Regulatory compliance: MiFID II solutions

An investment firm will need to set up a research payment account funded by specific research charges billed to the firm’s clients. Research charges to fund these accounts must be based on a research budget determined by the investment firm, and cannot be linked to the clients transaction volumes or values.

The amount and frequency of the research charge to fund the research payment account must be agreed between investment managers and clients. Research budgets may only be increased with a client’s written agreement, and must be managed solely by the investment firm, with senior management oversight. Investment managers need to put in place certain controls, including a clear audit trail of payments to research providers and how the amounts were determined. Investment managers need to regularly assess the quality of the research, including its ability to contribute to better investment decisions and the extent it benefits client’s portfolios and have a written policy documenting this process.

The amount investment managers are willing to pay to each broker supplying research will need to be determined in advance. The aggregation of these budget figures will determine the research charges for the firm’s clients. Increasing the research budget will require written agreement from clients. Research commissions will need to be tracked at the fund level. Broker votes can be used for allocating research charges, but do not address budgeting and client approvals.

Direct payment by investment managers only requires general disclosure and conflict management. Investment managers may account for their direct payment through an increase in their portfolio management or advice fees.

Asset managers may be able to use CSAs to pay executing brokers for trade execution while allocating part of the commission for a research provider. CSAs may become a mechanism adopted to implement research payment accounts. They help address conflict of interest issues between brokers and portfolio managers. However, CSAs alone do not meet MiFID II requirements as they allow research charges to be linked to transaction volumes.

Broker dealers may potentially benefit from the new guidelines as CSA brokers. However, ESMA states that research pricing should be unbundled and is calling for the European Commission to address conflicts between investment banking and research.

Where they execute over-the-counter, investment managers must be able to check the fairness of the price proposed to the client. This shall be done by gathering market data used to estimate the price of the product and through comparisons when possible to similar products.