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  • In 2018 MiFID II brought a raft of new measures designed to protect investors following the aftershocks of the 2008 financial crisis. But it’s only now, three years after it was introduced and in the face of some of the most significant market volatility in living memory, that cracks are becoming apparent.  

    The market instability of the last few weeks driven by Covid-19 has seen one particular requirement of MiFID II brought firmly to the fore. Namely, the need to issue letters to investors if their portfolio dips more than 10% since their last report.

    In recent days there have been calls for the FCA to offer guidance on how wealth managers should be dealing with regulatory obligations in the wake of unprecedented global uncertainty. As firms across the country are dealing with meeting Government requirements, and adjusting to new working patterns, 10% drop letters present an onerous and time-consuming administrative task. Aside from the fact that some firms haven’t got automated systems in place, there are logistical questions which could not have possibly been anticipated. For example, what if a wealth manager doesn’t have the ability to send physical letters (if that’s what the client has requested) from home?

    But aside from the unique situation that the world is currently facing, there are wider questions about the effectiveness of this particular measure. The majority of investors are much savvier than the FCA seemingly gives them credit for, understanding that their portfolio will fluctuate. This could be taken as a reflection of how wealth managers are successfully educating clients about the inherent risks that can be associated with an investment portfolio.

    Arguably, if an investor has been deemed suitable for a portfolio with a proportion of risk assets then they shouldn’t be rattled by a 10% drop. Investors will almost certainly be following the news and will be well aware of market drops significant enough to affect their portfolio, surely a letter is stating the obvious? Indeed, we have heard anecdotally from wealth managers that end investors are just ignoring these communications. If this is the case, then it begs the question as to why so much time is being spent on them in the first place, time that could be better spent servicing clients?

    There is also a question as to whether this particular part of MiFID II is driving the right behaviour from the investors it was created to protect. It seems that a letter of this nature might panic a less well-informed investor and drive them to change their investments to a lower risk strategy or take their money out altogether. But this is not always the correct course of action, and if a long-term investor takes their money out every time the market drops, then they will not reap the benefit of recovery further down the line.

    The market drop of the past few weeks has served as a monumental wakeup call as to the practicalities and necessity of 10% drop letters, one that the industry is calling for the regulator to address. Covid-19 has provided the first stress test of this particular measure and exposed other flaws in its wake. When the dust settles, questions should be asked about the behaviour this regulation has triggered and whether this has resulted in better outcomes for consumers.