Research Billing: The Current State of Affairs

Why U.S. Firms Must Pay Close Attention Ahead of MiFID II Implementation

U.S. financial institutions are scrambling to adjust to the expected shift within the trading industry with the implementation date of MiFID II, January 3, 2018,  quickly approaching. Whether or not financial institutions plan to absorb the cost of research, middle and back office CSA and research processes and reporting must adapt to meet these needs.

Just weeks after CFTC Commissioner Sharon Bowen strongly endorsed the U.S. adoption of MiFID II rules, American financial institutions are beginning to slowly realize that a paradigm shift is coming to the trading world in the way of investor protection. The days of ‘soft dollaring,’ the practice that allows for fund managers to pay executing brokers for research through trading fees, may very soon come to an end; The practice has slowly been falling out of favor in recent years. The end of CSAs, or Commission Sharing Agreements is just one of the ways that increased transparency may enter the U.S. market with the implementation of MiFID II on January 3, 2018.

Come January, American firms doing business in Europe or with European clients will have to do more than ever to prove that they are getting investors the best deals. This means saying goodbye to the cost of research that is directly funded through trading commissions.

Some of the largest U.S.-based asset managers have already decided to cough up research costs from their own P&L. However, not all houses have decided on this approach, so it by no means signals an end to the research billing and commissions saga. On the contrary, significant implications as a result of a broker’s business are likely to be felt long beyond January 3rd. As fund managers begin budgeting and assessing research value, brokers are still left fielding the first wave of questions such as, “when and how am I going to be charged?” and “what exactly am I going to be paying?” The second wave of questions, such as, “Are all research providers invoicing in a standard pricing approach, standard format and frequency?” have not even yet arisen.

While those in equities research may be akin to these questions (albeit with minimal contracts and invoices managed retrospectively and manually), Fixed Income, Currency, and Commodity (FICC) intermediaries are on less familiar ground. The cries from the research sales desk can already be heard: “I have never had to charge for this before, how do I go about recording and enforcing these agreements?”

Previously, FICC research was subsidized by the banks, who were assured to receive some revenue from trading. They now need to find a way to manage large numbers of global and regional research contracts and agreements, this includes budgets and invoicing in regional currencies which will need to be converted to the base currency for global client servicing. All of this leads to a mountain of contractual paperwork and tracking of interactions.

However, even if the sell-side gets to grips with research, the problem starts to get thorny when attempting to figure out how CSA agreements tie into creating eligible research pots, where permissible. Can the interplay be viewed as an inducement – trading commission splits versus research spend? The problem is, under MiFID II, the number of counterparty agreements is set to increase tenfold. Therefore, it is much harder to create and manage CSA agreements while linking to the right research buckets.

As a case in point, banks are anticipating the number of both Research and CSA agreements increasing from the hundreds to the thousands over the next six months. Apart from the very apparent administration workload and cost implications, why does this matter? Firms may need to provide clients with very intricate trading and research interaction details for buy-side reconciliation. To meet the requirement, firms must show when and what specific rate cards were agreed upon – including a copy of the rate cards/fee structure and a signed agreement (although some institutions are establishing that verbal agreements are sufficient), which must also be auditable for good measure. All of this means that the sell-side needs to find a way to manage multiple agreements, rate cards across different markets and regions, numerous instrument types and various service offerings. Try doing this successfully with the old-fashioned manual spreadsheet approach.

With so much to consider, is it realistic to think that the big sell-side houses will get their client contractual negotiations and agreements sorted in just four months? Whether it is new audit trails for proving that the best client advice was provided or the huge increase in processes that need to be automated, brokers and banks still have plenty to ponder. So, while January 3rd may well be the date everyone is currently working night and day towards, when it comes to MiFID II Research and CSAs, one can’t help but feel that the real work has yet to begin.

To remain the world’s most attractive investment market, the U.S. must double its efforts to improve its data transparency and commit itself to acting in end-clients’ best interests. The rest of the world is moving in the same direction, and the U.S. must comply, or risk falling behind.