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November 28, 2022

What is open architecture?

Are you an investor? You’ve probably come across the term “open architecture” when looking for information online, or during a conversation with your wealth manager. But what exactly does it mean, and what are its benefits?

Definitions

When shopping for clothes, do you tend to buy everything from a single brand or do you prefer a retailer that supplies various brands of clothing? While investing is undoubtedly a more complex affair than buying clothes, this question is still a good way to explain the difference between open and closed architecture.

“Open architecture” is where a financial institution offers its clients financial products and services from third parties in addition to in-house products and services. Conversely, a closed architecture signifies that the bank confines its offering to in-house solutions. More specifically, these concepts are a reference to the investments (funds, SICAVs, etc.) offered by banks to their clients.

Why open architecture?

The decision to opt for an open architecture stems from a clear realisation that it is impossible to simultaneously be the best in all asset classes or in all markets. An open-architecture offering therefore provides clear advantages: broadening the range of solutions available by creating an offering that comprises a large number of funds from various fund management companies and other financial institutions.

As well as making comparison easier, open architecture boosts competition in terms of fees and enhances transparency.

This gives investors the assurance of having a single point of contact able to offer them a wider range of solutions to meet their financial needs and diversify their investment portfolio. In addition, an open architecture helps reduce risks for the investor by ensuring that their entire future potential returns are not dependent on a single issuer and its investment strategy. Finally, as well as making comparison easier, open architecture boosts competition in terms of fees and enhances transparency. The latter point is particularly important since the EU’s MiFID II directive entered into force in 2018 and made it mandatory to ensure transparency in relation to costs and fees.

The ability to directly offer clients everything they need means banks and investment companies can avoid seeing clients go to the competition to look for the things the former cannot provide themselves. In particular, it also guarantees that they are able to act in the best interests of their clients by providing – or recommending – products and services best suited to the client’s circumstances, even when it isn’t an in-house solution. Thus an open architecture enables avoidance of conflicts of interest that could exist if the advisor had no choice but to offer the products from their own institution.

It should be pointed out here that not all institutions operating in accordance with the open-architecture principle offer the same services, and therefore don’t charge the same fees. Although some may include client advisory services as part of their offering, others confine themselves to execution-only. In the latter case, investors need to hunt around for the solution that most closely matches their expectations based on the understanding that what is offered to them depends on their investor profile. While the open-architecture principle is not yet very widespread within the range of investment products offered by retail banks, much of the private banking world has already been operating in accordance with this principle for some time.

What are the drawbacks?

Although there are no real downsides as such, there are one or two areas where it is important to remain vigilant.

There is no legal definition of open architecture; nor are there any specific regulations on what it actually covers

First of all, there is no legal definition of open architecture; nor are there any specific regulations on what it actually covers. Therefore, it is important to carefully research what your provider calls open architecture as well as what is really involved in the products and services offered to you. Whereas some online “fund supermarkets” have hundreds of funds to offer you, traditional banks are more likely to limit themselves to a number of external partners that are hand-picked based on their trustworthiness and the degree to which their line-up complements the internal solutions already in place. Your bank will therefore choose external funds on the basis of criteria such as rating, historical returns, fees and the reliability of managers. And for good reason: even though everything happens via your bank as intermediary, the use of open architecture means some or all of your investments are managed by different asset managers.

It is important to find out more about the fee policy applied before making your choice. It’s also advisable to check all entry and exit fees, management fees, and fees per transaction, as various packages can overlap one another. In particular, the management fee can vary sharply depending on the type of fund considered. The basic principle is that the more active the management and the greater the degree to which it involves risky asset classes, the higher the associated fees will be. Moreover, some institutions try to favour their own funds by increasing the fees relating to third-party funds, for example. Rather than open architecture, this is called “guided architecture”. Transparency in relation to the costs and fees for your investments became mandatory with the adoption of MiFID II. That’s why you receive an annual summary of all the fees relating to your investment portfolio and transactions carried out within the portfolio. Look out for this!