This the first of a two-part examination of the French regulatory interpretation of new European rules unbundling research payments from execution.
L’Autorité des Marchés Financiers (AMF) released its consultation paper interpreting the research payment provisions in the MiFID II Delegated Acts, fulfilling its plan to preempt UK regulators, which are rumored to have pushed back the release of their MiFID II consultation to October. The AMF interpretation is generally balanced and suggests that the French will try to be accommodating to industry concerns so long as they do not conflict with the MiFID II language.
The AMF plans to adopt the directives as authored by ESMA. The purpose of the consultation paper is to elaborate the AMF’s interpretation of the new rules. The deadline for responses is October 28th, 2016.
The AMF chose not to tackle the issues surrounding fixed income research, instead focusing its comments on equity research.
Commission Sharing Agreements (CSAs)
The AMF was a vocal proponent of continuing to allow research payments with client commissions, fearing that full unbundling would favor larger (UK) asset managers at the expense of smaller (French) asset managers. It is therefore no surprise that the AMF consultation paper endorses the use of CSAs to fund research payment accounts (RPAs). The paper notes that execution fees will need to be charged to client accounts separately from research costs, which is a modification of the current process where one CSA fee is charged, then subsequently separated into an execution component and a research allocation.
Typical CSA fees are around 15 basis points (bp), with execution potentially being 7 bp and the research allocation 8 bp. Going forward, the execution fee, in this example 7 bp, will be charged to the client account with a separate 8 bp attributed to the research payment account.
The AMF raises the issue of counter-party risk associated with CSAs: “[I]t is up to investment firms to ensure that the legal security of accounts held with their intermediaries is satisfactory.” Although the AMF did not elaborate, we infer that the concern is whether the RPA balances might be deemed to be brokerage monies rather than client balances, as with current CSAs in some domiciles.
For this reason, we expect that CSA aggregators which offer physical aggregation, such as Instinet or Westminster, will have an edge over virtual aggregators such as Markit or Cogent, particularly where the accounts are ring-fenced.
The AMF considers what types of research might be considered ‘a minor non-monetary benefit’ and thus exempted from the new MiFID II rules. It suggests that brokerage macroeconomic research distributed widely to a large client base for marketing or sales purposes might be construed as exempt:
“Insofar as such research has been widely disseminated, it might reasonably be considered that the provider has not allocated specific substantial resources to any given portfolio manager in order to produce it. Consequently, such research constitutes a minor non-monetary benefit which could be received by the investment firm free of charge, without compromising the firm’s obligation to act in the clients’ best interests.”
On its face, this may not be happy news to independent macro shops which charge subscriptions for their services, but there is a potential two-edged sword for brokerages offering macro research. While it is potentially ok to bundle macro research with other services, at least in France, clients have no obligation to pay for it. Therefore, over time the funding for brokerage macro research deemed a minor non-monetary benefit becomes increasingly uncertain.
The AMF makes it clear that services that charge a fee cannot be deemed to be ‘a minor non-monetary benefit’: “Insofar as the benefit in question constitutes a minor non-monetary benefit, it will not be charged to the investment firm by the service provider, and the investment firm will therefore not be able to charge the cost to its own clients.”
At the other end of the spectrum, you have services which the regulators do not deem research. Since research payments can still be funded with client commissions, the regulatory concern that asset managers not unduly broaden the definition of research remains.
The AMF published a list of non-research items in 2007, which includes portfolio valuation services but does not exclude market data. It is considering updating the list, but has not done so yet.
The paper suggests that trade ideas distributors like the TIM Group can be considered as research and funded through RPAs: “Regular business contact between investment firms and their market intermediaries, who highlight suggested investments (“trade ideas”), can also qualify as supporting investment decisions.”
We will cover the AMF’s views on corporate access, research budgeting and disclosure in an article tomorrow, as well as providing our take on the paper.