This article is one of a three-part series.
As asset managers prepare for the January 2018 implementation of MiFID II investor protection rules, S&P Global Market Intelligence investigates the impact on firms in Europe and beyond.
Click here to read about the implications for U.K. fund managers, and here for how Asian firms will be affected.
German asset managers are less prepared than their British counterparts for the implementation of the new MiFID II regulatory requirements, which will involve greater changes for them than for British managers but may turn out to benefit the growth of German exchange-traded funds (ETFs) in a presently fragmented continental market.
MiFID II — the second Markets in Financial Instruments Directive, which will require greater transparency from European asset managers and make it harder for them to accept third-party "inducements" that relate to the provision of services to clients — will replace an earlier 2004 directive in January 2018, a year later than planned. In light of Brexit, some managers may be hoping for a second reprieve, according to Joe Vittoria, CEO of Mirabella Financial Services, a regulatory hosting firm that works closely with asset managers. But such a delay "isn't going to happen," he told S&P Global Market Intelligence.
Disrupting established distribution models
MiFID II will "significantly impact the investment management industry in Germany," Thomas Bundschuh from BayernInvest — the asset management arm of Bavaria's state bank Bayerische Landesbank, which has €63.8 billion in AUM — said in an interview.
One aspect of MiFID II — prohibiting third-party financial advisors from receiving commissions and other "inducements" for sales of funds — will effectively outlaw a traditional distribution model, which is widespread in Germany. Insulated against this prohibition — and therefore comparative beneficiaries — are Germany's five largest fund managers, which represent 70% of the domestic market. That is because they are owned by banks and insurers and distribute retail funds through high-street bank branches.
Smaller firms will, however, be exposed to consolidation pressures of a similar scale to those seen in the U.K. after the Financial Conduct Authority's Retail Distribution Review (RDR) in 2012 introduced a similar ban. And "small but active secondary marketplaces" for funds provided on the Hamburg and Hannover stock exchanges "may be unintended casualties of MiFID II," said a Deloitte report in 2016, as participants struggle to meet the regulation's rules requiring a thorough understanding of the product as well as information-sharing with consumers.
"[The new regulations] will require fund distributors to identify target markets, ensure that funds are compatible with those markets and carry out regular reviews," notes Bundschuh.
"The sector is still dominated by banks like Deutsche Bank AG and insurers like Allianz Group, but there is still a very large number of small players that we expect will consolidate in the coming years," Moody's Vice President Marina Cremonese said in an interview with S&P Global Market Intelligence.
She added that further regulation after MiFID II is likely and that this will intensify consolidation pressures on smaller German managers. "We don't think the regulatory pressure will come down any time soon — it's still going up for asset managers, and we haven't reached the peak yet," she said.
Good news for German ETFs
Cremonese also believes that by increasing costs, regulation is helping drive the increasing shift from active to passive funds, with German asset managers hoping that MiFID II will increase the attractiveness of their own passive products, such as ETFs.
"ETF liquidity in Europe has always been very fragmented because products list on multiple exchanges, each with their own set of reporting requirements," Manooj Mistry, Deutsche Asset Management's head of EMEA passive investment, told S&P Global Market Intelligence.
For example, Deutsche's Eurostoxx 50 UCITS ETF, worth £4 billion, is chiefly traded on the Deutsche Börse and Borsa Italiana, but on another five exchanges, too, he said.
"We're hopeful that MiFID II will create a consistent framework with consistent tickers to report both on- and off-exchange trades, which would add to the perception of better liquidity," he added.
ETFs were excluded from the original Markets in Financial Instruments Directive. But under MiFID II, they will be subject to after-trading reporting requirements, and greater transparency about the amount of liquidity in ETFs will be beneficial to luring investors, according to Mistry.
MiFID II's new transparency requirements also arrive at a time when German asset managers face a growing domestic push for greater transparency both with regard to fees and in identifying so-called passive-trackers.
Following the European Securities and Markets Authority's February 2016 report on these funds — which make up 15% of actively managed funds and charge actively managed fees, though in practice they closely track a benchmark — German regulator Bafin said it would bring in transparency regulations in mid-2017 under which these "closet trackers" would have to declare themselves publicly and state the benchmark they track.
Since 2000, German asset managers' administrative costs have shrunk by 75% through digitization and greater economies of scale, but managers have not passed these savings on to investors, Uwe Rieken, managing director of Germany's Faros Cost Advisory, said at a press conference in Frankfurt on Jan. 27, pointing to Dutch and Swiss cost transparency regulation that Germany could adopt. The cost quota for Dutch pension funds is 20% lower than the cost quota for German ones, Frank Vogel from Germany's KAS Bank said at the same press conference.
And so MiFID II, while posing grave and largely postponed implementation costs for German asset managers, may in the end benefit them by aiding the liquidity of ETFs and addressing domestic pressures for transparency in fund management.