Hedge funds and other buy-side institutions are under pressure to justify the so-called soft dollars they pay to brokerage firms.

The U.K.’s Financial Conduct Authority and the European Securities and Markets Authority have issued proposals to either ban or regulate commission sharing arrangements and soft dollars.

Soft dollars refer to commissions paid over and above the agreed upon cost of execution by money managers to brokers. In return, brokers provide research and services used to benefit accounts over which a money manager has investment discretion.

“You look at the research constraints that have been imposed by the FCA over in the UK, and we know that this is a global marketplace,” said Adam Sussman, head of market structure and liquidity partnerships at Liquidnet. “We’re seeing global fund managers impose those constraints around the world.”

Under Esma’s draft rules for MiFID II, asset managers will be required to provide a rigorous assessment of how much each piece of research will cost, and will have to receive periodic “opt-in” by their clients of the proposed research budgets. While these requirements are considerably more onerous than current rules, they are not as strict as the FCA’s proposed complete ban on paying for investment research with dealing commissions.

“Despite the fact that the MiFID II language around ‘unbundling’ isn’t quite as extreme as the initial language, there are still additional requirements for funds to unbundle and be more transparent about how they pay out commissions,” Sussman said. “We think that there’s going to be a lot more transparency by the buy side when it comes to how much they pay brokers for research, how much they pay brokers for execution, and what’s the value-add they get from that.”

Whereas the last few years the focus has been on commission compression and reducing the explicit cost of commission, “now it’s more about prove the value that you’re paying,” he added. “It doesn’t matter if you’re paying $10 million or $5 million. What’s the value you’re getting for that?”

The same push for buy-side transparency as it applies to commission is also likely to play out in execution, said Sussman.

“We certainly see that there’s been pressure on ATSs, on broker dealers, to be more transparent about their order routing practices and about their matching engine practices,” he said. “The next logical conclusion is that the SEC is going to come down on the buy side and say, ‘You need to be more transparent about how you route and why you route to the brokers you route.”

Finra is conducting a sweep of dealers that route a significant percentage of their unmarketable customer limit orders to trading venues that provide the highest trading rebates for providing liquidity. As part of the sweep, Finra is reviewing routing decisions for marketable versus non-marketable orders and how such decisions are impacted by rebates.

While the review is ongoing, the assessment has revealed that some firms do not have active best execution committees or other supervisory structures in place to meet their obligation to evaluate the quality of customer order executions.