European CSA Usage to Expand Ahead of MiFID II
Usage of commission sharing agreements by the buy side to the sell side in Europe is set to grow as new regulations that mandate more accountability and formality in the trading process loom.
Ahead of the scheduled January 2018 implementation of Markets in Financial Instruments Directive II and its attendant need for more transparency, Tim O’Halloran, co-president at Westminster Research Associates, a unit of Convergex, expects many institutional firms will need to enhance their CSA infrastructure as a means of paying for research.
Commission sharing or client commission agreements are the primary means by which a buy side trader pays research providers. When a trader pays for trades, there is normally some extra monies included aside from the cash commission to pay for the actual trade execution. Via this agreement, the broker or vendors get paid for research from this bundled cash pool.
“CSAs in Europe will move toward the top of the list of the things that European firms will need to take a look at,” O’Halloran told Markets Media in an interview. “We envision that investment managers will seek to establish a more formal, institutionalized infrastructure which will include broker voting and CSA processes that are more auditable and repeatable and can assist in disclosing more timely information to all stakeholders such as fund boards, clients, potential investors, etc.”
It is this more formal infrastructure that defines the term ‘enhanced’ CSA, O’ Halloran said. Currently, a bit more than half of buy-side firms use CSAs to pay for research. As more stringent regulations come from the Financial Services Authority and possibly other Euro regulators, the buy side will need to more accurately account for how it pays for its research — in particular to what firm, how much and for what kind of research, e.g. corporate access or written reports. He estimated that CSA usage could grow to upwards of 65 percent as MiFID II approaches.
“CSAs are a very big product in the U.S., used by close to 80% of the buy side. This percentage is not as high in Europe but, we think that is about to change,” O’Halloran said. “Commissions will be the currency of exchange going forward, with the buy-side embracing the use of CSAs as the regulators want to see a more vigorous process around trading and paying for research and reporting.”
This new focus on CSAs and enhanced or more detailed/enhanced CSAs will move into buy side focus as this will likely be included in European regulators’ definition of best practices, O’ Halloran added. An enhanced CSA infrastructure, he explained, should include proper budgeting for and valuation of research, a sound mechanism for facilitating the compliant payment of all research costs, thorough oversight of all research payments, full reporting, disclosure and archiving of research costs, separate and apart from execution costs, and a methodology to ensure best execution when trading to acquire research.
“Regulators are going to demand that the buy side better articulate what their research spend is,” O’Halloran said. While many institutional trading desks have a process in place already to provide this information, others will need to bulk up their processes while still others might have to actually put a formal process in place.
For these latter firms that have no actual extant CSA process, they might, O’Halloran added, need to contract broker-dealers who have an established CSA system, firm’s such as Westminster Research that specializes in CSA provision or other firms. While establishing a CSA system is not particularly costly, he said, some firms will require a longer lead to time to get some of the fundamental processes CSAs require, such as the establishment of a broker vote process, to come into full compliance.
The broker vote is the process where the buy-side trader, portfolio manager and others pertinent to the trading process get a designated amount of votes that are cast for research providers and decide which get paid, which the firm decides to use and those it does not, etc.
“Clearly, there will be a heightened focus going forward on having a rigorous internal process for managing research. From an operational perspective, this means that an investment manager will likely need a formal broker voting and budgeting process to rationalize and clarify their research spend,” he said. “While larger investment managers typically have systems and processes in place to address these needs, we still see others handle these issues in a more informal manner, perhaps on Excel spreadsheets or with a favorite broker.”
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