The ongoing situation is also responsible for re-triggering one of MiFID II’s much loved rules; the 10% drop reporting requirement.
This rule captures MiFID II investments being managed on a discretionary basis (defined as the service of portfolio management). This impacts advisers with discretionary permissions as well as those advisers who use discretionary investment managers (DIM) for bespoke mandates and DIM model portfolios on platforms. The rule doesn’t apply to advisers managing their clients’ investments on an advisory basis
What's the 10% drop rule?
Clients need to be notified by the end of the business day where the overall value of a portfolio has dropped by 10% or more over a reporting period (usually quarterly,) as well as any subsequent falls of 10% over the period. Bearing in mind that most UK-domiciled funds are priced at midday - that leaves a very narrow window to identify, prepare and make sure the client receives the notification by the end of the business day.
It's worth noting that since March 2020, when global lockdowns started as a result of Covid-19, the Financial Conduct Authority has adopted temporary measures for this requirement. So for example, the requirement to issue subsequent notifications within the same reporting window has been dropped as long as the client received an initial notification for the first fall. These temporary measures have been extended to the end of 2022 to sync with the findings from the Regulator’s Wholesale Markets Review (WMR).
However, the current uncertainty and volatility is thrusting the complex practicalities of this requirement back into the limelight and is asking serious questions of advisers’ processes.
What does this mean for advisers?
COBS 16A.4.3 states that the discretionary manager should communicate any 10% falls to the client but in reality, the issue regarding roles and responsibilities is going to come down to the fine print in the terms of business between the adviser firm and the DIM.
If there’s a direct agreement in place between the DIM and the client, that’s not really much of an issue as the DIM will have the client contact details and communicate any 10% falls. It’s pretty clear-cut that advisers with discretionary permissions will need to notify their clients too. However, the lines are blurred where an adviser uses a DIM model portfolio.
The ‘agent as client’ agreement is most likely to be used in this arrangement where the DIM effectively treats the adviser as the client. The DIM doesn’t know who the adviser’s clients are so has no client contact details and, in this instance, the responsibility to communicate the drop would fall on the adviser’s shoulders. A lot of advisers will be reliant on their platform to help them in this situation but there's no regulatory requirement for platforms to do anything.
Most platforms do have some form of mechanism in place for reporting but unless there’s a robust process in place to monitor and communicate 10% falls, this is going to be creating some significant headaches for some advisers. Even identifying a 10% drop at portfolio level isn't an easy task particularly where clients’ assets are split over multiple platforms. Manual calculations may well be required which makes this a thorny issue and offers more questions than answers.
There’s no doubt that more robust processes have been put in place to deal with these issues over the last couple of years. However, this period of heightened volatility serves as a reminder of this issue and the FCA’s temporary measure, as well as a trigger to think about the wider guidance and advice given to clients against this turbulent backdrop.
Above all, I remain deeply concerned by the events unfolding in Ukraine. In terms of the 10% drop rule, I’m still not its biggest fan. I understand and respect the logic behind why it was introduced to improve transparency, but I think it compounds a lot of unnecessary issues for advisers. Why not send clients a letter when portfolios have gone up by 10% or more?
I do support the temporary measures that the FCA has implemented over the last couple of years, but would like to see some clarity as to what we can expect going forward. The conclusions of the WMR may just indicate whether this rule is going to be further amended or scrapped altogether.
In the meantime, it’s vital that advisers using discretionary investments are clear about where the responsibility lies for communicating the falls and ensure that a robust process is in place.