• MiFID II killed my business

    By B2B Lateral Thinking Solutions

    07-01-2018

    We recently had a few meetings with clients who in short told us that their once legitimate, legal and rather profitable business became redundant with the introduction of new regulation, the Markets in Financial Instruments Directive II (“MiFID II”).

    The business model was simple, working fine for many years and well known to the regulators across the EU. The clients were introducing business to banks, mostly for private banking solutions, and were receiving in return retrocessions (also known as commissions, inducements, kickbacks or rebates) for as long as the business remained with the bank. The payment was usually a fixed percentage of the revenues the bank was earning from the introduced business.

    Of course, everyone is working towards greater transparency and to protect the end-client from hidden costs and/or arrangements, hence MiFID II has been designed, and we all know it will be beneficial to the greater investor community. However, a number of legitimate practises under MiFID I will face extinction in their current model.

    MiFID II, which came into force on 3 January 2018, is very explicit on inducements given by financial institutions to introducers of business. Without going into details, MiFID II prohibits financial institutions from paying or receiving inducements, unless certain conditions apply. These conditions concentrate mainly, but not exclusively, on whether the recipient of such inducements enhances the quality of the service the end-client receives.

    By nature, a pure introduction does not add value, and certainly not on a recurring basis, and as such the clients have been receiving letters from different banks informing them that as of 1 January 2018 no commission will be payable for clients introduced, in line with MiFID II.

    So, how did one of our clients approach this challenge?

    Firstly, he was in denial. He started considering different solutions that would, at least in theory, assist him in maintaining his business in its current format, without losing the retrocessions. He explored setting up offshore solutions, renaming retrocessions to marketing, research or training fees. Through his explorations he understood that MiFID II is watertight and that there are no viable long-term solutions that entail the receipt of inducements.

    The decision had to be bigger and aligned with both the letter and the spirit of the new law. As such, the client followed the below steps in designing a long-lasting solution:

    1. He incorporated a Cyprus company and went through the process of obtaining the necessary licence to operate as a Cyprus Investment Firm, authorised to provide investment services to its clients.
    2. He negotiated with the banks to reduce their fees by the amount of the retrocession he was receiving (or more).
    3. He onboarded his clients to his newly licensed Investment Firm and offered them the reduced fees he already negotiated and agreed with the banks.
    4. He agreed with the clients to charge them an annual fee of up to the amount of their savings (same as the retrocession amount he was receiving before).

    So, what has the client achieved?

    The client has managed to move from a dying model to a viable, robust and long-lasting business solution. Furthermore, through this, he created a platform by which he can better service his clients and explore further revenues from his strong and existing relationships:

    • He can now offer investment services to his clients, getting therefore closer to them and creating the necessary infrastructure for more revenues, e.g. advisory and performance fees.
    • He offers better transparency, with regards to fees, to his clients, which is what MiFID II wants to achieve.
    • He can negotiate the banking fees without having a conflict of interest. When you receive a percentage of the fees you don’t necessarily try to reduce them.
    • He eliminated the risk of being accused of offering investment services (e.g. investment advice) without having the necessary licence.
    • He is now running a licensed financial institution which is prestigious and assists in finding new clients.

    Is this a universal solution?

    Absolutely not. This solution is not only difficult to implement and manage, it is also expensive. It is suitable only to people that have a sizable client base as well as the ambition and commitment of creating an investment firm for servicing their clients.

    Luckily, having a limited scope licence without holding clients’ funds reduces the capital strain as well as the compliance and operational requirements, making it possible for medium size investment firms to be financially viable.

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

B2B Lateral Thinking Solutions

B2B Lateral Thinking Solutions is a boutique consultancy operating from Cyprus and servicing private, corporate and institutional clients. Our team of dedicated, passionate and highly qualified professionals assists numerous clients across the EU, Russia and CIS countries. Lateral thinking is not only a name. Lateral thinking defines how we approach problems and our work ethic. We partner up with our clients to uncover solutions through indirect avenues and by employing creative thinking.

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