Draft European Union (EU) proposals around the MiFID II indicate that asset managers will be permitted to pay for sell-side research through commission sharing agreements (CSAs) providing they give investors full cost breakdowns.
This announcement is a welcome respite to fund managers who had feared CSAs would be banned altogether. “Every operational arrangement for the collection of client research charge, where it is not collected separately but alongside a transaction commission, has to indicate a separately identifiable research charge,” according to the leaked draft, seen by Reuters. Other reports indicate market commentaries or “non-substantive materials” from banks on economic statistics or company results will have a clearer exemption from the MiFID II transparency rules.
The leaked transparency obligations could require sell-side brokers to clearly outline the costs of research to fund managers, something which has long been called for. The draft proposal is a shift away from the European Securities and Market Authority’s (ESMA) previous stance, which called for a full unbundling of the cost of research and trading, in what could have forced fund managers to pay directly for their sell-side research.
Forcing managers to pay for sell-side research could have negatively impacted the P&Ls of research-dependent smaller managers, or led to an increase in management fees. Other managers would have purchased less sell-side research, which could have a detrimental impact on performance. The most likely scenario of a complete unbundling would have resulted in managers establishing pre-funded research payment accounts, fully paid for by investors.
The latter would have led to managers having to renegotiate investor agreements, something which could have been problematic for fund managers with thousands of accountholders. The legal fees would also have been substantial, while there were question marks as to what would occur if some investors did not sanction the research spend or if the research spend went over budget post-agreement.
Others feared unsophisticated investors would be put off by what they perceive to be ostensibly high research costs. A survey by Deloitte of 13 investment managers with £475 billion in Assets under Management (AuM) found 65% believed MiFID II’s clampdown on the use of equity commissions to pay for research was their biggest challenge.
MiFID II was due to be implemented from January 2017, but it is looking likely that it will be pushed back until January 2018. A number of market participants were struggling with the technological and infrastructural changes associated with MiFID II, particularly around areas such as transaction reporting and other transparency obligations. A one-year delay was advocated by a number of industry groups including the Investment Association (IA) and the European Fund and Asset Management Association (EFAMA).
The impact of MiFID II on fund managers should not be underestimated. Many asset managers routinely complain that the cost of regulation is stifling their businesses. A study by The New City Initiative (NCI), a think tank representing asset managers, found 46% of its members spent 10% and 20% of their management time dealing with regulatory compliance. 8 per-cent spent in excess of 20 percent of management time on regulatory matters, added the study – “The Next Five Years: Regulatory Challenges which will Impact Asset Managers”. MiFID II will undoubtedly add to this workload.