Regulatory changes in European financial markets are driving significant shift in ways banks and brokers engage their clients (we refer here to the Asset Manager clients). Some of the changes, particularly around Market Abuse Regulation (MAR) is being brought about to ensure the marketing of financial products (and investment advice) is objective while providing a boost to investor confidence and protection. As a broker-dealer providing investment research and advice – Are you ready for the new regime?
Implementation of MAR has consequences for firms transacting business and providing investment research as a service to their clients. While some may view these regulation induced changes to be Euro-centric and therefore of little consequence elsewhere, we believe the implications could be far-reaching and could be adopted as best practice by many firms, and their internal compliance organization.
In September 2015, the European Securities and Markets Authority (ESMA) published its final report on the draft technical standards under Market Abuse Regulation (MAR). The proposed MAR replaces MAD and communication came into effect in the UK on 3rd July 2016 and is an obligation for firms replaces the 2003 Market Abuse Directive (MAD) that has been in to comply; not merely a place. The move to MAR while not explicitly linked to the various best practice advisory changes being proposed under the MiFID II delegated acts that are expected to come into effect from 1st January 2018 in Europe, there is some move to coincide their impact. MAR is designed to cover a broad range of potential market abuses, including market manipulation, unauthorized disclosure of inside information, suspicious transactions, irregular Directors’ dealings and conflicts of interests. Additionally, it imposes a list of organizational controls and standards that need to be adhered to when making “investment recommendations”. We will look into some of these regulations and more importantly reflect on their impact on the day-to-day client servicing function at a bank or brokerage.
The applicability of MAR is far more widespread (compared to MAD) as it applies to activities across a wider range of trading venues, including multilateral trading facilities (MTFs) and organized trading facilities (OTFs), including instruments that may not be admitted to trading on a regulated market.
While the FCA in the UK does not (or is not obligated) to adopt all things coming out from ESMA, MAR is one piece of regulation that the FCA has endorsed and would like UK firms to comply from the beginning.
ESMA on its part has provided a Clarification Paper that helps to shed more light on the actual workings of MAR and how it will impact daily client engagement practices at firms. The primary areas that MAR would impact are as follows:
In this analyses, we are going to focus on Investment Recommendations and Marketing Soundings activities; bringing out some practical upshots as well as what firms need to do in this space to ensure compliance.
This area is important as it has to do with disclosure provisions. Primary amongst them is the need to have a clear date and time stamp on all recommendations on the basis of when they were completed and first distributed (to clients), as well as disclosure around conflicts and personal holdings. Most reasonably sophisticated banks and brokerages have been maintaining clear records on personal holdings (both long and short positions) and conflicts; however to the extent to which they are in an “auditable” database is really the question.
MAR clearly states that all those involved in the preparation and distribution of investment recommendations have to ensure that the recommendations are objective in their presentation and all involved disclose their interest or conflicts of interests. The latter warrants a compliance disclaimer and disclosure management solution, integrated within the document authoring and workflow approval process to deliver an electronic “audit trail” as well as not add to the tedium in the document publication process.
Additionally what is defined as “investment recommendation” has also been sharpened (or one can say broadened) in its scope. For a long time, firms could put out research on companies (i.e., issuers) that did not carry a rating and call it “Not Rated”. However, in many instances when one read such reports it was clear that there was an implicit recommendation within the text. Such “Not Rated” research reports under the new MAR regime would not be acceptable; as it stands, in our opinion.
We believe changes around MAR compliance have implications for both research creation and delivery technologies as well as the client-servicing CRM platforms in place at most brokers and banks; including the need to train staff on the importance of MAR. While many of the provisions under MAR have been in existence in many other jurisdictions around the world (in some way or form), there is a need to visit them in the context of what is required specifically in the European context. The over-arching scope of MAR (way beyond what was provided for under MAD) is once again something the industry is yet to fully acknowledge and grapple with successfully.
For research coming out from FX (currency) teams, strategists and economists (since most such reports do not have specific recommendations on issuers) there will be some debate and discussion on the compliance controls that need to apply to them; especially when it comes to currency and interest rate calls as well as asset allocation strategies and resulting advice. We believe there will be more work in this space conducted over the course of the next year in order to fully understand and clarify the regulatory requirements and how they can be implemented in practice.
The regulations prior to MAR were largely directives (therefore called MAD), however, with the advent of MAR the industry is now been asked to comply in a far stricter sense (as its regulation now) as well as MAR has broadened its reach beyond MAD. MAR has been extended to include less standardized sales recommendations (and commentaries), that includes relative value plays between different instruments. Such sales commentary coming under MAR compliance has vastly increased the disclosure and compliance burden on the investment advisor/broker.
The very nature of the compliance requirements even on the sales team level means firms will dissuade sales professionals from swaying away from the “firm view” and not provide their “personal take” to their clients; and whatever is provider is in a form that is auditable and retrievable form in the event of a regulatory scrutiny or dispute.
One could argue that this may take down the quality of the client engagement experience, by removing the “human connect quotient” and making it somewhat robotic in its engagement. We believe some of these nuances may evolve over time, but one cannot ignore the fact that there is a greater compliance burden on service providers engaging in investment advice. Although MAR has been somewhat vague and ambiguous in this area as to whether such deviations need to be captured separately and documented within the organization; we believe this is an area that requires careful attention to avoid potential non-compliance fines in future.
In every bank, brokerage firm and/or independent research organization the research product and associated investment recommendation is produced by the research team and it is the “job” of the sales team to market that research (“idea”) to the client base. However, for those of us who have spent years in the trenches (in the business) we are all familiar with various instances where the salesperson does not wholly or partially agrees with the recommendation and provides his/her own “perspective” to the client. Such deviations from the “house view” or varied perspective now have to be captured separately to comply with MAR requirements.
MAR clearly identifies two classes of professionals involved in the investment recommendation value chain within a bank or broker-dealer:
A Qualified Person is defined as any independent analyst, investment firm, credit institution, and any other person whose main business is to provide investment advice (or recommendations or investment strategy).
An Expert is defined as a person who repeatedly proposes investment decisions or provides investment advice, in a professional (investor advisor) capacity; and presents himself or herself as having the requisite financial markets knowledge to offer such advice.
Taking the above into the context of an investment bank or broker-dealer firm, one could require under MAR to capture any deviation from the “house view” in the investment advisory “client interaction” stage and the salesperson (or Investment Advisor or Expert) making it explicitly clear to the client (or recipient of the investment advice) that this is a divergence from the “house view”. Such communication to the client base, we believe, needs to be explicit and needs to be tagged as “Expert Recommendation” within the firm; for easy storage and possible regulatory review.
In the event of any recommendation provided over the phone to a client, ESMA has not been entirely clear on how it needs to be reported (in the event of a divergence from the “house view”). I believe it would require some level of individual training and requirement to follow up with an email that captures in explicit terms the “advice” offered over the phone and marking any divergence from “house view” appropriately.
For those of you who are unfamiliar with this terminology “market sounding”, it relates to the activity generally conducted by the Equity Capital Markets (ECM) and Debt Capital Markets (DCM) teams within a bank or a broker-dealer (referred to under MAR as Disclosing Market Participant “DMP”) that are involved with placing secondary or primary offerings (or transact in off-market large orders/transactions in specific instruments or issuers; (referred to under MAR to Market Sounding Beneficiary “MSB”).
MAR defines Market Sounding as “communication of information prior to the announcement of a transaction in order to gauge the level of interest of potential investors in a possible transaction and the conditions relating to it.” While ECM and DCM activities within a bank or a broker-dealer are not “illegal” by their nature, MAR does provide for safe-harbor rules that subject to certain conditions and parameters being fulfilled such “market sounding” events are perfectly admissible. Under MAR, the record-keeping and audit-trailing of all such activities have now become mandatory.
We believe since safe-harbor rules would apply to such DMPs and MSBs, during the course of activities leading to securing “feedback” on a potential transaction opportunity. Such “Market Sounding” communication or feedback activity will need to be captured appropriately as part of any CRM platform, in order to ensure any subsequent audit provides the necessary compliance trail. When the discussion moves beyond merely “interest feedback”, but now the conversation is around concluding the transaction, the latter will not be captured within the safe-harbor rule and will be seen as an “over the wall” capital markets activity and outside of the institutional investor investment advisory business.
While MiFID II and the discussion around the use of commissions to pay for research and research related services stole the limelight, there are significant internal compliance and client servicing strictures around MAR that requires careful consideration at most banks and broker-dealers. We believe MAR and its applicability is not be taken lightly, as it has implications within the research creation and authoring value-chain as well as the sales & trading led client service organization.
We believe many of the impact points and their assessment around MAR will work itself through over the course of 2017, we believe using technology and “smart” software will go a long way to address MAR requirements and it’s compliance within the investment research and client servicing organization at a bank or broker-dealer.
