It’s also responsible for 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.
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.
This all played out in Q4 2018 when concerns over global trade and slowing economic growth led to falls of more than 10% in equity markets. 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 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 is no regulatory requirement for platforms to do anything.
Most platforms now 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 is not an easy task particularly where clients’ assets are split over multiple platforms. Manual calculations may well be required which makes this a really thorny issue and offers more questions than answers.
Personally, I’m not a huge fan of this rule. 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. Do clients really need to be told that their portfolio has dropped by 10% or more right now in the midst of a global pandemic? Why not send them a letter when portfolios have gone up by 10% or more? I definitely support the PFS’ view that the FCA should relax this specific rule during this period of great uncertainty.
There’s no getting away from the fact that we’re currently experiencing extreme day to day price volatility. This means that customer experience in the same portfolio can diverge considerably depending on individual rebalancing profile. It’s vital, therefore, 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.