MiFID 2/MiFIR: What, When, Who and How? Payment for research and other value add services by asset managers

This article sets out a summary for Asset Managers of the key issues to consider in relation to the dealing commission regime under MiFID 2.

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What does MiFID currently do?

Are these provisions currently in MiFID?

Directive 2004/39/EC: Art. 19(1)

Yes, currently MiFID permits firms to give or receive fees, commissions and non-monetary benefits subject to satisfying certain conditions.

What are the key differences between the current regime and MiFID 2?

MiFID 2 will significantly change the rules on inducements and paying for research. These changes include:

  • Ban on the receipt of non-monetary benefits from third parties unless they are minor
  • Requirement for payments for research to be fully unbundled from payments for execution (or other) services
  • Introduction of an exhaustive list of acceptable non monetary benefits that would be regarded as minor (with the potential for ESMA to add more items through guidelines).

What is MiFID 2 going to do?

What does Level 1 say?

Directive 2014/65/EU: Art. 24(7) to (12)

  • When providing portfolio management services or investment advice on an independent basis investment firms shall not accept and retain fees, commissions or any monetary or non-monetary benefits paid or provided by, or on behalf of, a third party.
  • The acceptance of minor non-monetary benefits will be permitted provided that these are capable of enhancing the quality of service to the client and will not inhibit the investment firm from acting in the best interests of its clients.
  • Such benefits will be subject to a disclosure obligation.

What does Level 2 say?

Final Report 2014/1569 (FR)

  • ESMA has proposed that research (whether generic or bespoke) and other “value-add” services provided by brokers to their asset manager clients on a “bundled” basis (eg preferential access to analysts, corporate access), are non-monetary benefits that are capable of breaching the new prohibition on the receipt of inducements.
  • ESMA has advised the EU Commission to adopt a narrow interpretation of what constitutes a “minor” non monetary benefit, encouraging the EU Commission to produce an exhaustive list of acceptable non monetary benefits that would be regarded as minor (with the flexibility for ESMA to add more items through guidelines).
  • ESMA has made it clear that, where the relevant research or other service is paid for by the asset management firm from its own balance sheet, the receipt of the relevant research or service will not infringe the rule prohibiting the receipt of non-monetary benefits (including where the firm increases its management fees to reflect the increase to its cost base).
  • In response to feedback from the industry relating to the widespread use of commission sharing arrangements (CSAs) and the perception that such arrangements largely deal with the potential conflicts of interest that form the rationale for the new inducements rules (namely that the asset manager might be tempted to direct order flow to brokers that it perceives have provided it with the high quality research), ESMA has also suggested that, as an exception to the inducements rule, MiFID firms should be permitted to establish separate research payment accounts to be pre-funded on a consensual basis by a reasonable research charge made by the firm to the client, which could then be used to pay for research received by the firm. ESMA has made it clear that such accounts would not be permitted to be funded by fees from trades and that there should be no link between trading volumes and the balances on the accounts. This would appear to outlaw the use of CSAs after MiFID comes into force.
  • ESMA has also advised the EU Commission to adopt a rule requiring sell side MiFID firms to adopt execution only pricing structure that do not include bundled rates or a research element.

Will any Member States be gold-plating?

  • Level 1 provides Member States with the option to impose further restrictions at a national level and it is likely that the UK and Netherlands will continue to apply wider bans.
  • The FCA in its Feedback Statement FS 15/1 on Discussion Paper DP14/3 has indicated that it may seek to apply the MiFID 2 inducements rules described above to AIFMs and UCITS management companies.

When will it happen?

When will these provisions apply?

Member States are required to adopt and publish measures transposing MiFID 2 and delegated acts into national law by 03 July 2016. MiFID 2 and delegated acts under MiFID 2 will apply from 03 January 2017.

What happens next?

ESMA delivered its final technical advice for delegated acts on the 19 December 2014 to the EU Commission in the FR. The EU Commission shall adopt the delegated acts within 6 months which will then be published in the Official Journal. The European Parliament and Council have the right to object to a delegated act within 3 months (which can be extended by a further 3 months).

Deadline for responses to CP2 was 02 March 2015, following which ESMA will update the draft technical standards and send its final report to the EU Commission. ESMA is expected to publish its final RTS by July 2015 and final ITS by January 2016 and submit them to the EU Commission. In both cases the EU Commission will have 3 months to decide whether to endorse the submissions. It is likely that the technical standards will be adopted by way of regulations published in the Official Journal.

How is it going to impact my business?

Who will be affected by these changes and how will it impact their business?

Buy-side MiFID firms:

  • These developments will fundamentally impact the way in which asset management firms consume, account for and pay for bundled services from their brokers.
  • Asset managers will be left with the choice of (1) paying for research from their own balance sheet and absorbing the cost into their business, (2) paying for research from their own balance sheet and attempting to increase their management fees to offset the additional cost or (3) setting up (with the consent of their clients) pre-funded research payment accounts and using the balances on those accounts to pay for research.
  • The new rules will apply across all asset classes and so will affect the fixed income markets (unlike the FCA’s current rules on use of dealing commissions which only apply to trading in equities and equity like instruments).
  • ESMA’s advice that the EU Commission should adopt an exhaustive list of minor non monetary benefits means that a variety of additional value add services not mentioned in the CP1 or the FR but that are often provided by brokers to their asset management clients (for example capital introduction services, talent search services) may now need to be paid for separately by the asset manager on an itemised basis.
  • The new rules do not apply to AIFMs or to UCITS management companies when dealing on behalf of the AIFs and UCITS funds for which they act as AIFM/UCITS manager. However, ESMA has recommended that the EU Commission should adopt fresh legislation to apply these requirements to such firms. Additionally, given that the FCA has been the driving force behind this particular initiative, it seems likely that the FCA will gold-plate the MiFID requirements to apply the new inducements rule to UK AIFMs and UCITS management companies (see the commentary in Feedback Statement FS 15/1).

Sell-side MiFID firms:

  • Sell-side MiFID firms will be required to have in place separate pricing and contractual arrangements for execution services that are independent of any research or other bundled services they provide.

Action for firms?

Q1 2015

  • Consider implications of ESMA’s FR published December 2014 and responses published March 2015.

Q2-Q4 2015

  • Review current practices and procedures within the business and perform impact analysis to determine changes required to business practices and procedures. Identify which services are currently being received on a bundled basis and will need to be unbundled when MiFID 2 is implemented.
  • Consider the options for how investment research will be paid for following the implementation of MiFID 2 (ie absorbed as a cost of the business, offset by higher management fees or through separate research payment accounts) and relevant changes to documentation or additional contractual documentation and procedures required.

2016

  • Prepare required internal documentation and/or amend existing documentation (compliance manual, conflict of interest policy, customer documentation) in line with new requirements.
  • Discuss with sell side counterparties how the unbundling of research and other value add services will affect commission rates/transaction spreads and put revised commission arrangements in place.
  • Provide training to staff to ensue they are aware of the revised compliance arrangements, contractual relationship with brokers and internal processes and procedures.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.