The Risk of Regulatory Arbitrage______

Rob Swan, Managing Director and Head of Data Services

Fund manufacturers and distributors have repeatedly complained that regulatory arbitrage undermines their ability to attain compliance and complicates their internal processes. It can add costs and confusion, and MiFID II is no exception to this.

Regulatory arbitrage is a challenge that affects nearly every EU directive. AIFMD and UCITS V are just two examples of directives where EU member states have implemented their own nuances and requirements, adding complexity to the compliance process. MiFID II is likely to fall into this trap as well.

A failure to ensure harmonised standards around MiFID II will inevitably lead to inconsistencies across different jurisdictions. This means managers distributing across the EU will need to be mindful of the individual rules on product governance across each member state. This will likely mean firms will have to liaise with legal counsel or local area experts at considerable expense at a time when margins have faced pressures.

As such, 33 per-cent of respondents told Calastone that harmonisation of MiFID II obligations across the EU was important while 37% confirmed it was desirable. The product governance provisions could be particularly vulnerable to multiple interpretations across the EU. Product governance is a regulatory reaction to product mis-selling.  It is designed to put the onus on the fund manufacturer as well as distributor to ensure the target market is suitable for the fund product in question.

The UK – through its 2012 Retail Distribution Review (RDR) – and Holland have already implemented their own rules ahead of MiFID II on product governance. Jurisdictions such as Germany, France and Italy have taken a tough approach towards implementing other EU directives and they could adopt a similarly robust stance on product governance with heightened requirements over and beyond the original MiFID II text.

This uncertainty and potential for arbitrage is leading to industry-wide confusion and hesitation around implementing a meaningful product governance strategy. The Calastone survey found more than three quarters of respondents are awaiting final clarification from regulators or industry-wide agreements before proceeding with a MiFID II strategy on product governance. A handful (15%) have adopted their own standards on product governance although this carries obvious risks if regulators pursue a different path to the one which the aforementioned financial institutions have adopted.

Whether or not industry and EU-wide consensus is achieved on MiFID II product governance provisions is an open question. Some experts in the industry are confident that the reformist agenda currently underway at the European Commission could spell good news. The Capital Markets Union’s (CMU) core objective is to facilitate more non-bank lending into the real economy, but it also seeks to harmonise and streamline regulations across the EU where impediments may be hurting financial institutions.

A consultation exercise has already been launched on distribution challenges faced by managers running AIFMs or UCITS. Should discrepancies or divergences become evident in MiFID II product governance provisions (or other requirements for that matter), regulators may consult with the industry on a possible streamlining of the rules. As MiFID II has yet to be implemented, any consultation will likely be several years away.

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