MiFID II also impacts investment firms outside of Europe

18 May 2017 Consultancy.uk

Ricardo Cruz, Senior Consultant at Delta Capita, explores the effects MiFID II will have on the business landscape outside of Europe.

With less than nine months to go, European investment firms are, unsurprisingly, frantically preparing for the major overhaul that is MiFID II. In the meantime, outside Europe, some are still trying to understand what it all means and certain firms believe the rules simply do not apply to them. With this in mind, who outside the EU needs to be concerned by MiFID II and what exactly do they need to get their heads around?

MiFID II’s impact outside the EU

Firms incorporated outside the EU may be impacted by MiFID II in two ways. Directly and explicitly by provisions such as those governing the establishment of branches to serve retail clients, or indirectly, from obligations that on the surface appear to apply only to European firms or subsidiaries. And it is exactly this type of indirect effect that is the hardest to pin down – particularly as it is not explicitly written in the regulation and must be inferred from the obligations of European firms.

Consider the first following scenario – a US broker executing orders on behalf of an EU based asset manager. In this case, several obligations of the European firm will have an indirect impact on the U.S broker. For example, the trading obligation for shares may limit the broker’s ability to cross client orders off-exchange. This is due to the fact that the EU asset manager needs to ensure that trades on listed securities, with some exemptions, are executed in a regulated market, MTF, systematic internaliser or an equivalent third country venue. On top of this, the EU asset manager is also likely to demand an execution policy from its US broker that is aligned with the revised MiFID II best execution requirements, as well as the separation of research and execution payments.

MiFID II also impacts investment firms outside of Europe

Away from the U.S, another example could involve a South African custodian bank holding client funds on behalf of an EU investment firm. One of the broad aims of MiFID II is to protect the end investor. As a result, European investment firms are required to perform much stricter due-diligence on third-parties used to hold client assets. Crucially, the rules restrict the options of European firms to jurisdictions where “the safekeeping of financial instruments for the account of another person is subject to specific regulation and supervision”. The European investment firm in question will not only require additional information from its South African custodian, but also carry out regular reviews of its third-party relationships.

A third situation could be an Asian asset manager executing orders through an EU based broker. In order to comply with transaction reporting obligations under MiFID II, the European broker would require the Asian asset manager to have a Legal Entity Identifier (LEI), otherwise it will be unable to execute its orders. While the LEI may be irrelevant in the context of this asset manager’s regional operations, it will suddenly become a pre-requisite to deal with its existing EU brokers.

European origins, global impact

No investment firm, regardless of where it is incorporated, can afford to ignore the global effect of MiFID II. Each firm will need to assess its business model and the services it provides with respect to European, firms against MiFID II. All this before identifying the process, technology or indeed enterprise changes which in some cases may require restructuring or shutting down unprofitable business lines. The origins of MiFID II may be in Europe, but the impact is truly global. And with the clock ticking, it is time for financial institutions with operations across the world take notice.

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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.