Europe’s regulatory authority has backed down on an outright ban on buy-side firms using dealing commissions to pay for equity research. However, investors could still be faced with higher research costs.
The European Securities and Markets Authority (ESMA) released its technical advice on the implementation of the revised Markets in Financial Instruments Directive (MiFID II) in December. In the paper, it confirmed the practice by which asset managers’ receive research from brokers in exchange for using the same brokers to execute trades should be “induced”, as a means to bring greater transparency.
However, the technical standards suggested the obtaining of research will not be “induced” if the asset manager directly pays for it, either from their own funds or raising fees for their investors.
"The IMA (Investment Management Association) supports ESMA's decision to allow investment research to continue to be purchased by clients. ESMA's proposed approach would raise standards and reduce conflicts of interest across Europe and ensure that payments for research are clearly distinguished from payments for trading,” says Daniel Godfrey, CEO of the IMA.
"The IMA also supports the proposed requirement for brokers to offer to price execution and research separately, in order to help investment managers meet their obligations.”
Instead, ESMA proposed that asset managers should choose to adopt commission-sharing agreements (CSAs), where a portion of the commission charged by the broker is segregated into a client account. This allows the cost of research and the cost of execution to be unbundled.
This has been widely adopted in the U.K., after the Financial Conduct Authority banned the use of equity trade commission to pay for “corporate access” in June this year, and is now largely relied on as a primary revenue source by many small research providers.
However, many fear the ruling on “unbundling” could lead to radical changes in the European brokerage business model, and could lead to small asset managers being pushed out.
In a report published by Greenwich Associates in November, John Colon, managing director, securities & trading, banking & capital markets said: “If implemented in current form, investors would have three choices: 1) cut a check to research providers and absorb the cost, 2) pay providers and pass along costs to customers via higher management fees, or 3) stop buying certain research and services altogether.”
Furthermore, UK stockbroker Numis predicted in September full unbundling of research and execution could hit profits for buy-side firms by as much as 5%.