Banks and asset managers exposed to class action lawsuits
L'AGEFI: Tuesday, October 3rd 2017
MIFID II. New regulations go beyond compliance checks when investing in a financial product. They aim to protect the investor against any event that could influence risk.
The European regulator wants to impose on financial intermediaries a new approach in customer relations. Financial advice that focuses on investor protection, rather than the ad hoc sale of a financial product, is not just a trend that is growing in the industry.
The MiFID II guidelines reveal that this transition is simply required as soon as they come into effect in early 2018. The risk profile of the client must remain consistent with the risk profile of the financial product throughout the relationship with his advisor. But financial intermediaries often remain in the old logic, focused on compliance when investing in a product. By doing so, they misunderstand the purpose of the guidelines, which is to protect the investor.
Their lack of preparation for this new rationale also exposes them to considerable risk. Investors seeking to pursue the intermediary in court after suffering losses could easily win their case.
Because it is up to the financial intermediary to produce the documentation proving compliance with the MiFID II provisions, just as it is not the advice given to the customer that is at the origin of the losses suffered. The reversal of the burden of proof remains on a European scale. The collective complaints already possible under MiFID I only provide a taste of the much greater complexity that lies ahead with MiFID II.
The change of approach is no small task. The primary objective of MiFID II is to protect investors against any event that could potentially lead to losses. This is the definition of risk under MiFID II. In this spirit, about 500 very complex requirements have been developed in the chapter on investor protection. This is not to say that it is impossible for investors to lose money when markets are down. If they want that guarantee, they should simply not buy financial products. What is certain, however, is that in the event of losses, investors will seek legal advice, especially when they are under a regime they trust to protect them. Synthetic Risk Indicators (RISs) for insurance-based retail investment products (PRIIPs), for example, include only three product categories (out of 12) and do not meet the product governance requirements of MiFID II.
The philosophy of this set of guidelines is well in line with the approach of many investors. "Whatever you do with my money, I just do not want to lose it" is the attitude of 95% of customers. The challenge of discussions with the client is to find a balance between (potential) risk factors. The permanent agreement between product and customer risk profiles also implies that many other requirements must be taken into account, such as correct communication and information, the limitation of conflicts of interest, and the optimization of products. The immense complexity makes the situation extremely sensitive.
The idea behind MiFID II is to restore confidence in the capital markets. Otherwise, the economies, very dependent on the financial markets for their development, will collapse. It starts with the protection of private investors, as provided by the legislator. The European Parliament, the European Commission and ESMA (the equivalent of Finma at European level) all share the same vision with regard to the MiFID II objectives. Often seen as the last round of regulation, MiFID II is a priori favorable to the world of finance. The question is whether the banks and the other financial intermediaries are really determined to bring out the best of MiFID II, rather than just think of it as a new exercise of tick the boxe - which may cost them dearly. Launching very boring, hyper-safe products in order to limit the risk of customer loss and thus lessen the impact of MiFID II, reflects the desire to do only the bare minimum, and is totally contrary to the spirit of this directive. It is an open architecture, a dynamic environment. And not reactions like taking a customer out of a product as soon as it records losses greater than 5%.
Remember that financial intermediaries need to evaluate several factors that are decisive for determining whether a product is suitable for a client's risk profile. If this is no longer the case, they must notify the customer. These factors do not include only price or volatility. Liquidity, events that may affect the characteristics of a product, the type of a product, the deterioration of the market environment, the crossing of a threshold, solvency / counterparty risk, as well as the complexity of a product must also be re-evaluated.
The very clear and precise vision of the authorities is to make capital markets affordable again for everyone. But the complexity of the market volatility guidelines makes this part of MiFID II very difficult to put in place. Yet solutions for its implementation exist.