Inducements Under MiFID II
MiFID, the Markets in Financial Instruments Directive, is a fundamental part of the financial law in the European Union. It sets out standards for investment services and activities across the EU, although its influence stretches beyond European borders. Last year’s update to the directive, the Markets in Financial Instruments Directive II (or MiFID II) significantly overhauled existing requirements of financial firms and marked a change in how firms communicate and report on their activities.
The new directive, featuring more than 1.4m paragraphs of rules, is designed to strengthen the protection of investors and improve market confidence, after a steady 10-year increase in suspected market abuse. Amongst the most notable changes for firms are the updated requirements around conflicts of interest, commission and inducements under MiFID II. Inducements (namely a fee, commission or non-monetary benefit) have long been considered problematic in the industry, with financial arrangements between product providers and investment firms potentially incentivising firms to promote a specific product to their clients.
Conflicts of interest and inducements under MiFID I
For MiFID I, firms were required to adhere to the following requirements around conflicts of interest and inducements:
- Identify and manage conflicts of interest that may arise in business
- Where conflicts of interests cannot be adequately managed, to disclose the nature and details of the conflict to clients, before any business is conducted.
- Carefully consider the payment of fees or commissions (or other non-monetary benefits) between firms and advisory firms to ensure they aren’t an inducement (and therefore don’t create conflicts of interest)
- Assess any payments to ensure they help the firm to act in the best interests of the client and that they improve the service the firm is able to provide to the client.
Firms were also required to conduct ongoing research into the conflicts that firms face, and put together policies to set out how these conflicts can be managed. In order for clients to make an informed decision on a service, any conflict of interest disclosures needed to be made in a durable medium and include sufficient detail.
How have the FCA and MiFID II impacted your firm with regard to inducements?
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What’s changed for inducements under MiFID II?
While these core requirements remain the same, regulations on inducements under MiFID II have been expanded.
When providing an investment service or ancillary service, an investment firm is only permitted to pay – or be paid – an inducement where the payment:
- Improves the quality of the service to the client
- Does not prevent the investment firm from acting honestly, fairly and professionally, and in the best interests of the clients
All relevant details (namely, the existence, nature and amount of the payment) must be clearly disclosed to the client before the service is provided. If the amount isn’t definitive, the method of calculating the account will also need to be disclosed to the client, in a manner that is comprehensive, accurate and understandable. Where applicable, the firm will also need to keep the client informed on mechanisms for transferring the fee, commission, monetary or non-monetary benefit.
Any payments or benefits (either received or provided by an investment firm) that are essential to the provision of investment services will not be considered inducements, providing they won’t result in a conflict with the firm’s requirement to act in its clients’ best interests. Examples of these payments or benefits include settlement and exchange fees, custody costs and legal fees.
The evidence required for inducements
In order to demonstrate that your firm is actively working towards MiFID II compliance, firms should hold evidence that any inducement it pays or receives is solely designed to improve the quality of service to a client. An inducement should meet the following criteria:
- Be justified. The level of inducements received should be proportionate to the level of improved or additional services a client receives
- Not personally benefit the firm, its shareholders or employees, without there being a substantial benefit for the client
As the rules around inducements under MiFID II state, an inducement shouldn’t be accepted if it leads to a client’s service being biased or distorted.
FCA statement on MiFID II inducements and research https://t.co/udXTFdf127
— Financial Conduct Authority (@TheFCA) October 26, 2017
Preventing conflicts of interest
In order to ensure that firms act in the best interests of their clients, many of the changes to inducements under MiFID II are designed to prevent conflicts of interest from occurring. Previously, advisory firms could portray themselves as being independent, but receive payments from third parties, like product providers.
The following requirements are designed to increase transparency for clients and reduce conflicts of interest, and are relevant to companies intending to provide or receive inducements under MiFID II. Firms need to:
- Act honestly, fairly and professionally, and always in the best interests of their clients
- Actively work to identify and prevent conflicts of interest from occurring, and implement company-wide policies to prevent conflicts of interest affecting their clients
- Price research separately, as opposed to supplying research as part of a bundle of services with no explicit charge
Staff targets and inducements under MiFID II
One of the best ways to approach the changes to inducement rules is to examine any staff performance targets that are currently set. Under MiFID II, firms are required to ensure that they don’t assess staff performance in a way that might encourage employees to give biased advice.
Investment firms will need to make sure there is no system of remuneration or sales targets that might incentivise staff members to recommend a particular option or financial instrument to a client, when something else might actually suit them better.
Firms can also take a close look at how their services or products are packaged, and make certain that they are as transparent as possible. Firms are required to inform clients whether it’s possible to purchase different parts of the package separately and the risks that may come with separating certain aspects. It’s also important to be honest about the costs of each individual service – again, keeping the clients’ best interests in mind.
Handling inducements under MiFID II
In order to comply with MiFID II, investment firms will need to review the existing policies and procedures around how they supply or receive inducements. Ultimately, firms will need to provide clear evidence that they keep the client at the forefront of their decision making, and that employees act honestly, fairly and professionally at all times.
Eflow is the perfect software to help your firm get organised and implement effective organisational procedures. With eflow, secure data storage and retrieval is easy, so you don’t have to worry about the administrative side of MiFID II. Instead, you can focus on driving your business to success in a fast-paced, global market.
To find out more about eflow, MiFID II or the latest rules on inducements, contact eflow Global today.