Future of CSAs in Europe in Doubt
The use of commission sharing arrangements under MiFID II is in doubt as the U.K.’s Financial Conduct Authority presses its view that CSAs fail to adequately separate commissions paid for execution from commissions paid for research.
Under a CSA, commissions paid to broker-dealers are pooled to permit investment firms to acquire research created by independent research firms without regard to the broker whom the investment manager may choose to execute client transactions.
In advice released in December by the European Securities and Markets Authority related to MiFID II, portfolio managers will only be able to accept broker research where they pay for it directly or from a ‘ring-fenced’ research account that is funded by a specific charge to their clients. Firms providing execution services will need to charge for execution costs, research and any other good or service through separately identifiable charges.
While the Esma advice does not prohibit CSAs per se, the FCA in February issued a statement that current CSA approaches “would seem incompatible with the intention of Esma’s proposals, and specifically the view that there should be no link between execution and research payments.”
“The issue is that the Financial Conduct Authority has had a bee in its bonnet about the use of dealing commissions since at least 2001, when the Myners Report came out,” Andrew Upward, vice president in the market structure group at Rosenblatt Securities, told Markets Media. “As the biggest national regulator in Europe, the FCA has a great deal of influence on Esma.”
The Myners Report argued that standard market mechanisms presented a weak control on the total cost of bundled services, as the lack of transparency and accountability in relation to commission costs made it difficult or impossible for customers to establish whether the investment manager was controlling conflicts of interest effectively, and was therefore delivering value for money to its funds.
In response to the Myners report, the FCA’s predecessor — the Financial Services Authority — enacted rules requiring unbundling of commissions for execution and commissions for research.
In its February statement, “the FCA asserted that CSAs would not qualify as a so-called research payment account, which is what Esma had suggested as the mechanism by which payment for research could be made,” said Upward. “It was supposed to be a separate account that would be effectively pre-funded and distributions would be made out of that account to pay for research.”
Last month, Instinet Europe announced its application as a payment institution with the FCA, whereby it would offer a new segregated cash management and payment service to clients who choose to operate a hard dollar “research payment account.” Instinet views RPAs as complementary to its existing Commission Management business, having seen CSA balances double year on year, and reach a new record high in February 2015.
“Since it is not clear yet whether the final MiFID II rules will allow research payments through existing CSAs, Instinet’s action is a hedge for its own commission management business,” Integrity Research Associates said in a research note.
If CSAs are scaled back or prohibited in Europe, asset managers are likely to increase their CSA usage in other regions.
“Globally, the issues like what the Europeans are dealing with right now will serve to increase usage of CSAs,” said Upward. “The jury is still out on what it means in Europe, because if on the European level, it’s clear that CSAs, in their current form, are not going to be adequate, CSAs in Europe are either going to have to be enhanced to fit the parameters of Esma’s technical advice, or they are not going to be used at all.”
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