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Today New City Initiative is comprised of 53 leading independent asset management firms from the UK and the Continent, managing approximately £400 billion and employing several thousand people.

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MiFID II's Delegated Acts and its impact on fund manager research

MiFID II's Delegated Acts and its impact on fund manager research

The passage of the Markets in Financial Instruments Directive II (MiFID II) Delegated Acts in April 2016 was meant to provide clarity on a number of outstanding issues affecting the asset management industry. The most pressing concern of course was the on-going uncertainty about paying for sell-side or broker research through equity trading commissions. The European Commission’s (EC) latest announcement on the status of commission sharing agreements (CSAs) has simply confused the market.

The provisions appear to require more transparency on how research is paid for. The rules state: “Investment firms providing both execution and research services should price and supply them separately in order to enable investment firms established in the Union to comply with the requirement to not accept and retain fees, commissions or any monetary or non-monetary benefits paid or provided by any third party or a person acting on behalf of a third party in relation to the provision of the service to clients."

Regulators and investors can also demand a summary of the research that has been provided to prove that it was not an inducement. Furthermore, research cannot be linked to transaction volume or the value of transactions executed by brokers on behalf of their clients. In effect, this makes CSAs operationally challenging albeit not impossible. There were high hopes the EC had softened its stance on CSAs in December 2015 when reports indicated that full unbundling was unlikely to happen provided managers were wholly transparent about the charges they paid their brokers.

Aside from the complexities around CSAs, there are two avenues managers can go down in regards to research. The first is to pay for it themselves. This will obviously eat into overall profit and loss (P&L) and could result in firms having to increase their management fees. Given the sensitivities around fees at the moment at active managers, this is hardly going to go down well among some investors. Most managers will conduct cost analysis to determine how much research is being used and how regularly. This is a sensible approach and will enable managers to be more selective about the research they purchase. After all, a lot of the research does not always get read.

However, small asset managers are often dependent on broker research. They do not have the scale to hire researchers internally, and these rules could make business even more cost prohibitive. It could also hinder performance as opportunities could go amiss if research has not been purchased. Again, this contravenes the very purpose of MiFID II which is investor protection        as it undermines the managers’ fiduciary responsibility to deliver returns to stakeholders. This is all happening at a time when regulations and enhancements to internal operational infrastructure are disproportionately impacting smaller managers.

The second approach would be to create a separate research payment account. Again, this must be wholly transparent as managers are obliged to provide information on the nature and costings of research on an annual and ad hoc basis.  Most importantly, the budget for the research payment accounts must be pre-agreed with investors and cannot be linked to transactional volumes and value.  

If a fund manager has only a handful of institutional investors, this ought not to be too difficult. The problem will be for managers who have hundreds of accountholders. At present, there is no mechanism or viable solution to obtaining agreement with all of those investors. It also has the potential to increase legal costs as investor documentations and agreements will have to be rewritten to account for this new research budget. This could prove operationally burdensome, particularly if the research spend goes over limit.

The uncertainty around CSAs and the operational heavy-lifting required for maintaining a research payment account give managers few options but to pay for research themselves or to stop purchasing research altogether. The problem is likely to be compounded as individual regulators have scope to implement the rules how they see fit. This could result in widespread divergences in implementing MiFID II’s research provisions across the EU. This will only sow the seeds for confusion.