The following is a guest article from John McGough, Global Head of Business Development of Castine LLC, a provider of research procurement solutions including P&L Centre.
Recently, a fair number of large global asset managers have gone public about their plans to pay for investment research from their own resources post MiFID-II.
Managers electing to pay for research through their own resources in lieu of using client money must understand that using this payment approach will not eliminate the inducement risks under MiFID II.
Article 13 within the European Commission’s Delegated Directive makes it clear that paying for research through execution is an inducement which must be mitigated. Paying for research from the P&L involves fewer stipulations than charging clients for research, but does not eliminate the inherent risks under MiFID II regulation.
Similarly, guidance published by the UK trade association for asset managers, the Investment Association (IA), cautions that choosing to pay for research from its own resources does not release asset managers from MiFID II obligations:
“Whichever route firms decide to go down (including model 1 – P&L) they will face a series of issues that they will have to tackle in the run up to implementation of MiFID II, in particular:
- Budgeting and allocation of research costs in the best interests of clients.
- Acquisition of fixed income research.
- Paying US brokers who offer research alongside execution.
- New pricing models from the sell side that will need to be negotiated.
- Global structures and international clients.
- The mechanisms required to transition to one of the three options in the new regime.
- Application of VAT.”
Managers paying for research from their own resources may not be the immediate focus of local EU regulatory reviews, but since many of European asset managers are adopting the policy, it will not provide immunity from inspection. Managers will need to justify the value of the research they consume to ensure they’re not underpaying for research on the understanding of directing trades.
For this reason, EU regulators will be examining the research budgets and payments made by asset managers subject to MiFID II, irrespective of how research payments are funded. Additionally, valuations will be under scrutiny to see if they are consistent with industry practices.
Managers must focus on inducement risks by executing written agreements with ex-ante pricing, gathering of metrics to demonstrate fair research valuation, routinely perform due diligence and evaluate their research providers and take measures to ensure research is not received for free.
Global managers consuming cross-border research who have elected to ring fence their EU business to pay research with P&L in the EU while operating CSA’s outside the EU must be especially careful. Under MiFID II, local EU regulators will expect the allocation of research costs be handled consistently with MiFID II requirements. Regulators will examine what research costs were waived for EU clients and how they were derived, forcing international managers to adopt consistent research budgeting and valuation on a global basis.
 Page 26, EC Delegated Directive of 7.4.2016 https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-2031-EN-F1-1.PDF
 Page 3, the Investment Association’s “Approach to Research Under MiFID II” http://euroirp.com/wp-content/uploads/2016/10/IA-Approach-to-Research-under-MiFID-II.pdf