While much has been discussed in the press about the proposed MiFID II rules regarding research payments, very little has been said about the mechanics of an RPA due to a lack of clarity from regulators on this topic. Consequently, while most asset managers know they must use an RPA to pay for research, few understand how one is likely to work.
There are three ways under MiFID II that an asset manager can pay for research – a direct charge to clients (the accounting method), a research charge collected alongside execution (the transactional model), and from a firm’s own P&L. Given the popularity expressed by asset managers for using CSA’s to fund an RPA, we will discuss this option today.
Players in the RPA Solutions Marketplace
Integrity Research is currently conducting a deep dive analysis of the “RPA Solutions” marketplace and will be publishing a proprietary report on this topic in the coming weeks. This is the term we are using to describe the eleven firms we have identified which have developed new systems or modified existing services to meet the mandated research budgeting, valuation, trade reconciliation, payment, and reporting requirements associated with MiFID II. According to our analysis, there are two different types of players in this marketplace today.
The first type are financial technology firms that have developed enterprise wide software platforms to help asset managers meet MiFID II requirements. These firms generally provide research budgeting, valuation, trade reconciliation tools, payment authorization, and reporting capabilities. We call these firms “Research Procurement Solution Providers” as they enable asset managers to meet the new research procurement rules associated with the new EU regulations. The firms that either currently have a service or who are developing a service like this include Castine Consulting, Commcise, Eze Software, FrostRB, and Investars.
The second type of firms are primarily agency brokers, which have existing commission management clients who wish to leverage existing commission management infrastructure in implementing RPA solutions. For this reason, agency brokers have extended their capabilities, and in some cases partnered with software providers, to offer a broader suite of tools for implementing MiFID II research procurement requirements. In addition to many of the services provided by the Research Procurement Solution Providers mentioned above, these firms have all decided to provide payment or RPA Administration services. Consequently, we call these firms RPA Administrators. The firms that either currently have a service or who are developing a service like this include Bloomberg Tradebook, IHS Markit, Instinet, ITG, Liquidnet, and Westminster Research Associates.
The Transactional Method
The Transactional Method of funding an RPA describes an approach where an asset manager collects a research charge from their clients alongside an execution commission. Most market participants believe that it is possible to fund an RPA using a Commission Sharing Agreement (CSA) style approach.
Funding An RPA – The Transactional Method
1 Currently the firms planning to be RPA Administrators include Bloomberg Tradebook, IHS Markit, Instinet, ITG, Liquidnet, & Westminster Research Associates. 2 Research Procurement Solution Providers include Castine, Commcise, Eze, FrostRB, and Investars. All RPA Administrators are also providing clients with much of the functionality provided by Research Procurement Solution Providers.
As you can see from the above diagram, using the Transactional Method to fund an RPA, asset managers would execute unbundled trades with CSA brokers, establishing a defined execution rate and research charge. The CSA brokers would sweep the asset manager’s research fees which were generated from trades from the CSA to a discreet research payment account (RPA) on a regular basis. While the frequency of these sweeps have not been completely clarified, many European asset managers are getting comfortable that a monthly sweep of these funds would be acceptable to EU regulators.
The funds in these RPAs would be controlled by the asset manager, and for all extents and purposes would be asset manager funds. These RPAs would generally be housed at the commercial bank partner of the RPA Administrator they decide to use.
The asset manager would use either internal systems or external research procurement solution providers or RPA Administrators to meet the MiFID II research budgeting, valuation, trade reconciliation, payment, and reporting requirements. The asset manager would authorize invoices for payment using these systems, and would communicate this information to their RPA Administrator, who would manage the physical payments and would communicate that these payments were made back to their research procurement solution providers in order to reconcile their RPA accounts.
Besides making payments on behalf of their asset manager clients, the RPA Administrator would also be responsible for conducting KYC (Know Your Client) and Anti-Money Laundering (AML) Due Diligence, as well as due diligence to determine whether the providers they want to pay are eligible to receive payment using client commissions. This due diligence would entail the manager making sure the provider met regulators’ definition of “substantive research”.
In certain circumstances, the asset manager might need to provide authorization to the banks for the RPA Administrator to make payments from the asset manager’s RPA account.
Managing Your Own RPA
In some instances, an asset manager could choose to manage their RPAs without the use of a third-party RPA Administrator. In these circumstances the asset manager would establish a bank account at a bank of their choosing. CSA brokers would sweep their research charges from their CSA to their RPA account on a regular basis.
Once the asset manager performed their own “eligibility due diligence”, they would then be responsible for directly paying their research providers. Once this payment was made, the manager would enter the payment information into their own internal system, or a solution provided by a third-party, in order to keep their RPA balances reconciled.