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MARCH 30, 2016

Total Cost of Ownership and the Rolling Twelve Months

Gert-Jan Hoogendoorn

Client Solution Director

Reading time: 2 min

OWINTALK | BEHIND BUSINESS, BEYOND NEWS

The European Commission sent all of us on a new mission with the MiFID 2 regulation: a transparency mission. Everything has to be, or at least should, transparent to the investor. Above all, costs.

This involves the notion of Total Cost of Ownership, much heralded in the computer market, much less in the fintech world… until MiFID 2 came out.

Total Cost of Ownership Is About… Costs

When an investor signs a contract with a bank, he or she of course gets indications about the cost of the investment: commission schema, management fees, performance fees, all possible kinds of fee involved. If you open a regular account with a bank, e.g. a savings account, you perfectly know what your fees are.

Investment accounts are different, because they depend on the type of investment and commissions and management fees start trickling once one starts to invest, depending on how and how much one is going to invest. This way, knowing in advance the exact amount of investment expenses is practically impossible.

Before MiFID 2, there was the obligation for the financial institution to report the fees applied to the portfolio on a monthly or yearly basis, as absolute numbers; the costs were shown in absolute numbers, in a direct way.

A New Concept

MiFID 2 brings the new concept of Total Cost of Ownership and asks financial institutions to show costs as relative amounts, as a percentage of the investment, in an indirect way. This is good but doesn’t entirely solves the problem, because investment accounts (e.g, mutual funds) have indirect costs that are not transparent for the investor and are not depending on the market as, for instance, do stocks.

Moreover, if you invest in a fund, you are told that fees are, for instance, 0,8 percent, except there are no ways to check that the percentage is true to itself or it’s going to be actually different. And, what about seasonality? If cost are reported when they occur, a great deal of transparency vanes.

MiFID 2 wants to solve for investors problems arising from a too simplistic reporting of costs and fees associated with an investment.

Think of a contract that makes you pay fees and costs in January: by reporting them just as they happen, you get an expense peak in January and zero expenses on the rest of the year. It almost naturally comes to the mind to split the expense in twelve parts and compute on-twelfth of the cost every month. But, in absolute terms, this means that January will appear as a very cheap month for fees while, months after months of buildup, December will seem quite expensive. This may seem trivial for very simple investments, but things can get out hand pretty quickly.

Talk With the Bank

The regulation from Brussels is very high-level and implementing it in day-by-day operations can be a daunting task, if the software doesn’t fully answer the needs of the financial institution. There should be a way to optimize as much as possible the regulation implementation, so, when MiFID 2 became public, software providers needed to talk with their clients, brainstorming with them about the best way to do all of that.

The solution was again simple, but not trivial: showing direct costs over a rolling period of twelve months. This way, relative cost is stable. It doesn’t go up and down and the result is always a flat figure. No buildups, no uncertainties.

And, what about indirect costs? This is another interesting solution to be told, in a next post. In the meantime… keep rolling!

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