The topic of research under MiFID II has been a popular discussion lately amongst top firms at JWG’s MIG meetings. MiFID II demands that firms be transparent to investors about how they plan to pay for research and the value which they place on it, which has led managers to think about how much they are willing to spend on reports and who they want to buy research from. The aim of this article is to discuss these changes in more detail and highlight the queries that were raised in our MIG meetings from a buy-side perspective.
As a result of these new rules, firms need to be wary of passing research without it potentially being considered as an inducement. Therefore, managers must decide whether they should pay for research themselves out of their own profit & loss (P&L), which may lead to an increase in management fees to cover additional costs, or pay for research using a research payment account (RPA).
An RPA is an account controlled by the manager and it allows firms to set an absolute monetary budget to pay for their research, which will help separate research costs from trading activity. However, if a manager opts to use an RPA, there are certain conditions that must be followed:
- The RPA must be funded by a specific charge to the client, which has to be set based on the research budget and not on the volume or value of transactions. The firm must regularly assess the research budget at both the aggregate and client level
- Keep research charges within the approved budget. If total research charges exceed the research budget, managers should meet any shortfall out of their own funds
- A process should be put in place to refund any surplus balance left over at the end of the year or to offset the surplus against the research budget/charge for the following period
- Agree the budgeted research charge and the frequency of deduction over a year with clients. Clear information should be given beforehand about any intended increases to the research budget
- Provide the total cost of research to clients on an annual basis
- A manager cannot use the research budget or RPA to fund their own research, therefore, controls must be put in place, i.e., a clear audit trail of payments made
- Must regularly assess the quality of research purchased
- Provide a written policy addressing the extent to which the research will benefit the client’s portfolio and how the firm intends to allocate costs fairly across different clients’ RPAs
- Provide a summary of the providers paid including amount, timeframe and any rebate or carry over.
There were a few queries that were raised during our MIG meeting on research. Clarification is needed regarding the methodology when charging for research, as to whether the buy or sell-side determines the price of the research. In regards to providing a free trial period for research to a prospective client, some buy-side firms have said this could be viewed as an inducement. Some firms are providing a discount on research in the first few months but members need further clarification from the regulators.
RPAs build on the Commission Sharing Agreements (CSAs), which are currently used by firms. CSAs breaks down the commission into the distinct components of execution and research and are generally controlled by a broker or bank. In other words, RPAs are designed to enhance controls around commission spend.
The introduction of these new rules is to set a tighter rule on budgeting, reporting and controls for research spend. McKinsey estimates that, as clients will now carefully choose what they pay for, the $4 billion that is currently spent on research annually by top-10 sell-side banks may fall by 30%.
With the above in mind, it is important for managers to ensure that efficient and clear processes are in place and that they are meeting the increased transparency requirements, especially if they are taking the RPA route.
Other buy-side topics are regularly discussed in our MIG meetings. Our next three MIG meetings are:
- 29 June 2017 – MIG 90: algo/HFT implementation note meeting 2
- 4 July 2017 – MIG suitability and appropriateness guidance note call 1
- 25 July 2017 – MIG 94: record keeping guidance 2.
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