On 7 April 2016 the European Commission published its Delegated Act which deals in particular with the receipt of investment research under MiFID II and consequently how that will effect UK and EU Investment managers.
As part of MiFID II’s inducement rules, MiFID firms, when providing portfolio management services, must not accept and retain fees, commissions or any monetary or non-monetary benefits paid or provided by (or on behalf of) a third party.
Consequently, when the European Securities and Markets Authorities (“ESMA”) released their Final Technical Advice concerning MiFID II and MiFIR in 2014, they proposed that the receipt of investment research by an investment manager should be treated as an inducement and therefore could only be paid for either by the manager’s own resources or through a research payment account (“RPA”). ESMA went further to state that it would not be permitted for those RPAs to be funded by commissions generated from execution trades. This proposition would have a knock on effect on the use of dealing commissions and commission sharing agreements to pay for investment research.
Broadly speaking, the European Commission does adopt ESMA’s view that the receipt of investment research should on the face of it be considered an inducement for MiFID purposes. However, the European Commission on publishing their Delegated Act (the final rules on investment research), have clarified the stance on the unbundling of payments for research from dealing commissions. Article 13 of the Delegated Act preserves the ability of investment managers to receive research from third parties through payments either:
- directly by the investment manager out of its own resources; or
- from a separate RPA controlled by the investment firm and provided they meet certain conditions relating to the operation of the account.
Yet, it is stated that the RPA may be funded by transaction commission/dealing commission, subject to certain conditions. These conditions will effect the way in which investment firms obtain client agreement, the operation and disclosures related to the RPAs. Article 13 outlines the operational requirements for the use of RPAs as follows:
- the research payment account is funded by a specific research charge to the client;
- as part of establishing a research payment account and agreeing the research charge with their clients, investment firms set and regularly assess a research budget as an internal administrative measure;
- the investment firm is held responsible for the research payment account; and
- the investment firm regularly assesses the quality of the research purchased based on robust quality criteria and its ability to contribute to better investment decisions.
The requirements relating to the disclosure of information to clients when using RPA’s are as follows:
- before the provision of an investment service to clients, information about the budgeted amount for research and the amount of the estimated research charge for each of them; and
- annual information on the total costs that each of them has incurred for third party research.
Subsequently this will call for investment mangers reviewing and adapting any existing procedures which do not fall in line with those conditions. For example, one of the conditions relates to informing the client of the research charges as budgeted by the firm and how frequently such charges will be deducted from the client’s resources. These arrangements will need to be reflected in the firm’s investment documentation for example; investment management agreements, commission sharing agreements and/or general terms of business.
Additionally, there will also be an impact on sell-side firms i.e. banks and brokers. The last paragraph 9 of Article 13 relates to execution service charges. Here, the Delegated Act now requires those firms providing such services to identify separate charges that solely reflect the cost of executing the transaction and any other services provided, including research. It should be noted however that this rule is limited to other MiFID firms within the Union and therefore this rule does not apply if a firm is dealing with non-EU investment managers.
The European council and parliament have 3 months to scrutinise the Act, after which they can either extend the period of scrutiny for a further 3 months or if no objections are made the Act will be published and it will apply from the date of the introduction of MiFID II (expected to be January 2018).
The Delegated Act can be found here: https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-2031-EN-F1-1.PDF
Should you require any assistance in updating your agreements to reflect the new rules, Cleveland & Co, your external in-house counsel, is here to help.