Since 3 January 2018, institutions have been required to supply their clients with a new document providing information on the costs and charges of financial investments pre-trade (ex-ante). This is aimed at ensuring compliance with the European Markets in Financial Instruments Directive II (MiFID II) and the Act implementing it into German law (the Second Act Amending Financial Market Regulations (Zweites Finanzmarktnovellierungsgesetz – 2nd FiMaNoG); see also BaFin expert article from July 2017). These regulations require institutions to inform their clients about all the costs and associated charges related to the investment services and the specific financial instruments they provide.

As the competent supervisory authority for Germany, BaFin monitors the institutions' compliance with the new provisions. At the beginning of 2018, BaFin conducted a market survey on the implementation of MiFID II (see the May 2018 edition of BaFinJournal; only available in German). The feedback the surveyed institutions gave showed that some clients had complained about the cost information provided, when using telephone banking services, for example, as this was read out to them in detail.

But are institutions actually legally required to read this information out? This article provides answers to this question and offers details on other issues that are relevant to consumers while providing an overview of major changes. In particular, it is intended to give consumers a clearer understanding of the purpose of cost transparency, and to show the benefit they can derive from the costs and charges disclosure.

Purpose of the new costs and charges disclosure

Information on the cost of financial instruments is actually nothing new for clients. However, up to now, this information only referred to the “price” and could be found in many different documents, for example, in the product information sheet, the key investor information, the institution’s list of prices and services or the advisory agreement.

(European) legislators wanted to change that. The aim was to make cost information more transparent for clients and, above all, easier to compare by consolidating the cost information in a separate document. Legislators wanted to ensure that clients no longer had to search for all of the necessary information themselves.

Information on costs and charges to be given before services are provided

Institutions are now obliged to inform their clients on all the costs and associated charges when buying or selling a financial instrument. This needs to be done in good time, i.e. before any investment services are provided – including when execution-only orders are placed.

Unlike the statement on suitability, for instance, the law stipulates that this information may not be provided post-sale (ex post). This is aimed at removing surprise costs for clients and enabling them to make financial decisions on an informed basis. To ensure this and to prevent abuse, clients are legally required to receive this information as well.

Durable medium

Institutions are required to provide their clients with information on the costs and charges in a durable medium, i.e. on paper, via email, fax, or by sending it to the client’s electronic inbox with the institution or making it available in a secure area on the investment firm’s website, depending on how the institution provides this information.

In telephone banking, delays may occur if the client does not have internet access or cannot be reached via fax or via an electronic inbox with the institution. In this case, the only way for the institution to make the information available to the client is either by post or in a personal conversation. The current legal requirements do not provide additional leeway for this. Reading the cost information during a telephone conversation – even if this is recorded – does not comply with the regulatory requirements, as a recording cannot be given to the client in good time, for example, before an order is entered into the bank’s system, although this is mandatory. Therefore, there is no legal requirement for institutions to read out the cost information over the phone.

Information must be based on an individual or notional investment amount

Institutions have two options for disclosing the costs and charges to clients. The first option is to disclose the information in relation to the amount that the client wants to invest. This is the option that most institutions use according to the market survey mentioned above.

The other option, which is legally permissible but less convenient for the client, is to disclose the cost information in relation to a notional investment amount, e.g. EUR 10,000. In this case, the client would have to use the rule of proportion to calculate the costs for the actual investment amount themselves.

Information must relate to a specific financial instrument

However, the information must also relate to a specific financial instrument, even if it is given in relation to a notional investment amount. Providing general cost information relating to average values for an asset class, such as real estate funds, shares, bonds or certificates, is not sufficient.

Even if such general information may be useful for clients, it does not meet the applicable legal requirements. In any case, institutions are required to additionally provide their clients with information on the costs of the relevant financial instrument in good time.

Structure of the cost information

Institutions are required to disclose the total costs and charges in aggregated form – both as a monetary amount and as a percentage of the investment amount. These total costs then have to be broken down into service costs, product costs and, if applicable, foreign currency costs. Benefits must always be disclosed separately as part of the service costs. If certain costs do not apply, this must be indicated with a “zero” for the individual figures to be disclosed.

As institutions cannot determine all of the costs and charges when the ex-ante cost information must be provided, reasonable estimations of the costs may be used where necessary. However, they are required to explain this accordingly in the costs and charges disclosure.

Institutions must also provide their clients with an itemised breakdown of the costs upon request. This provides more details than the aggregated information about costs and charges. It includes at least a breakdown into one-off costs and ongoing costs and also provides details on transaction costs and other costs for ancillary services. The latter could be, for example, fees for switching between funds and custody costs.

General costs that are incurred irrespectively of the financial instrument, including, for example, custody fees for the entire securities account, may be specified separately, for instance at the end of the costs and charges disclosure, followed by an explanation.

Impact on the return

For clients, information about the effect of the costs and charges on the return is at least as important as information about the costs themselves. For this reason, the costs and charges disclosure must also illustrate the impact of the costs on the return of the financial instrument concerned, as well as any anticipated spikes or fluctuations in the costs. In other words, the disclosure must show whether higher costs are incurred in specific investment periods than in others.

For certain financial instruments, this occurs in the first year, when front-end loads are charged, for instance. This information must be clearly explained to the client so that they can better understand the effect of costs and charges and better assess the investment in its entirety.

A major step for consumer protection

From a consumer and investor protection perspective, these new and highly detailed cost transparency requirements are a major innovation. For the first time ever, clients are given, in advance, a concise overview of the costs and charges associated with the financial investment they intend to make. This allows them to see at a glance whether and especially to what extent the institution receives benefits from third parties for the services it provides.

Since the requirements apply to all financial instruments, product costs and their effect on the return can be compared not only within one asset class – for instance by comparing one fund with another – but also across asset classes, i.e. the costs for fund X can be compared with the costs for share Y. In addition, investors can now compare the service costs that different institutions charge for the same financial instrument. In this respect, the costs and charges disclosure is an important step towards more clarity for investors.

Outlook: ex-post cost information

From 2019 at the latest, institutions will also be required to provide their clients with ex-post information on the actual costs and charges.

But what additional benefits will clients gain as a result? The answer is simple: While the ex-ante cost information shows the client what costs to expect when buying or selling a financial instrument, the ex-post cost information is set to disclose the actual costs and charges incurred due to the financial investment.