MiFID II may go further on unbundling than FCA

UK and European regulators are at odds over how commission payments should be used to pay for research, which could see the buy-side paying for research from their own funds.

UK and European regulators are at odds over how commission payments should be used to pay for research, which could see the buy-side paying for research from their own funds.

The European Securities and Market Authority’s (ESMA) current consultation paper on MiFID II proposes new guidelines for commission payments under the directive’s rules on inducements. UK regulator the Financial Conduct Authority (FCA) had requested Europe-wide rules in its own consultation paper on the use of commissions issue in November last year, but the European regulator is proposing a very different research market regime.

In both its November 2013 consultation and a policy statement published in May this year, the FCA stated that commissions should only be used to be pay for research that is substantive, of value to the investment process and enables the asset manager to reach a meaningful conclusion on whether or not to invest. The FCA is hoping this will encourage firms to ensure they seek out high quality research that is of genuine value to their clients. 

Minor benefit?

But Richard Balarkas, founder of Quendon Consulting and former CEO of Instinet Europe, said ESMA’s proposal requires value-added content to be paid for out of the asset manager’s own pocket – on top of the dealing commissions passed onto the end-client.

 “What ESMA’s discussion paper seems to be saying on inducements is that research which is of a minor non-material benefit can continue to be paid for using commissions, whereas anything more bespoke or of value gives rise to a conflict of interests and should be paid directly by the asset manager. This appears to be the reverse of the FCA’s position,” Balarkas told theTRADEnews.com.

ESMA’s consultation states receipt of financial research may be permissible as a minor non-monetary benefit “provided it is of a scale and nature such that it could not be judged to impair a firm’s duty to act in the best interest of their clients”.

It goes to on to say: “ESMA considers any research that involves a third-party allocating valuable resources to a specific portfolio manager would not constitute a minor non-monetary benefit and could be judged to impair compliance with the portfolio manager’s duty to act in their client’s best interests.”

ESMA also says the common practice of asset managers paying higher execution rates to obtain more substantial research will not be allowed under MiFID II, stating that asset managers should pay for this type of service from their own funds.

The end goal

Richard Phillipson, principal at consultancy Investit, says that while ESMA’s current view is more radical than the FCA’s existing guidelines published in May, he believes the FCA also wishes for asset managers to fund more research directly.

“Looking into the detail from the FCA’s various statements on this topic, it is clear that the current proposals on unbundling are a temporary measure and its final goal is a much more radical reform of the way asset managers pay for research,” he said.

“The National Association of Pension Funds, whose members account for a major part of the buy-side’s assets under management, has also stated it wants asset managers to fund research themselves, though as yet pension funds themselves have yet to put pressure on their investment managers.”

Balarkas says ESMA’s proposed model may prevail largely due to past industry inaction since the UK government-sponsored Myners Review first highlighted the issue in 2001.

He said: “There will be many who think ESMA’s proposal goes too far, but if the industry had not dragged its heels on providing clearer pricing structures for research for the last ten years I doubt the use of commissions to pay for research would be in the regulatory spotlight.”

The FCA and ESMA were unavailable for comment at the time of going to press.

Responses to ESMA’s consultation paper, which is accompanied by a much larger discussion paper on regulatory technical standards (RTSs), will be used to provide the European Commission with further advice on the implementation of MiFID II. Responses for both papers are due by 1 August with advice for the Commission and a consultation paper on RTSs to be published near the end of this year.