illiquid or hard-to-value assets this obligation could present more difficulty.

Advisers who outsource their investment management functions will not be significantly affected by the new best execution rules, although they should ensure that investment firms’ best execution policies are appropriate during their DFM due diligence processes.

What are my responsibilities around telephone recording?

MiFID II will require investment firms to maintain good client records. For example, conversations relating to transactions and client orders will have to be recorded. Firms will have to ensure that they have policies in place regarding record retention. More information surrounding the changes to firms’ record-retention responsibilities can be found here and here. As a DFM, we will be recording all client-related telephone communications by the end of 2017.

What is PRIIPS?

Alongside MiFID II, PRIIPS (Packaged Retail and Insurance-based Investment Products) regulations also become effective on 1 January 2018. The purpose behind PRIIPS is to help investors understand and compare the key features of certain products through the use of Key Information Documents. It applies across the distribution chain, which includes life companies, fund groups, investment platforms, advisers and DFMs. Impacted retail products include, but are not limited to, the following:

• Open ended investment companies• Unregulated collective investment schemes• Investment trusts• Unit linked Insurance Plans• With profits policies • Structured products

Important Information

While the information in this article has been prepared carefully, Brooks Macdonald gives no warranty as to the accuracy or completeness of the

information. For use by Professional Advisers only. The information in this article does not constitute advice or a recommendation and you should

not make any investment decisions on the basis of it. If you invest in currencies other than your own, fluctuations in currency value will mean that the

value of your investment will move independently of the underlying asset.

Brooks Macdonald is a trading name of Brooks Macdonald Group plc used by various companies in the Brooks Macdonald group of companies. Brooks

Macdonald Group plc is registered in England No 4402058. Registered office: 72 Welbeck Street London W1G 0AY.

Brooks Macdonald Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England No 3417519.

Registered office: 72 Welbeck Street London W1G 0AY. Brooks Macdonald Financial Consulting Ltd is authorised and regulated by the Financial

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