By Amrish Ganatra
Any day now, the European Commission (EC) will officially release its long-awaited draft of the MiFID II “Delegated Acts”, part of which will refer to the unbundling of commission payments.
Although a leaked draft of this document has been circulating around the market, investment firms are still looking for answers.
- What will change under the Delegated Acts?
- What exactly is a Research Payment Account (RPA)?
- How will firms account for research payments under MiFID II?
- What steps should an Investment Manager take now to prepare for the future?
This article is the first in a short series that sets out to provide answers to these questions and more.
The Delegated Acts changes how research services must be paid for
The key driver behind the Delegated Acts is greater transparency around commission payments for research. The regulator wants to ensure that:
- end clients know exactly what they are paying for;
- a clear separation exists between research and trading activity; and
- research cannot be provided as an inducement to trade.
The EC’s preferred solution is for firms to pay for research from their own P&L; they believe this removes the risk of inducements (even if the firm then recovers those costs by increasing customers’ fees!).
However, our conversations with asset managers suggest that fewer than 10% of investment firms will adopt this P&L approach; typically those with a research budget of less than $1m or so. Such firms have often cited cost/benefit reasons for moving to a hard dollar model.
“RPAs are designed to enhance the controls around commission spend, controls which currently tend to exist simply as discretionary CSA budgeting or monitoring processes”
The majority will opt to pay for research out of a separate Research Payment Account (RPA) that they control, funded by client money specifically allocated for this purpose. Whilst many asset managers currently operate Commission Sharing Agreement (CSA) programmes, RPAs are designed to enhance the controls around commission spend, which currently tend to exist simply as CSA budgeting and monitoring processes at the discretion of internal teams. There are various proposals for the exact mechanism of funding a RPA – the subject of a future post…
The Buy Side must take control
An investment firm will be ultimately responsible for their RPA account(s), and this is one of the main areas where the new regime differs from the old.
- In the past, CSAs were generally controlled by a broker or bank and often sit on their balance sheets.
- Under the new Delegated Acts, the RPA is categorically the responsibility of the investment firm, even if its administration is outsourced to brokers or a third-party service provider.
The investment firm will now need to set clear and external-facing research budgets and collect the corresponding charges from its clients.
This brings us to the first potential area of confusion:
- The language in the leaked draft Delegated Acts talks about clients, but the reality is that investment firms generally run things at a fund
To accurately monitor commission spend at the individual client level is generally out of practical reach for most large investment firms. This is because there are often hundreds or thousands of clients in a given fund who can change on a daily basis.
Our expectation here is that firms will be allowed to manage payments at the fund level (rather than right down to individual client level) provided that they make clear to fund investors that charges will be in proportion to their holding.
RPAs create an opportunity for firms to provide better value
Firms are seeking clarity on how the Delegated Acts will impact research budgeting: The leaked text states that the budget must be set by the investment firm, but does not specify the level to which it applies – firm, region, fund, or client. One interpretation of this is that firms could be compliant by setting and managing a single firm-level budget for their research spending. Our view is that firms must be able to demonstrate budgets are being managed at a much more granular level.
Best practice will be for firms to provide evidence for:
- the rationale behind their overall research spend;
- how and why this budget is spread across various regions, sectors, teams or funds.
We believe large asset managers may consider grouping funds (which have similar research consumption profiles) together into ‘pools’, and then manage a hierarchy of budgets at the pool level. In reflecting on the distribution of research spend, firms have an opportunity to increase the impact of money spent (or even to reduce the cost burden on their clients!)
“Investment Firms will be expected to produce justifiable, granular research budgets; doing so is an opportunity to increase the impact of money spent on research”
In future posts in this series, we’ll be looking at:
- the competing methods of funding a RPA (transactional versus accounting);
- the link between budgets, research quality and voting mechanisms;
- the documentation of how research is consumed and who it benefits; and
- administration of the RPA
Please check back soon for the next installment!
Amrish Ganatra is a Managing Director at Commcise Software Ltd. Commcise provides an innovative fully integrated cloud-based Commission Management solution that incorporates automated reconciliation, invoice management, commission budgeting, service history or consumption tracking, service evaluation (“voting”), commission management, share of wallet reporting and accounting functionality. Commcise is used by over 75 asset managers and brokers globally.