UK Takes Own Approach to Unbundling
There are a number of significant areas, including payments for research, where the UK will take its own approach to implementing MiFID II, the regulations covering financial markets in the European Union from 2018.
Last week the Financial Conduct Authority, the UK regulator, published its third consultation paper on the implementation of MiFID II.
Jake Green, partner in the London office of law firm Ashurst, said in a note to clients: “Whilst much of the content of the consultation merely explains the FCA’s “copy out” approach to implementing MiFID II, there are a number of significant exceptions, where the UK will take its own approach.”
These exceptions include inducements and research; independent advice, suitability and appropriateness; product governance; and telephone taping requirements.
One area of MiFID II that has created most debate is how to pay for research. The FCA wanted to unbundle research payments and ban the use of trading commissions to buy research but this was not adopted by the European Securities and Markets Authority in the final MiFID II regulations. Instead MiFID II requires asset managers to either pay for research themselves out of their own revenues or set up research payment accounts for clients with agreed budgets.
Last month the L’Autorité des Marchés Financiers, the French financial regulator, said it approved the use of commission sharing arrangements to fund research payment accounts under MiFID II under certain conditions. Green said: “The FCA seems to take a different view.”
The UK regulator requires managers to have a single research payment account which prevents multiple brokers from holding amounts on their balance sheet. “The FCA states that operationally, this will require changes to current commission sharing agreement accounts,” added Green.
In addition the FCA requires research charges that are deducted alongside transaction fees to be swept, preferably daily, to the RPA (although detailed reconciliations might take place less frequently, such as monthly). The cash in the RPA must also be ring-fenced and separately identifiable from the assets of the broker and manager.
“The FCA falls short of saying that these sums must be treated as client money,” said Green. “This therefore appears to be a hybrid model, where money must be ring-fenced in some way, but without all of the process relating to client money rules applying, or the need to seek a permission to hold client money.”
Fund managers will be allowed to set research budgets at a desk-level or strategy level providing the interests are sufficiently similar.
Green said: “The FCA states that these changes will “ensure the investment firm retains a strong behavioural incentive to account for the use of RPA monies, and not treat it as money already spent or given up to an executing broker. It will create a clear contrast and step change to practices we have seen” – this is a clear and deliberate linguistic difference from the “not incompatible” wording used by the AMF.”
Vicky Sanders, co-founder of RSRCHXchange, the online marketplace for institutional research, said in an email that buyside firms will be relieved that research budgets can be set at the strategy level, rather than for individual portfolios. “The FCA are also extending these rules to collective managers as well which will make it easier for blended models to comply,” said Sanders.
She added that unlike the French regulator, the FCA has left very little wriggle room on their approach to unbundling. “The FCA implementation of MiFID II will ensure that a transparent, priced research market emerges and that research becomes a core and fixed cost of doing business,” said Sanders.
She continued that it is also very clear that the era of free research has come to an end as the FCA said asset managers will have ot pay for all their research.
“Investment managers and independent advisors will also need mechanisms to enable them to block the receipt of unsolicited research,” said Sanders. “That’s quite difficult to achieve when research is predominantly consumed through a fund manager’s inbox.”
Michael Lewis, financial services regulation partner at law firm Pinsent Masons, said in an email that firms will be keen to test their plans for compliance with the rules against the views of the FCA to check they remain on the right track.
Lewis added that the new proposals on taping phone calls in MiFID II apply to a wider range of activities and remove the exclusions for corporate finance business and retail financial advisers and the limited exclusion for discretionary investment managers which are currently available.
“The requirement to keep records of conversations for five years rather than six months and for those records to be readily available to a firms’ compliance teams and the FCA will likely have significant cost implications for firms,” added Lewis.
Preparations for MiFID II are likely to cost firms a total of $2.1bn next year according to a report last week from Expand (a Boston Consulting Group company) and IHS Markit, the financial data services provider. The study covered 40 global investment banks and 400 global asset managers with each side of the industry expected to spend in excess of $1bn.
The study found that investment banks are planning to implement the majority of their MiFID II preparations next year while fund managers vary considerably in terms of preparedness with some still at a preliminary planning stage.
“Over half of the average MiFID II budget of the investment banks is allocated towards enhancing trade reporting and transparency, whereas the increased emphasis on best execution means that asset mangers’ budgets are primarily targeted at allocating resources towards improving investor protection,” said the report.
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