As appeared in Bobsguide, TABB Forum, The Trading Mesh, & AT Monitor.
As we eagerly await the final verdict on unbundling under MiFID II, here is a list of 10 things we can expect for research while we’re expecting ESMA’s much-anticipated release.
1. January 2017 is here to stay
The delay of the final text from the original June deadline, was the subject of much attention earlier this summer. This particular postponement, however, is no reason to speculate that the January 2017 implementation date can be pushed back. The date was agreed by a European Parliament vote and therefore can’t be changed by ESMA or the EC independently.
2. Research will be unbundled
While the original MiFID draft is undergoing some edits, (why else have we been waiting?), the fact remains that key proposals are not up for debate. Amongst them, it is clear that research unbundling is going ahead. ESMA has no doubts that research is an inducement. Therefore, third party research may only be accepted by investment firms where it is explicitly paid for. Brokers will need to price research services to enable fund managers to meet the new restrictions, demonstrate their compliance and improve transparency in the market.
3. Not just an “equity issue”
The inducement and therefore research rules apply to all asset classes covered under MiFID II. As a result, unbundling is not just an “equity issue.” Nomura’s recent headcount cull in fixed income research demonstrates they have no doubt that the new rules apply across asset classes.
“The specific research charge shall…not be linked to the volume and/or value of transactions executed on behalf of the clients. ” (MiFID II Technical Advice). This one word has been subject to immense lobbying from buy and sell side alike. Organisations, such as APIR, have suggested changing the word in question to “determined” would meet the regulator’s objectives while preventing unintended consequences. That sounds too simple and we would expect given the intensity of feedback further clarification, given the intensity of feedback, as well as refinement rather than a simple word replacement.
5. CSA or RPA or ??
The word “linked”, which rang the death toll of CSAs and gave rise to RPAs (Research Payment Accounts), may not make a reappearance in the upcoming release. It has generated an intense debate, and lobbying, around the future of CSAs. While that debate has focused in on CSAs versus RPAs, the real question at hand is actually “what mechanisms are available to fund an RPA?” Many suggest that RPAs, currently only allowed to be funded by charge applied to the fund, could be financed with commissions and still meet the regulator’s needs. Others argue that adding a budget cap to CSAs, currently a well functioning mechanism for paying for third party research, would meet the regulators demands without the need to reinvent the wheel. National regulators are also split between the two with the UK’s FCA consistently backing “pure” RPAs while France’s AMF has declared a preference for the existing CSA model.
A combined structure could prove to be one of the biggest surprises in the document.
6. Hard or soft dollar
Last December’s release explicitly states an openness to an asset manager paying for research either directly, out of its own resources, or by charging the end client. Many have felt, however, that the detail around research payments funded by the client were too burdensome to be practical and that the industry would need to either A) move entirely to hard dollar, with firms either absorbing the cost of research themselves, or B) increase headline fees. While option A hits margins which are already under considerable pressure, option B puts European fund management firms at a distinct disadvantage to their global peers.
We would anticipate some relief in the language around soft dollar payments to ensure that they are more feasible.
7. Budgets and disclosure to clients
ESMA’s advice is to require that research costs should be disclosed to clients. On top of that, “the investment firm must agree with each client the research charge…” Asset managers fear the hefty administrative burden associated with the latter. In addition to taking time and incurring cost, it also raises fears about how to proceed practically and fairly, if not all investors in a fund are sharing the cost of research. Research costs should be disclosed to clients; but how that communication works, is likely to be revised.
8. Not only a budget
Keeping in line with increased post-trade communications which appear elsewhere in MiFID II, asset managers will be required not only to set and communicate budgets in advance, but also to inform clients of the total amount actually spent on research. Beyond accounting, firms will also need to keep track of the goods and services received. Again, we don’t expect material changes here but we could see further clarification on when and how firms will need to disclose. This requirement will, however, necessitate some material changes on how research is received, consumed and monitored by the buy side and the creation of audit trails for research providers’ payments. Otherwise, firms will incur further creeping costs.
9. Something new?
Glaringly absent despite from the text thus far is a definition for research. It seems rather obvious that a European-wide definition should be introduced. The existing FCA language offers good inspiration.
10. Corporate access…
One particular line caught our attention as it leaves a very big door rather wide open . ”Any other goods or services rendered [by brokers] should be subject to a separately identifiable charge; the supply of these goods or services should not be influenced by (or be conditional on) levels of payment for execution services.” We would anticipate further guidance and examples of which services should be separated out…corporate access comes to mind.