The link between MiFID and Risk Appetite Framework as an application of best practices for wealth management and the entire value chain of the financial industry

Abstract

After a short review of the MiFID regulations and the RAF, the paper identifies the link between them which allows to mitigate a balance sheet risk sustained by the financial intermediary and, at the same time, to improve its stability and value creation, through a maximization of customer loyalty. The client’s attitude towards risk can be summarized in these terms: "I don't like risk, but I like to win". Thus, a three-dimensional approach towards expected utility is suggested for estimating risk tolerance: risk aversion, loss aversion and reflection. In addition, a definition of the client's financial objectives is required, combined with greater disclosure - which allows the construction of a financial statement – to attest that risk-taking is indeed a luxury, as indicated by the metrics of the discretionary wealth ratio, and therefore, of the Standard of Living Risk (SLR). The next step consists in the determination of a set of portfolios along the efficient frontier where risk is represented by the expected shortfall, the determination of which belongs to a Generalized Extreme Value Theory logic. The client's objectives are described in terms of probability of success, where the latter is a function of an initial endowment, a potential positive contribution of financial resources over time as well as an expected return level. The above is expressed through a practical case that envisages the determination of a set of EGPF portfolios and the identification of the specific portfolio, obtained as a solution to a static and dynamic optimization problem, where the objectives have been formalized through the calculation of the associated utility