Trade Groups Pan Proposed Research Commission Ban

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Comments on the proposed language in MiFID II banning research commissions have been negative, reflecting broad opposition among asset managers.  Despite this, informed sources expect little change to the proposed language in the final rules.

The European Securities and Markets Authority (ESMA), the European-wide regulatory authority whose members are the financial markets regulators in each of the 28 member states, is charged with codifying the regulatory language associated with the MiFID II laws passed by the European parliament in April 2014.   ESMA published a 500-page discussion paper in May 2014 and requested comments by August 1st.   Many of the groups commenting have made their submissions public.

The Investment Management Association (IMA), which represents the UK asset management industry,  expressed strong opposition to the ESMA draft language:

“The IMA does not support ESMA’s proposals.  Research associated with the use of dealing commissions is not an inducement.  Rather, it raises conflicts of interest, which need to be managed.  Further, ESMA’s proposals would create a muddled regime with never-ending debate about what was allowed and what was not.”

The IMA argued that the ban would invite regulatory arbitrage putting European-based asset managers at a disadvantage to asset managers based in other domiciles, such as the U.S., which are not moving to ban research commissions.

The IMA also warned of unintended side effects from the ban such as “reduced research coverage, poorer price formation, reduced liquidity in small cap stocks and raised barriers to entry for new entrants to the investment management industry.”

The IMA intends to host a conference for global regulators, investment managers and the sell-side providers of investment research to begin an evaluation of both current and alternative research models, including those where dealing commissions are no longer used.

The Managed Funds Association (MFA), a U.S. based trade association for hedge funds, also called for further study, and asked ESMA to delay any changes until a “thorough consultation and extensive study/survey” could be conducted.

The German fund association, BVI (Bundesverband Investment und Asset Management) also requested additional discussion:  “ESMA should allow for a genuine discussion on this subject before deciding on an approach which will lead to radical changes to the European Financial Market causing competitive disadvantages also to the detriment of the investors ESMA intends to protect.”

The BVI said ESMA’s proposals would have “severe consequences”, and argued the changes would lead to a decline in the number of research providers and a decrease in the information available to fund managers.   Research provided to asset managers should be viewed as a manageable conflict of interest, it added.

The AFG (Association Francaise de Gestion financière), the French fund association, reportedly said that research on smaller and medium-sized companies would suffer if ESMA’s plans were implemented.

The Swedish Investment Fund Association (SIFA) asked ESMA to exclude research from its definition of inducements because it views research is a financial service fundamentally connected to execution. It warned of unintended consequences such as increased cost for asset managers favoring larger firms with in house research facilities and creating an un-level playing field with markets outside the EU.

The Wealth Management Association (WMA), the UK trade group for smaller wealth managers, said ESMA’s proposals were “somewhat severe” and may have unintended consequences.

Conclusion

Despite the deluge of negative comments, those who have spoken to regulators and the European legal community believe that the ESMA language banning research commissions is likely to be adopted.  Partly this is a function of the large volume of other regulation contained in MiFID II, diverting focused attention on the inducements component.

On the other hand, the market regulators in France and Germany are rumored to be uncomfortable with extensive reform.  The Autorité des Marchés Financiers (AMF) indicated in July that it was hesitant to adopt changes that would reduce the volume of research.  It said it was concerned about the impact of a ban on French asset manager profit margins, which remain depressed after the financial crisis.  The AMF was also worried that smaller asset managers would be less able to afford research than larger managers, putting them at a competitive disadvantage.

The next step is for ESMA to publish a consultation paper which is expected between December 2014 and March 2015, which will contain the next version of inducements rules.  In the meantime, you can be sure that asset managers, investment banks, and other interested parties will be meeting with regulators to underline their concerns.    EU Member States are required to adopt MiFID II provisions by June 2016 and the rules would take effect January 2017.  How it plays out will be a matter of great interest to the research community in both Europe and elsewhere.

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