Article by Matthias Busuttil
When trustees are vested with the ownership of assets to be held under trust for the benefit of the beneficiaries identified by the settlor, they are bound by the obligation to perform their duties with prudence, diligence, attention of a bonus pater familias and utmost good faith while avoiding any potential conflict of interest.
In many cases, trust assets would be in the form of financial assets. In these instances, trustees are compelled to perform their obligations by employing an investment manager or an investment adviser who they consider to be competent and possesses the necessary expertise to manage or provide investment advice on the trust property.
The revised Markets in Financial Instruments Directive (MIFID II) which will come into force in January 2018 may potentially provide a partial solution in bridging the gap in the information being provided by the investment manager or adviser to the trustees on their responsibilities with respect to the trust assets. These new requirements may potentially provide an additional layer of comfort to trustees with regards to the manner in which their delegates are performing their duties with respect to the trust.
While MIFID II consists of a broad set of regulations relating to various aspects of investment services, this article is only intended to highlight a few salient features which may be of particular interest for trustees namely on the reporting and disclosure requirements of investment firms to clients. The two elements of the regulation discussed below relate to the two ends of an investment decision process – the selection of an investment and the evaluation of performance.
In this regard, probably the most effective requirement introduced in MIFID II is the reporting of the suitability assessment conducted by the investment firm to the client. In the provision of investment advice, investment firms will now be required to supplement each recommendation with a report that outlines the investment recommendation as well as an explanation on why the advice is suitable for the client and how it is intended to meet the investment objectives and constraints of the client.
Likewise, in the provision of portfolio management services, the regular report provided to the client on the service provided shall contain a description on how the investment strategy meets the objectives, preferences and other relevant characteristics of the client.
This new regulation will require the investment manager to share that rationale of investment decisions with the client on a regular basis. In the case of trusts, trustees will be provided with more detail on an on-going basis on how the assets are being managed with the view of achieving the investment objectives of the trust.
The second important requirement of the new regulation is for investment firms providing a portfolio management service to establish a suitable method of evaluation which will enable the client to assess the performance of the firm. Investors seldom fall in the trap of judging the performance of an investment by just looking at the bottom return figure and give little or no regard to the risks undertaken in the investment and the market context in which the investment is managed.
Benchmarks are probably the most widely adopted tool for evaluating investment performance. However, investors as well as trustees should be careful in selecting a benchmark for their portfolios. An appropriate benchmark for evaluation purposes is one which represents the scope of the investment and features the same risk and return characteristics of the investment. Moreover, to better understand the performance of an investment manager, the comparison of the performance of the investment and the benchmark needs to be supplement by an analysis of the drivers that explain the deviations between the two.
While the new regulations mention the use of a benchmark as a possible method of evaluation and will require investment firms to display the benchmark performance, if one is selected, in their periodic reports to clients, it falls short of requiring investment firms to provide an analysis on the deviations of the investment performance from the benchmark.
One would find that good investment firms would have already adopted most of these practices in some shape or form as a result of the natural progression of their business offering. However, as these practices are adopted by EU member states as regulatory requirements, the minimum acceptable standards of investment firms are automatically raised which will hopefully result in an overall improvement in the level of service of the industry as a whole.
While the MIFID II poses substantially greater reporting obligations on investment firms, the balance between the quantity of information and the interpretability of such information is crucial to achieve a stronger line of communication between investment firms and clients. We believe that through collaboration and design, trustees and investment firms may leverage the new regulation on disclosures to clients to reap the full benefit of the reporting requirements of investment firms.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.