Investment companies not automatically considered ‘complex’ under MiFID II

For those who follow the intricacies of regulatory reform, the debate over how closed-ended investment companies might be affected by the introduction of the MiFID II legislation will have seemed very familiar. It mirrors closely the arguments that preceded the introduction of the European Union’s Alternative Investment Fund Managers Directive (AIFMD) five years ago.

Then, as now, many in the investment company sector were deeply concerned that their funds could be the big losers from the regulation. While most open-ended funds were not considered “alternative” by those in the EU responsible for framing the AIFMD, it initially appeared that investment companies would come under the full glare of the regulation, with all the restrictions and intrusion that would entail.

Similarly, until this week, many investment companies have been concerned that they will automatically be considered as “complex” by the MiFID II regulation, which is due to come into full effect in January 2018. That would raise the regulatory bar in the sector – not least by preventing firms providing access to investment companies on an execution-only basis to do so without first looking at investor suitability.

Now, however, the Financial Conduct Authority has taken a more common-sense approach – pledging to assess investment companies against the criteria in the regulation, rather than declaring them complex by default. That’s a victory for the closed-ended fund sector, just as careful and patient lobbying from groups including the Association of Investment Companies mitigated the most potentially damaging impacts of the AIFMD.

This is important. Not so much for the investment company industry itself, though it clearly has a commercial interest in remaining as accessible as possible to a wide audience of investors. Rather it is investors themselves who would be the biggest losers were their access to investment companies suddenly to be curtailed.

This is not to pit investment companies against their open-ended counterparts. Most people on either side of the fence – as well as the adviser community – will concede there should not be an either/or debate here. There will be times when an investment company suits a particular investor’s needs especially well. On other occasions, an open-ended fund may be more suitable.

What we must avoid at all costs, however, is a regulatory system that skews the choice artificially – advisers and investors should be picking funds on their individual merits, rather than because legislation has closed off one avenue or sent them down another.

That, of course, is exactly the state of play we endured for many years in the UK, during the period when open-ended funds were free to make commission payments to advisers but investment companies weren’t. The result of this uneven playing field was that the open-ended fund universe became the default option for too many advisers; investors who might have been much better served by an investment company simply didn’t get the option.

In the end, the regulatory debate has to be about outcomes. How do we ensure investors get access to the best possible advice and the full range of investment products that might be appropriate for their needs? Unfortunately, sometimes, the law of unintended consequences sees regulation that is designed to protect investors do exactly the opposite. Hopefully, though, the FCA’s intervention in the MiFID II discussion will head off that possibility this time.