“When providing investment advice or portfolio management the investment firm shall obtain the necessary information regarding the client’s or potential client’s knowledge and experience in the investment field relevant to the specific type of product or service … so as to enable the investment firm to recommend to the client or potential client the investment services and financial instruments that are suitable for him” –MiFID II article 25.2
What you can sell, to who, and how you do it is all going to change under MiFID II, in large part due to the passage quoted above. What a firm can sell to a client has to line up with the client’s ‘knowledge and experience’, as assessed by obtaining the ‘necessary information’. This throws up a number of questions to which we have few answers at this stage of the regulatory process, but we can at least identify and shed some light on some of the issues.
How do you know what they know?
What constitutes the ‘necessary information’ that is referred to in article 25 and, once you have it, how do you use it to classify clients? The answers to these questions depend on the way in which you interpret the word ‘necessary’ and, in areas of such subjectivity, discretion will often be left to the firms, under the guidance of their respective national competent authorities, but we will have to await ESMA’s technical standards before we know for sure. At some point, however, it must become necessary to define what will count as verifiable evidence of client knowledge.
When do you need to know what they know?
Currently, the process of ensuring that a client is suitable is typically part of the onboarding process. In other words, after products have been promoted to prospects. But this could well be set to change, since firms will no longer be able to promote certain products to clients without the suitable ‘knowledge and experience’. It is likely that firms will need to know what a client knows earlier than they currently do.
This could have serious ramifications in terms of how firms market their products, proving to be both expensive and time consuming since it is conceivable that often, after gathering the ‘necessary information’ on clients, they may turn out to be not suitable.
How do you know what they know is suitable?
Once you have solved the problem of working out what a potential client knows, how do you work out what is suitable to sell to them? A lot of work was done during the implementation of MiFID I on the definition of ‘suitable’, but the extent to which firms can now rely on the original meaning is unclear, and will therefore cause just as much confusion and difficultly as the word ‘necessary’. The industry is hoping that ESMA’s technical standards are much more explicit about exactly what this means.
If they are not, this may again come down the discretion of firms or national competent authorities. Obviously, this has the potential to cause firms significant legal risk – without regulatory standards on the matter, suitability checks will always be open to challenge from clients or authorities … or both.
Who is liable for the purchase of complex products?
It is no longer clear where the liability for buying complex products ultimately lies. It appears that the onus is being pushed more and more onto the firms with the ever-growing burden of ensuring that everything is sold to ‘suitable’ individuals. Surely, there must be a point at which the client takes responsibility for choosing to buy a particular product? But where that point is remains unknown.
Are you allowed to store the ‘necessary information’?
Even if they knew exactly what constituted the ‘necessary information’ and firms worked out how and when to get it, whether they could legally store it – especially for the 5 years required under MiFID II – is unclear. Cross jurisdictional data protection laws could cause problems here and, at the very least, force firms to have a number of varying policies to satisfy different regulators.
What about existing clients?
Firms will need to consider all of this, not only when attracting and onboarding new clients, but also when interacting with the old ones. This almost certainly means that all existing customers would essentially require a remediation effort in order to make sure that they comply with the new rules and definitions, potentially involving a complicated process and vast amounts of resources.
Waiting and hoping will not do
These new rules are attempting to prevent the proactive marketing of overly complex products to clients that do not necessarily understand what they are buying. Investor protection and market stability are noble aims but, for this to work, two things stand out. ESMA’s technical standards need to provide clarity on these issues, and firms need to start working out how to manage these problems now. Time flies very quickly when you are implementing.