Financial services: The 5 main challenges to gain competitive advantage from MiFID 2

The new regulatory configuration in financial services, including MiFID 2, MiFIR, PRIIPs and IDD, requires banks and other financial institutions to re-shape almost all aspects related to investment products and services. Manufacturers, which has benefited from being almost free of specific responsiblities towards final customers, now has been heavily impacted by the new regulatory configuration.

Now that the target is getting closer, we have to carry out a huge effort to be compliant within January 2018.

However, compliance is not enough.

This journey is bringing an increase in compliance costs, that is undoubtedly true, but also a unique chance to re-define the strategic outlook and gain competitive advantage. This is possible only if you focus on your winning horses, in terms of core competencies, best employees, target markets, successful products and services and cutting on your deadwoods. There are at least 5 strategic challenges for banks and financial institutions, to be the future leaders in their respective markets.

1.      Being independent or not

Surely, the first, and more challenging, question to ask yourself. The modern Shakespearean question more than “To be, or not to be” is “Independent, or not independent”.

If you are a UK organisation, please skip to the next question, since you have no choice (with the Retail Distribution Review all UK financial institutions must be independent to offer financial services without restrictions). Alternatively, if you belong to another country, you are asked to make a choice and it is not only related to the way you are going to be paid.

This is surely the most immediate aspect of the choice: being paid for the product sold (inducement based) or for the service offered (fee only). However, this is not the only driver to make your decision.

Starting independent advice will allow you lowering compliance costs, defining more effective budget strategies since your income will be related to your overall AUM, building trust relationship with your customer base, enhancing the quality of the service offered and limiting complaints and lawsuits. If you want to offer independent advice, you must increase the quality of the service related to your client base if you want to be competitive. The client must recognise the quality of the service offered, or you will be forced to lower the price to be competitive. This is not a short-term strategy, since it needs time and investments to change your strategy and let the customer be ready for the change.

Otherwise remain with non-independent advice is surely a better choice in the short term since you do not need to transform your strategies, invest in marketing and communication and prepare your client-base to the new paradigm.

2.      Going digital or stay physical

In all industries, what is called the Fourth Industrial Revolution, is happening. It is introducing emerging technologies as artificial intelligence, robotics and quantum computing. It is inevitable to think that also the financial services industry will adopt these new technologies, but it is difficult to identify exactly how to introduce these paradigms in the strategic configuration of services, products and channels.

The hottest trend in financial services is automation in financial advice. This technology allows advisors and asset managers to focus only on high value added activities by automating standardized activities such as profiling, monitoring, rebalancing, controlling and reporting. There are several ways to combine this technology in investment services, like algorithm-based asset allocation tools, using big data analytics to enhance customer experience and tailor marketing communications and commercial offering, developing artificial intelligence techniques as machine learning and cognifying to do predictive analysis on clients’ needs, groups’ trends, best timing and channel to contact the clients. The choice is not that easy to make, since there are several aspects to consider.

Firstly, you need to have the capabilities in terms of resources and infrastructure to adopt this paradigm. High initial investments are required, while other significant costs will arise from the continuous testing, maintenance and marketing of automated tools.

Your strategic business plan have to be coherent with a long-term digital strategy. Change is not immediate; it requires time, work, resources and a good planning. Look at your customer-base, products, services, stakeholders and try to configure a robust digital strategy.

The last question is “buy or make?” Buy a white-label automated solution is surely the simplest choice. You will have a ready-to-use solution at a determined price, but it is hard to find that product that perfectly fits your strategy.

3.      Active or passive investing

While passive investment strategies are more common by institutional investors, it is relatively new for the individual investors. However, the trend is changing.

The new regulatory background is introducing full transparency in all the cost and charges applied by intermediaries, therefore, the clients will focus more on pricing topics when choosing between alternative products.

Products like Funds and Sicav are actively managed by asset managers with the purpose of beating the linked benchmark, while passively managed instruments like ETFs simply tracks an index to replicates its performance. However, while the latter is typically charged only for its management, actively managed products includes in addition to (higher) management fees, also entry and exit fees.

That being stated, usually the extra performance of active strategies are not enough to assimilate its extra costs.

Many intermediaries, especially those who offers independent advice, already switched their investment strategy from active to passive. On the other side many traditional active asset managers, like UBS, started to manufacture passive investment products to broaden their customer perimeter.

What is your strategy? Active or passive?

4.      Buy or make?

In the new regulatory environment, conducting market-related activities will become more complex. Market-making has been impacted by the introduction of a new type of trading venue (Organized Trading Facilities), the broadening of the Systematic Internaliser perimeter, enhanced pre and post trade transparency, new best execution requirements, new rules for high frequency trading, algotrading and commodities derivatives.

Many intermediaries are going to outsource execution activities to qualified brokers in order to unload best execution activities, entering in a lighter best selection prospective. Also transaction reporting activities are usually outsourced to approved reporting mechanisms (ARMs).

Investment Research is now considered an inducement when bundled in trading commissions. To continue receiving it, intermediaries should budget research and set up payment and evaluation mechanisms to ensure the legitimacy towards client’s interest.

Financial firms uses investment research for building investment strategies referring to equity, debt, currencies, sectors and geography. Since receiving free research from asset managers or brokers is no more permitted, you should rely on your internal capabilities or purchase it from qualified firms.

5.      Human Resources training: comply or invest?

Financial organisations shall ensure that relevant staff in manufacture, selling or providing informations on investment products or services, must possess the necessary knowledge and expertise. ESMA is transferring this task to national competent authorities, since quantifying a standard threshold of these values for the whole market is impossible. The easiest way to do so is requiring periodical training programs plus an approved certification to all the relevant staff.

Organisations can merely comply with this requirements, trying to soften the impact in terms of costs and time, or they can invest on skill and knowledge development to stand out from the crowd and obtain competitive advantages. This last solution can also be adopted to enhance in the client’s eye the perception of the quality of the service offered.

Do you want to invest on HR training or just comply with the new regulatory requirements?

You can tell your positions about the described 5 challenges at the following link