Wait and see mode risks successful implementation of MiFID II

26 September 2016 Consultancy.uk

The 12 month delay of MiFID II has propelled many financial services organisations into a ‘wait and see’ mode, on the back of continuing uncertainty over key requirements, wider regulatory pressures and project teams which are struggling to maintain momentum. The approach however comes with a considerable risk, warns a new report, as it could leave investment banks, asset managers and private banks not being able to transact for, and with, key clients when MiFID II launches in January 2018.

The Markets in Financial Instruments Directive (MiFID) came into effect in 2007 and has the objective to make European financial markets more transparent and to strengthen the protection of investors. The regulations’ successor, MiFID II, which revises certain rules and regulations for investment firms and trading platforms, was set to be enacted in January 2017, however, after a proposal by the European Commission, the go-live date has been postponed until January 2018.

MiFID II is set to have a significant impact on the operations of players in the financial services space, and in a bid to gain insight in how the industry is shaping up ahead of implementation, PA Consulting Group surveyed 25 major banks – both investment and private banks – and asset managers in the UK. The study finds that nearly all firms (95%) agree that their business strategy will be impacted by the European regulation, yet the majority of respondents are still unclear about the exact impact. Over 30% believe that they are fully aware MiFID II will impact their firm's business strategy and are already taking action. The largest group, over 50%, acknowledge that they foresee an impact, but they are still reviewing what the extent of it will be on their operating models. 

MiFID II impact on business strategy

MiFID II does not serve as distraction from firms' overall non-regulatory strategic objectives, with 84% of respondents saying that none of these types of programmes have been put on hold to focus on compliance with the Directive. Asked for which requirements of the new regulation will have the most impact, respondents highlight transparency, best execution and business conduct. “Pre- and post- trade transparency requirements will clearly be one of the most important aspects of MiFID II,” says David Troman, author of the report, adding “They not only affect implementation in terms of difficulty and cost, but also the market structure and firm operations post-implementation.” Troman highlights that to overcome the challenge, firms will need to ensure robust plans are in place.

MiFID II requirements

In terms of costs, 64% of respondents expect the total estimated cost for adherence to the MiFID II requirements will be up to or less than £9 million. Banks are higher up in their cost estimate – all of the respondents who expect adherence to cost over £20 million (the remaining 26%) work at investment / commercial banks. 75% believe that transparency requirements will be the most costly to comply with, record keeping and best execution also are included in the top four. Transaction reporting too is seen as a costly exercise, however it is not seen as a key impact, according to Troman because third-party solutions are well suited to deal with the matter.

Costs of implementing MiFID II

MiFID II readiness

The twelve month delay of MiFID II has seen postponement creep into project portfolios. Over 60% of surveyed financial services organisations have put parts of their MiFID II programme on hold. These are primarily in the areas of record keeping, transparency (pre- & post- trade) and business conduct. The delay is though not just one of choice – many respondents complain that they have put projects / workstreams on hold as they still are awaiting clarity from the regulators. Surveyed managers in addition note that they have diverted some focus to deliver other compliance-related regulations that have earlier implementation dates, including Market Abuse Regulation (MAR) and Packaged Retail and Insurance-based Investment Products (PRIIPS). 

The changing and uncertain landscape leaves almost 40% of respondents feeling that they may not be ready by the implementation date. “Despite having an additional 12 months to deliver MiFID II, many firms are not confident they will make the implementation date. This is driven by a lack of clarity over the final requirements, other regulatory pressures and a difficult market environment,” comments David Biggin, a financial services regulation expert at PA Consulting.

MiFID II readiness

To avoid jeopardising an on-time delivery, 50% of respondents say that they need the final rules to be in by Q3 2016. Troman cautions that a realistic approach must be taken: “It is unlikely that all of industry’s questions will be answered by the final level two technical standards. Therefore, financial services institutions need to move forward using a set of working assumptions. This will allow progress to be made and plans adjusted as the requirements become clear.”

The run up to implementation will see programme teams ramp up their resourcing. Over 80% of respondents have projected that their MiFID II programme teams are likely to increase by a minimum of up to 20% and a maximum of over 50%, with the largest chunk of up-scaling to commence in Q3 2016. The majority (nearly 40%) of this increase is expected to be achieved using internal resources. However there will still be a significant external demand, with 24% being filled by independent advisers, 21% by contractors and the remainder by consultants of third-party solutions providers. Consultants brought in will mostly focus on IT/Technology and programme management positions, followed by legal and functional roles. Only 5% of MiFID II external hiring will go to strategy consultants. 

How do you think your programme team will scale over the next 12-18 months

IT solutions for MiFID II

From a technology perspective, 78% of respondents say that they are planning to utilise a third-party solution to address (certain) MiFID II requirements. Those that will do so are earmarking transaction reporting, record keeping and best execution as the key areas to be enabled by new technology. In particular reporting leans well for external solutions, says Troman: “reporting requirements can easily be met by using third-party solutions. Utilising these where they are available can often help firms meet requirements in their entirety without significant impact on the firm’s business itself when compared to an in-house approach.”

IT solutions for MiFID II

Reflecting on the study, Troman points out that although many firms are achieving progress, overall the picture raises some concerns across the MiFID II implementation landscape. “60% have yet to adjust their business strategy, 60% have placed part of their programmes on hold and 40% of firms are not confident they will make the implementation date. All this means firms need to take urgent action.”

×

The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.