What the Retail Investment Strategy means for MiFID Client Classification
The Retail Investment Strategy is one of the most recent endeavours of the European Commission. Conceived within the broader context of the Capital Markets Union, it comes with the ambitious goal of placing retail investors’ interests at the centre stage of the dynamics related to manufacturing and distribution of financial products.
We discussed already the main pillars of this new strategy of the European Commission. These range from improving cost transparency all the way down to offering value for money, passing by reducing risks of misleading communications and promotion of high-er quality investment advice. The pillars are then implemented via a package of legislative measures mostly consolidated under an Omnibus Directive.
Within the Omnibus Directive, one proposal intends to amend the existing MiFID Client Classification. Where the Retail Investment Strategy seems to want to mainly increase trust in capital markets and protection for retail investors, this proposed amendment of the MiFID Client Classification also bears the potential to assist with achieving other goals within the broader spectrum of the Capital Markets Union. That is granting access to SMEs investments to a larger investor audience, including certain retail investors.
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The Issue with a Dated Approach to Client Profiling
One of the acquis in European law for nearly twenty years now is the distinction between professional and retail clients. That is a cornerstone of the capital markets legislation in Europe. The distinction serves different purposes at different levels. For what concerns MiFID, for instance, it helps with calibrating the need for investor protection, by making sure that additional safeguards are in place only for investors who need them the most. The concept is also applied under AIFMD, which receives the same distinction between professional and retail clients existing at MiFID level. Here it is used to ensure that professional investors by default can access alternative investments, with retail – or certain retail – investors representing an exception to the rule.
The issue of client profiling is much more complex than it seems. Whilst the proposed amendments correctly interpret the need for more variety within the realm of client classification, they fall short in that they do not introduce a different way to classify clients. Society evolved quite dramatically since the original client classification was introduced and continues to evolve very rapidly. Maintaining an either-or approach to client profiling hardly allows for client categorisation to reflect the complexity and variety of the current investing scenario, where different level of knowledge, expertise and risk appetite do exist within one segment of the investor category.
Testament to the notion that a dichotomic approach is no longer sufficient to calibrate investor protection, some more progressive member states in Europe, like Germany and Italy, did introduce new client categories. We are mostly talking about the semi-professional investor category adopted at level of local law in both European domiciles. The newly introduced category shares some elements of the professional investor category but is afforded more protection, mostly like retail investors.
Amending the MiFID Client Classification
Zooming in on the actual amendment proposed to the MiFID client classification, it affects the so-called opt up procedure. That is the process for a retail client to forgo some of the protections afforded to investors of that category in presence of certain criteria ascertained as part of a fitness text carried out by an investment firm.
The proposed amendment to the existing criteria under MiFID II is twofold. On the one hand, the existing requirement of portfolio size for the individual willing to opt up is reduced from EUR 500,000 to EUR 250,000. In addition, the newly reduced threshold is required on average for the previous three years. One more criterion is introduced whereby individuals can also provide proof of recognised training and education to evidence understanding of the relevant transactions as well as the ability to evaluate related risks.
As part of the same proposal, also legal entities will be allowed to opt up in presence of specific thresholds for balance sheet, net turnover and own funds. In these cases, the actual assessment will be carried out on the person within the legal entity in charge of carrying out the actual transactions on behalf of the entity.
Conclusions
The implications of the proposal to amend the MiFID Client Classification are manyfold. For what concerns the fund management angle, this is undoubtedly another step in the right direction in the process of retailisation of private equity and similar strategies. By tweaking the eligibility criteria in the opt-up process, the investable audience gets to expand to include certain specific type of high-net-worth investors, before not necessarily directly reachable by strategies hosted in AIFs. At the same time, this move takes care of harmonising at European level a broader concept of professional investor, thereby reducing the impact of a recent trend, which saw only certain domiciles in Europe having introduced ad-hoc categories of investors to favour their local markets.
For what concerns the method, with the introduction of the criteria related to the proof of education or training on the transactions and the related risks we close the gap a little more with the US. With the advent of digitalisation, it is not hard to imagine that training courses on specific transactions and services could be offered by brokers and intermediaries directly on their platforms, thereby making the opt-up process less cumbersome and more immediate. This said, the current size of the portfolio, even though halved as part of the proposed amendment, will still represent a significant obstacle to the full retailisation of certain strategies for the time being.
Get in touch here with your contacts at Veneziano & Partners to see how we can help with MiFID Client Classification.