Risk & Compliance

AFM sets the bar  for MiFID II compliance

In 2013, the AFM started supervising product governance. Five years later, in 2018, it further tightened product governance and distribution requirements for institutions covered by MiFID II legislation. Since then, compliance with MiFID II obligations has been a key focus for the regulator. But few institutions still comply with the rules perfectly, according to a 2020 AFM research report.

Date:January 3, 2021

Shortcomings in cost transparency

In the report, the AFM first emphasises the importance of cost transparency. A clear and complete understanding of the costs of services and relevant financial instruments ensures that customers can make informed decisions. Moreover, clear cost information makes it easier to compare different investment firms.

In its report, the AFM identifies several identified shortcomings in cost transparency. Some of these include not reporting the costs of financial instruments (even if they were zero), the lack of an illustration of the cumulative effect of costs on returns, or reporting costs only in a percentage or an amount – when it is actually mandatory to report both in a percentage and an amount.

Based on MiFID II standards, it is right that the AFM considers these to be deficiencies. The fact that these are services provided to professional investors and ECPs does not detract from this. However, we do not think that these ‘shortcomings’ mean that professional investors and ECPs are not adequately informed about the relevant costs. Often, these clients receive very comprehensive cost statements, just not based on the format prescribed by MiFID II. When monitoring the application and interpretation of the rules, the AFM could, in our opinion, look more at the context and specific services provided to this group of clients.

Product governance rules less stringent for professional investors

Distributors of financial instruments should – in the context of their product governance obligations – ensure proper targeting and a corresponding distribution strategy.

First, the AFM notes that investment firms are sometimes under the impression that the product governance obligations do not apply to them because they would not qualify as a ‘distributor’. This is not correct, according to the AFM. It believes that the distributor concept should be interpreted broadly. The term includes any investment firm that receives and transmits orders, executes orders, performs asset management or provides investment advice.

In addition, the AFM notes that investment firms still sometimes identify the product governance obligations with the suitability or appropriateness test. The AFM values the extra protection that the product governance rules offer against mis-selling, and therefore emphasises that these rules are stand-alone standards that exist alongside the suitability or appropriateness test.

However, the AFM does place a nuance. Investment firms are allowed to apply the proportionality principle, which means the rules do not need to be applied as thoroughly to professional investors and ECPs, compared to non-professional investors. On this point, we fully agree with the AFM. Professional investors, and ECPs in particular, will in most cases already have a lot of knowledge to select products that are suitable for them. There is then no need to comply with the product governance rules as intensively and minutely as when providing services to an inexperienced, non-professional investor.

Strict interpretation of commission rules

In the section on fees, the paragraph on business gifts in particular stands out. The AFM has found that investment firms do not always check whether business gifts qualify as small non-monetary payments (KNGT) or meet the standards of Section 168aa(5) of the Bgfo Wft. According to the AFM, they should, because business gifts are commissions. Investment firms must therefore comply with the commission rules when receiving business gifts.

When investment firms actually start doing this, they will have to start turning down the vast majority of corporate gifts – however small.

While we understand that conflicts of interest must be avoided (and that large corporate gifts are not part of that), we believe that this strict interpretation of the commission rules goes a bit far. If we follow the AFM’s letter to the letter, an investment firm would no longer even be allowed to accept a cheap bottle of wine. After all, a bottle of wine is not on the list of KNGTs, and it is also hard to argue that the bottle enhances the quality of service. But would that bottle of wine really create a conflict of interest?

Our vision

At Projective Group, we support the safeguarding rationale of MiFID II. It is therefore right for the AFM to (1) remind investment firms of the importance of compliance, and (2) clarify the interpretation of rules that were apparently not entirely clear.

At the same time, we believe that the measures taken by organisations  to comply with laws and regulations should actually do something to protect investors. For some of the concerns raised by the AFM, this is the case, but on some points we wonder whether the AFM, with this strict interpretation of the MiFID II rules – and especially in light of the client group of professional investors and ECPs – is not overshooting its goal.

Want to know more?

We are happy to help financial institutions with compliance around product governance. For example, we have prepared an e-paper with tips & tricks for shaping the Product Approval and Review Process (PARP). Want to stay up to date with our publications on financial laws and regulations? Then subscribe to our monthly Risk & Compliance newsletter.