From the blog: Most rules handed down from Europe are treated with distrust, and the forthcoming markets in financial instruments directive – or MiFID II – legislation is no exception.
Some call it the death knell for competitive banking practices, but the truth is pension funds should actually benefit from what is essentially a consumer protection measure.
Some call it the death knell for competitive banking practices, but the truth is pension funds should actually benefit from what is essentially a consumer protection measure.
Implemented properly, the new rules will result in better retirement outcomes for millions by reducing costs of running investment funds.
Towers Watson analysis shows that for the average UK pension fund, transaction costs can exceed all other costs combined.
While trustees understand this, little is being done to manage these costs even though reductions in dealing commissions can have a significant impact on costs and therefore performance.
MiFID paints a complex picture for local authorities
Local government pension funds could find themselves reclassified as retail investors from 2017 under MiFID, raising questions over schemes’ access to certain investment strategies.
MiFID II will reclassify European local authorities as retail investors; because LGPS funds are not legally segregated from their administering authorities the scheme could also be drawn under the retail umbrella.
The shift from professional to retail investor status could puncture chancellor George Osborne’s plans for asset pooling across the scheme due to the investment restrictions that come with a retail label – most notably around complex structures including infrastructure and private equity.
Typical institutional execution-only commission rates vary; some funds pay 5-6 basis points while others can pay between 8-10bp. The cost of providing the ‘service’ is having a material impact on overall performance.
The present low-return environment magnifies the problem.
If a fund returns 7 per cent, losing 0.5 per cent in frictional costs doesn’t seem too bad. But in a 0.5 per cent world it’s a major problem.
Work by the London Business School has shown that over the lifetime of a pension, reducing charges by just 1 per cent would result in a 38 per cent higher income in retirement for the individual. So costs matter a lot in ensuring adequate retirement provision.
MiFID II will strip away the ability to hide costs
Forced unbundling of corporate access from both research and execution will prove material in helping investment managers reduce what they pay in dealing commission.
In the context of chronic pensions underfunding, the scrutiny on underlying costs and how to reduce them is all the more imperative.
When you add to this the fact that scrapping the requirement to purchase an annuity means the lifespan of the average person’s pension could be more than 50 years, any extra costs compounded over such a long time period will have a massive impact.
The Financial Conduct Authority has estimated that over 30 years, every 1bp improvement in trading costs could represent an additional £37.5bn in client returns.
Now MiFID II doesn’t seem like something to be so afraid of, does it?
Michael Hufton is founder and managing director of ingage IR
