Platforum: Firms taking on discretionary permissions grapple with Mifid II

Miranda Seath

Platforum’s recent research on investment approaches in the adviser market has uncovered that more advice firms reaching a certain scale are evaluating whether to take on discretionary permissions. However, as holders of discretionary permissions get to grips with their additional reporting requirements under Mifid II, will the EU regulation make advice firms think twice about moving up the value chain?

Why are more advice firms looking at taking on discretionary permissions?

Our conversations suggest that once advice firms reach between £250m and £500m in assets under advice, they are increasingly considering whether to adopt discretionary permissions and use in-house expertise to run the money. Our research shows that currently 16 per cent of advisers have discretionary permissions and 11 per cent of firms that don’t have discretionary permissions plan to get them within the next five years.

In Platforum’s recent report Adviser Market: Size & Structure we identify two profiles of adviser firm that we see as compelling models that are likely to survive and prosper: ‘empire builders’ and ‘nurturers’. We see empire builders as firms that that are likely to take on discretionary permissions. They are increasing adviser numbers, clients and assets under management and aim to boost their revenues by driving growth and scale.

Our research shows that the percentage of firms with discretionary permissions starts to increase as the level of assets under management rises. Over half of firms (53 per cent) with £1bn assets under advice hold discretionary permissions.

We see three main drivers for advice firms taking on discretionary permissions:

  • Greater efficiency and control

Some advice firms are fed up with the administrative challenge of having to seek client permissions for investment decisions and are attracted by the greater control to make decisions quickly and efficiently that holding discretionary permissions offers. It is possible to run an efficient investment proposition on an advisory basis, but it requires a high degree of automation and is considerably harder for firms looking for scale. One director of a regional advice firm told us:

“We wanted to get discretionary permissions because of administration, so that we didn’t have to write to clients every time we wanted to make a change. Centralised investment propositions are inefficient … clients don’t return documents and this creates a problem downstream.”

  • Justifying the position of the advice firm in the value chain

The trend towards in-house management suggests to us that advisers are trying to cement the importance of their position in the value chain by retaining an in-house capability. Much depends on the advice firm’s view of its core competencies. But many feel that outsourcing investment wholesale to a third party detracts from their value proposition. As owners of the client relationship understandably many advice firms feel in a strong position to offer in-house discretionary management.

  • Taking a greater share of fees

Taking on discretionary permissions allows advisers to charge an additional asset allocation charge for the discretionary management of client portfolios:

“Some [adviser] companies are bringing in people who do have the expertise and getting a slice of the cake.”

Will Mifid II put the brakes on advice firms taking on discretionary permissions?

Advice firms taking on discretionary permissions must also assess the risk. Not least they need to be very confident that they have the expertise to manage the assets and take on the liability.

However, under Mifid II there will be additional reporting requirements for firms that hold discretionary permissions. If a client’s portfolio is managed on a discretionary basis and the value of the assets drops by 10 per cent or more since the last reporting period – we believe this to be the beginning of the quarter – the discretionary manager will be required to notify the client of the drop within 24 hours. Arguably adviser firms are in a strong position to notify clients as they own the client data but the level of automation required to meet the 24 hour requirement means that many are looking to platforms to support client communication.

Platforms are very clear that the discretionary firm is responsible for compliance. But a number, such as Transact, are building the functionality to support discretionary investment managers make this communication whether the platform supplies the data to the discretionary manager on makes the communication on their behalf.

For advisory firms considering taking on discretionary permissions, it is important to check the position of their platform partners.And for advice firms of a certain scale – likely to be £1bn AUA upwards – buying a DFM might make more sense. As one adviser commented to us:

“Advisory firms with £1bn could just buy a DFM. A number are for sale at a reasonable price.”

By doing this, advice firms acquire a ready-made set of people, processes and importantly, compliance procedures.

We don’t think Mifid II should deter advice firms taking on discretionary permissions where it makes sense for their clients and future business growth but it does make it a more complex decision.

Miranda Seath is head of intermediary research at Platforum