Commission management software provider Commcise has partnered with trading systems provider Fidessa group to facilitate the use of commission sharing agreements (CSAs) to implement newly required Research Payment Accounts mandated under MiFID II regulations.
Under the new partnership, buy side clients of Commcise and Fidessa will be able to calculate how large a research payment to add to a CSA trade and then notify the broker counterparty’s settlement operations of that amount using Fidessa’s post trade utilities.
Murky rules around CSAs
It is estimated that 75% of European asset managers pay for research via CSAs. However, under new MiFID II regulations which go into effect in 2018 asset managers must budget and communicate a separately identifiable research charge to their clients, and that charge cannot be determined by the volume and/or value of transactions.
After intense lobbying by the industry and investment banks, the EU added vague language ostensibly permitting the use of CSAs:
“Every operational arrangement for the collection of the client research charge, where it is not collected separately but alongside a transaction commission, shall indicate a separately identifiable research charge and fully comply with the conditions [pertaining to an RPA].”
It has been left up to market participants to sort out how CSAs can be re-engineered to meet MiFID II requirements.
The Commcise/Fidessa approach is to put the buy-side in the driver’s seat for determining the size of the research payment added to a CSA trade. Under the traditional CSA model buy-side and sell-side firms jointly agree commission splits in advance of executing a trade. Under the new approach, the sell side has no say in the research portion of the trade.
The research payment amount allocated by an asset manager to any given CSA trade is determined by preset research budgets which typically would be managed at the fund level. Commcise’s commission management software calculates the amount of research budget remaining and how much is allocated to each relevant fund. The research amount allocated to the trade might be capped to ensure that any given trade does not exceed a defined target for trade cost analysis.
The research payment amount to be allocated to the trade is then linked from Commcise’s software to Fidessa’s AMS post-trade utility so that can it can be delivered directly into sell-side settlement operations.
As an example, a broker and asset manager execute a trade with 5 basis points being the execution cost of the trade. The asset manager determines that its large-cap European fund has £10,000 remaining research budget and its small-cap European fund has £1,000 remaining budget. It will then allocate a research payment of £11,000. This payment can be expressed as a cash amount, or in basis points for UK trading, or in cents for US trading.
So depending on the size of the trade, the broker might receive a notice through Fidessa’s AMS utility that the trade was 5 basis points for execution plus an incremental 5 basis points in research allocation. Or, if the trade is too small, the payment might be capped at 10 basis points for the research allocation, ensuring that no CSA trade exceeds 15 basis points.
Fidessa & Commcise
Commcise approached Fidessa a year ago to gauge its interest in collaborating on this solution. Because Fidessa’s trade systems are used by 85% of London-based brokers, it was one of the few trade systems operators who could support a post-trade process that could be entirely dictated by the buy-side.
Most trade systems require joint reconciliation of the sell-side with the buy-side, but because the research portion of the trade is entirely generated from the buy side, Fidessa’s system simply notifies the sell-side of the research payment allotment.
It is potentially confusing to speak of using CSAs to “fund” RPAs. MiFID II explicitly requires that research charges “not be linked to the volume and/or value of transactions executed on behalf of the clients.” Therefore CSA trades should not have any influence over the research costs charged back to clients.
Instead, research charges will be set a priori by asset managers budgeting their research costs and allocating those costs to their funds and the clients of those funds. Once those costs have been set, it is then a matter of allocating payments to the appropriate research providers. CSAs are a mechanism for allocating those payments.
Therefore rather than saying CSAs “fund” the RPA, it is more accurate to say that CSAs are a way of implementing the RPA. CSAs are one way to set up an RPA because they are an existing mechanism for research payments.
The power of the Commcise/Fidessa approach is that the sell-side has no influence over the research portion of the CSA trade, which is completely driven by the buy-side. The solution will help asset managers envision how they can use CSAs to implement MiFID II’s research payment requirements.
That doesn’t necessarily mean that asset managers won’t decide to chuck all the bother and simply decide to pay for research out of their own P&L, as Woodford, Baillie Gifford and a few others have done. However, for global asset managers seeking regulatory compliant solutions they can implement across multiple domiciles, any solution that makes CSAs more feasible will be welcome.