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“The Report of My Death Was an Exaggeration”, or “The Emperor Has No Clothes”? Some thoughts on the future of Commission Sharing Arrangements in a MiFID II world.

19 March 2018 Francis Land

Not long after starting my career in the City, I joined the Depositary Receipts Division at the world’s largest provider of Depositary Services. My initial enthusiasm for the job was tempered considerably by an early meeting at which a prominent investment banker confidently told me “ADRs will be dead in 5 years”. That was 1996, yet in 2018 ADRs are still “alive and kicking”, to quote my favourite Glaswegians, Simple Minds.

The banker had a point of course, why would such an apparently archaic structure for listing shares on an international exchange exist in the modern world? Well, perhaps because the market knows ADRs, understands them and they continue to help companies to access global capital markets where otherwise they might struggle to do so.

I was reminded of that conversation again on reading the news that Fidelity International had opted to pay for investment research themselves, ending their use of Commission Sharing Arrangements (CSAs). The largest UK asset managers, as well as a number of the biggest firms on the continent have decided to pay for research themselves under MiFID II, rather than continue to charge these costs to their customers and utilise a discrete Research Payment Account.

When describing the practice of using client commissions to pay for research, a senior fund manager said to me last year “The Emperor Has No Clothes”. And certainly, judging by the tone of recent headlines in the financial press the reader could assume that the whole asset management industry has taken the same collective decision.

But is that really the case? At IHS Markit we believe the position is less “cut and dried”. Our Research Procurement Services cater to asset management firms using all three payment methods to pay for research services; the afore mentioned “self-pay” model, and the two alternative approaches to fund a Research Payment Account where underlying investors pay for research, the “transactional” method (CSAs) and the “accounting” method (sometimes known as the “Swedish Model”). We see demand for all three methods with some firms using more than one model, often driven by their global presence and need for distinct solutions in different regulatory regimes.

Decisions taken by the biggest firms make headlines and set the tone of the debate, but can provide a distorted view. The European asset management industry has thousands of firms, big, not so big and very small. Those firms have their own unique circumstances; client base, investment style, organisational structure requirements for research. My experience of speaking to well over one hundred firms about their plans to conform with MiFID II during 2016 and 2017 taught me a lesson which IHS Markit has built into the design of our Research Procurement products.

Flexibility is vital. Do not assume you know how an asset management firm will want to utilise your products. Make sure those products are designed to cope with those differing requirements. The reality as we see it, is that many firms, especially small and medium sized managers, are implementing Research Payment Accounts, funded either through commissions or a direct charge to the client assets. Let’s not forget, they have permission to do so. Regulators decided, correctly in our view that asset management firms should be given the option of making decisions on funding according to their own distinct needs.

Think of it as an iceberg. Above the surface are the biggest firms, small in number but big in assets under management, profile and ability to generate headlines. Beneath are the majority of firms, smaller individually, and continuing in great numbers to use trading commissions and CSAs to pay for research services.

Let’s be frank, the average boutique asset management firm, set up in the last few years with entrepreneurial spirit but relatively low assets under management (for now) will have more cash flow issues than the average giant global asset management firm. Our boutique firm evaluates their research needs, negotiates hard on rates, unbundles execution and research, complies with best execution requirements and the other regulatory burdens they face, but frankly does not have the resources to purchase the research, analytics and data services that they believe are essential to delivering performance to their investors.

So the boutique explains this situation to their investors, gets their approval and continues to use commissions and CSAs to fund a Research Payment Account. Now, they are able, on a relative basis, to access the same high calibre analysis and data as the biggest firms. They can compete. And we think that is a good thing.

So will MiFID II prove that for CSAs, “The Report of My Death Was an Exaggeration”, or will the Edinburgh fund manager prove accurate in his assessment that “The Emperor Has No Clothes”. Too early to say perhaps, but we will continue to observe with a great deal of interest.

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