The forthcoming entry into force across the European Union (EU) of the Markets in Financial Instruments Directive, aka MiFID II, will bring significant changes in the whole financial services industry. It will impact at a strategic level on the ways that the sector’s firms interact with customers, on the business choices and the governance models and – at an operational stage – will require significant interventions on processes and technology.
The complexity of such a context sets a new challenge, when compliance has to deal with the digital transformation that firms have undertaken. The question arises of whether it is it possible to comply with regulatory requirements by exploiting, at the same time, the opportunity offered by the digitisation of advisory services and investment management.
Several interesting findings emerged from a survey, entitled ‘Digital Engagement and Collaboration in Wealth and Investment Management’, that Objectway conducted in partnership with the European Financial Management Association (Efma).
The study involved more than 2,000 financial institutions in 27 countries. On average, the institutions surveyed reported that each advisor serves around 350 affluent clients, while the comparative figure for the top income bracket high net worth (HNW) clients is around 100 clients per advisor.
Based on this data, for the sole creation of investment proposals each bank should perform hundreds of thousands suitability checks a year. Any proposal containing all the appropriate customised suitability checks, should be sent to the customer for acceptance before the investment recommendations can be executed. Moreover, periodic reviews of portfolios’ adequacy and portfolio rebalancing will need to be carried out in order to keep them compliant.
This process needs also to be fully integrated into a rapidly evolving service model; 71% of respondents who participated in the survey stated that the winning approach to advisory and investment services will be hybrid – integrating human and digital resources. Within the next two years, the use of hybrid advisory tools for investment management will increase by 37% overall.
This represents a remarkable change and a business opportunity that cannot be fully exploited without equipping with the right instruments, such as an advanced and scalable suitability engine, integrated into a digital business model, which can automatically handle a significant number of checks per day to ensure continuous compliance with regulatory requirements.
MiFID II’s impact on the organisation
Compliance with MiFID II involves several areas of each European firm operating in the financial services sector, with impacts on both management and business processes.
When implementing the regulatory updates, including the product governance, the advisory desk managing the advisory model and the products offered to customers will need a simply configurable suitability engine that can be easily integrated into the information system supporting the new service model.
The compliance team will be involved in setting rules to ensure investor protection, as well as the risk management function will support the definition of risk limits and their monitoring, together with the portfolios’ composition.
An engine for centralised compliance management
Various software developers have responded to the compliance challenges that MiFID places on firms, with Objectway creating a Suitability Rules Based Engine abbreviated to SURE.
SURE processes the information on the customer’s investment objectives, on his/her balance sheet, the level of financial knowledge together with the list of orders and the entire portfolio of instruments owned for assessing the consistency between the proposed investment and the investor profile.
The engine performs checks to verify the knowledge of the proposed financial products, the experience in financial instruments, the financial situation, the risk tolerance and investment horizon, including credit and liquidity risk. All those actively involved in the continuous suitability process are thus provided with a tool to run fast and automated controls.
The underlying engine is based on a multivariate rules system, which may be customised to reflect the distribution model, the type of service and the products offered. Each financial institution can decide which rules enable and which group of financial instruments or risk factors use to set each rule.
By integrating into the entire wealth management process, during the customer acquisition phase SURE supports the appropriate attribution of the risk profile. In the phase of portfolio management, the engine constantly monitors real-time suitability and provides useful information to the financial institution for rebalancing the portfolio, thus powering a constant virtuous cycle as outlined below in Figure 1.
Figure 1: The wealth management process
Thanks to the quantitative approach and to the automation of controls, banks can therefore focus on their core business, achieving the reduction of reputational and legal risk, compliance in case of external audits and the ability to develop business strategies based on their clients’ risk profiles.
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