The following is a guest article from Amrish Ganatra, Managing Director of Commcise Software Limited, a London-based provider of commission management software.
Research accounting – mapping research costs and usage to the asset owner level – is becoming increasingly important for asset managers, including those that are absorbing some portion of their external research expense. Even asset managers not subject to MiFID II are under some pressure to provide more transparency on research costs.
What Is Research Accounting?
Research accounting is a core component of achieving MiFID II compliance, often overlooked by asset managers pressed to determine how to pay for research or track their consumption. It describes the process of linking the consumption and funding of research back to the original asset owners. This transparency is a key aim of new MiFID II research rules and is expected to help asset owners compare the total cost of delegating a mandate between fund managers, while having greater certainty that they are only paying research costs that have provided direct benefits to them.
In theory, research accounting is not required if asset managers are paying for all research globally via P&L. In practice, however, the process is necessary to determine client profitability. We’ve seen internal finance teams at firms paying P&L requesting fund level reporting to ensure costs can be allocated appropriately and compared to revenues for each account.
Research accounting is absolutely required if firms are ring-fencing European obligations or have any form of mixed funding model.
How Is Research Accounting Achieved?
There are several key steps required to deliver accurate research accounting:
- Asset managers must model their research consumption profile. What does this mean? They must consider how research is consumed and map this to the funds, accounts or clients that benefit from its consumption. The regulators have given permission to put funds into groups that can be treated collectively, often referred to as desks or strategies. Asset managers must ensure that all funds that form part of a given desk or strategy have a similar investible universe and materially benefit from all the research consumed at desk or strategy level.
- Asset managers must track funding and consumption. Research costs must be accurately tracked at the fund level (irrespective of funding method) and research consumption must be tracked at a desk or strategy level. The challenge is that desks don’t consume research; individuals do; and these individuals often manage or support multiple funds that often sit across regions or desks. Some organisations run internal research desks, which may make use of external providers’ services, and report overall findings to investment desks. Multiple consumers may make use of the same research, attending meetings together, for example, and might offer a different evaluation of the services. Asset managers must have a defensible bottom-up valuation approach that takes account of the above difficulties, and can be used to feed into a robust research accounting framework. This requires asset managers to additionally consider how each research consumer maps adds value to each fund that is being managed.
- Asset managers must ensure that both costs and benefits of research are fairly allocated down to fund level. The regulators have provided guidance that firms may choose to use proxy statistics such as net asset value or assets under management as a means of allocating such costs and benefits. Allocating both costs and benefits down to fund level will help asset managers to provide evidence that there is no unintended cross-subsidization between clients. However, this may not always be an easy task, given that funds may be invested across multiple desks, and may vary in investment level over a period.
Do I Need Research Accounting If I Am Not Affected By MiFID II?
Many asset managers outside the scope of MiFID II are starting to see requests from asset owners asking for greater transparency on research costs. Research accounting can allow these firms to provide evidence that they are applying the principles of MiFID II whilst still respecting jurisdictional constraints. Such firms don’t have to set up an RPA or fully unbundle every trade into a CSA in order to demonstrate compliance with the spirit of MiFID II. By employing a best practice approach to research transparency, such firms strive to be “MiFID ready”.
What If I Don’t Have a Research Accounting Framework in Place?
Producing a defensible MiFID II-compliant ex-post report is very difficult to achieve without some form of research accounting framework in place:
- Asset managers may agree to different funding methods for clients, often within the same strategy
- Ensuring a clear separation of these funds, potentially in distinct bank accounts, requires detailed accounting
- NAV or AUM values vary over time, and accounts may leave or join a strategy
- Asset managers often share research globally across MiFID II and non-MiFID II regions
- Demonstrating compliance with the jurisdictional constraints of each region, while ensuring that non-MiFID II accounts are not subsidizing research for MiFID II accounts, may be very difficult to achieve
What Other Benefits Does Research Accounting Provide?
Asset managers who embed their ex-post MiFID II reporting into an internal control framework will be able to demonstrate that they are managing funding and consumption to communicated fund-level research budgets. Firms who have elected to pay research costs from their own resources will also benefit from being able to allocate funding and consumption directly to their funds, to provide insight into profitability.