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Research Payments under MiFID II: Is there no such thing as a free lunch?

06 July 2018 Francis Land

As the FCA embarks on a review of the MiFID II's research payment rules many asset managers will welcome further guidance into the new policies and procedures. A particular area of focus is expected to be the pricing of certain research packages by investment banks, and whether some of those packages could be considered to be an inducement to trade with those research providers.

Casting my mind back to days of studying 'A' Level Economics, in the long distant late 1980s, one of the first economic mantras my economics teacher told the class was, "there's no such thing as a free lunch". The phrase was popularised by Milton Friedman as the title of his 1975 book on economic theory, originating from a late 19th century custom of saloon patrons in the United States being provided with a "free" lunch after purchasing at least one drink. In economic theory the phrase understands that in the real world a consumer cannot expect to get "something for nothing". Even when a good or service appears to be free of charge, or even extremely "cheap", chances are there will be a hidden cost, somewhere to the consumer.

Through the subsequent decades, it is fair to say that the financial sector developed a certain reputation for entertainment and hospitality which suggested that the tenets of the "no free lunch" theory were not at the forefront of minds. Rather than "there's no such thing as a free lunch", it was more a case of "I'll have a fillet mignon and a large glass of claret, and thanks for taking care of the bill - I'll see you right later, back at the desk", or so the industry's reputation had it.

Writing in early July 2018 we are into the seventh month of the reality of MiFID II. In theory the idea of "no free lunch" should be quashed in research payments. Asset management firms will have decided either to pay for research themselves, or to unbundle their trading commissions and utilise a research payment account to segregate research monies. Either way, trading commissions are only used to pay for trade execution services.

That is how it should be - however, we already see evidence of greatly differing implementation of the rules in the context of payments for research. In the UK, the largest firms put in place working parties to discuss MiFID II implementation and ultimately decided to use their own money to pay for research services, therefore not passing the cost on to investors. Move across Europe and we find regulators who have not yet opined on the implementation of the research rules and industry participants who have yet to take the first steps towards the unbundling of trading commissions. Furthermore, it is also too early to know how each European regulator will interpret the rules in their own jurisdictions, if and how they will enforce the rules, and when that process will start.

There is much work to do in consolidating research consumption, enhancing research evaluation and the formation of research price benchmarking data sets. As the work continues, in my next post I will outline what I perceive to be a substantial unintended consequence of the new rules in payments for research.

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