1. Dealing Commission under MiFID II
Guy Sears Director
Ross Barrett Capital Markets Specialist
Adrian Hood Policy Advisor - Regulation
Investment Management Association

2. Outline Timeline European Securities and Markets Authority (ESMA)
Securities and Markets Stakeholder Group (SMSG)
Financial Conduct Authority (FCA) Current UK Position
FCA Discussion Paper Impact Analysis
Investment Management Association (IMA)
Transitioning to 1 January 2017

3. Timeline Date Event 22 May 2014 ESMA MiFID CP & DP Published
FCA PS 14/7 Published
10 July 2014
FCA Publish their Review
3 Sep 2014
SMSG Response to ESMA
December 2014
ESMA Provides Advice to Commission on Delegated Acts
ESMA CP on Draft RTS – follow up to the DP
June 2015
Commission Adopts Delegated Acts
ESMA submits Draft RTS to Commission
July 2016
Transposition into Member States Legislation
1 January 2017
MiFID II rules come into force

4. Article 24 (8) Directive
“When providing portfolio management the investment firm shall not accept and retain fees, commissions or any monetary or non-monetary benefits paid or provided by any third party or a person acting on behalf of a third party in relation to the provision of the service to clients.
Minor non-monetary benefits that are capable of enhancing the quality of service provided to a client and are of a scale and nature such that they could not be judged to impair compliance with the investment firm’s duty to act in the best interest of the client shall be clearly disclosed and are excluded from this paragraph.”

5. Recital 74
“In order to strengthen the protection of investors and increase clarity to clients as to the service they receive, it is also appropriate to further restrict the possibility for firms providing the service of investment advice on an independent basis and the service of portfolio management to accept and retain fees, commissions or any monetary and non-monetary benefits from third parties, and particularly from issuers or product providers.
This implies that all fees, commissions and any monetary benefits paid or provided by a third party must be returned in full to the client as soon as possible after receipt of those payments by the firm and the firm should not be allowed to offset any third-party payments from the fees due by the client to the firm. The client should be accurately and, where relevant, periodically, informed about all fees, commissions and benefits the firm has received in connection with the investment service provided to the client and transferred to him.
Firms providing independent advice or portfolio management should also set up a policy, as part of their organisational requirements, to ensure that third party payments received are allocated and transferred to the clients. Only minor non-monetary benefits should be allowed, provided that they are clearly disclosed to the client, that they are capable of enhancing the quality of the service provided and that they could not be judged to impair the ability of investment firms to act in the best interest of their clients.”

6. ESMA Position MiFID II CP (May 2014):
Proposes banning the use of dealing commission for:
Access to research analysts
Face to face meetings
Conference calls
Buying any bespoke reports
Analytical models
Investor field trips
Corporate access
Market data services
Permits paying for:
Minor non-monetary benefits:
Paying for a stream of generic research
Research available to a large number of persons
Widely distributed
Not tailored to a sector or firm
Query: Personalised Research (ESMA draft advice)

7. SMSG Position Securities and Markets Stakeholder Group (SMSG):
Level I framework did not imply a de facto ban on inducements
Treating procurement process for research as an inducement will lead to a de facto ban
Could have severe adverse consequences for research on SMEs
Contradicts MiFID II explicit aim to support SMEs
SMSG strongly advises ESMA to delete reference to investment research

8. FCA Position I Current UK position:
PS14/7: Changes to the Use of Dealing Commission Rules
New rules took effect 2 June 2014
Relationship between the good / service and the execution of the order tightened
The exclusion for research narrowed (new reference to “substantive” research)
Paying for corporate access services excluded
New guidance on when charges can be passed onto clients
COBS 2.3 and COBS 11.6 (Use of Dealing Commission)
Prohibition on accepting any goods or services unless: (a) reasonable grounds to be satisfied that service will assist in provision of services to clients; (b) does not impair compliance with the clients best interest rule; and (c) directly relates to execution of orders and is ‘substantive research’.

9. FCA Position II Further Reform:
Discussion Paper DP14/3: Discussion on the use of dealing commission regime
Submissions on policy debate close 10 October 2014
Unbundle research from dealing commission – exclude generic research?
FCA supervisory findings:
Lack of price transparency for research
Lack of appropriate incentives
Widespread lack of compliance with current letter and spirit of rules
Findings from supervisory review & PS 14/7 expected to be complied with now.
Consider how firms would evidence compliance

10. FCA Position III FCA Review:
FCA review of 17 investment managers and 13 brokers between November 2013 and February 2014 found only two investment managers met the regulator's expectations.
In 11 cases, the amount of research purchased with dealing commission was linked to the volume of trades carried out as firms did not have research budgets or caps in spending in place.
One firm had used dealing commission to pay for market data services in full without any attempt at a mixed-use assessment to determine which parts of the service could be paid for with dealing commission and which could not.
Brokers did not explicitly price their research services as a distinct service, leading to price opacity in the market.
Brokers did not give proper consideration to potential conflicts of interest when arranging corporate access.
“Strong evidence” to suggest firms’ current use of dealing commission creates a clear link between research spend and trading volume without assessing  the value to investors

11. FCA Position IV UK Current position:
The FCA’s current rules, as confirmed in the November 2013 consultation, make clear firms should only pay for services directly related to executing a trade or substantive research out of dealing commission.
FCA rules have already banned the use of dealing commission to gain face time with company management.
FCA chief executive Martin Wheatley:
“The UK is a global centre for asset management – to keep this position it is crucial investors are confident that they get a fair deal.
There is a strong evidence to suggest the current model of using dealing commission to pay for research reduces transparency and creates a link between research spend and trading volume, without a clear assessment of the value this offers to investors.
I want to see a level playing field to ensure the market delivers the best outcome for investors.”

12. IMA Report I
The Use of Dealing Commission for the Purchase of Investment Research:
(Feb – 2014)
The report describes the processes adopted and implemented by asset managers to ensure fairness to clients, whether through the use of commission sharing arrangements (CSAs) or other models.
The report also makes a number of recommendations that could improve the current model, notably by optimising the effectiveness of budgeting and oversight.
IMA commits itself to a review of the IMA Disclosure Codes
A new – and therefore global model would be better than the current model, the IMA recommends strongly that the International Organization of Securities Commissions (IOSCO) be the co-ordinating body.
Propose a set of eight measures, against which the overall benefits of any model for research payment, existing or prospective, can be evaluated.

13. IMA Report II Clients: Market:
The regime should operate in the best interests of clients
Investment managers should behave demonstrably as the guardians of their clients’ best interests within that regime
Any costs borne by the client should be in the interest of that client
Timely and meaningful disclosure of research costs to clients
Market:
The research market should operate efficiently and transparently
The market structure should create a broad spectrum of competing research providers
Research providers should not discriminate in their supply according to the use of other services
The new regime should not undermine the UK’s international competitiveness

14. FCA Impact I Competition in Research Market:
Likely to improve competition in the research market and outcomes for the end-investor.
Greater incentives to secure value for money when purchasing research
Improvement in the quality & reduce cost of research
Investment managers more likely to consider purchasing from independent research providers (IRPs).
IRPs may provide a greater constraint on research provided by brokers.
Potential number of suppliers of research increases and more tailored and innovative products can be developed.
FCA do not expect, given other MiFID II proposed changes, that UK firms would be put at a competitive disadvantage.

15. FCA Impact II Research Markets Generally:
Similar impacts for both FCA’s proposed options. Don’t expect research coverage will reduce as:
Investment managers still need to access a flow of investment ideas and will be prepared to pay for value-added external research
Brokers need to produce in-house research for other purposes (e.g. inform in-house trading strategies)
Facilitates independent research providers to compete more effectively in the market – expect this will drive up the quality of research, and drive down prices, in the research market
There remain other sources of research that will be unaffected by these changes, such as issuer-sponsored research and research commissioned by exchanges.

16. FCA Impact III Market Integrity:
Improves transparency and accountability of investment manager spending on behalf of the end-investor, reducing the perception of conflicts of interest throughout the investment chain
Has a greater ability to improve transparency and accountability of investment manager spending on behalf of the end-investor, reducing the perception of conflicts of interest throughout the investment chain

17. FCA Impact IV Quality of Equity Trading:
Similar impacts for each option
FCA consider it won’t limit impact on firms ability to provide best execution for their clients
Could even improve quality of equity trading
Competition between trading venues is likely to constrain spreads on equity trading
FCA do not expect spreads to widen as a result

18. FCA Impact V
Tax:
Research services provided outside of dealing commission will be subject to taxation
(a transfer from affected firms to HMRC)
Less prominent for option (i) given some research could still be received linked to execution arrangements

19. FCA Impact VI International Competition:
Make it more difficult for UK firms to win and retain foreign mandates
Allow firms with international capability to conduct regulatory arbitrage, giving them an unfair advantage over UK-only firms
Deter investment management start-ups in the UK
Incentivise some firms to relocate part or all of their UK operations to other jurisdictions

20. FCA Impact VII International Competition: FCA Response:
Unlikely that UK investment managers would be directly competing with firms outside the EU
Many retail and institutional investors prefer local managers.
Outcome of the proposed changes is a more efficient asset management sector in the UK,
Offering a lower cost proposition
Should enhance the UK’s ability to compete internationally.
Influence of changes in the EU will drive global changes for the largest asset managers
Managers will seek to comply on a global basis to the highest standards
Will struggle to justify to their customers why they are adopting a lower standard in other markets given their fiduciary duties.

21. IMA Position
The use of dealing commission to pay for research gives rise to conflicts between the investment manager and its clients or between various clients of the same investment manager
Research clearly does have monetary value
Managers will have to put a price on research – even if it is complex
ESMA stretched the definition a ‘benefit’ in Article 24
It is the underlying investors who benefit from Research not the manager
‘Hold’ positions:
The cost of the research is covered by investors whose funds were trading
This is a cross subsidy between clients
Creates a conflict
Equalised over time?

22. Transitioning to 1 Jan 2017
Firms should now classify purchase of research as a “conflict of interest”
Permissible under FCA rules
Put in place a capped and pre-determined budget
Independent oversight
The FCA rules are already robust in this area:
If the European result is the use of dealing commission is banned
Only purchases of a minor nature will be allowed
If the European result is a conflicts approach:
Use of dealing commission will continue as under the current FCA regime
Robust controls on usage will be required
The rules could potentially only be finalised by early 2016 giving firms only a year to change their business models

23. Transitioning to 1 Jan 2017 Impact on Investment Banks:
Need to consider:
Subscriptions
Price menus
Tariffs
Execution
Banks will likely have to put a price on the research

24. What about UCITS? ESMA proposes to:
Prohibit managers from charging the fund separately for research where a fund appoints an external investment manager
If fund managers directly manage the whole portfolio - rules do not apply
MiFID does not catch that relationship
ESMA suggests the rule should be applied to UCITS and AIFMs
Causes an unequal situation for MiFID firms, UCITS and AIFMs.
Managers of collective undertakings must be able to receive research
Conditions under which the managers are able to receive this research are equal
How is a level playing field between self-managed funds and those with a separate management entity created?

25. The New World Brokers: Portfolio managers: Regardless of outcome:
Concerned about how to cover their costs for producing research
Portfolio managers:
Concerned about the cost of buying research
Future of Commission management
Open question on how the cost of research will be covered when the established way of paying for it ceases to exist
Regardless of outcome:
Industry must separate decisions over buying execution from decisions over buying research
Firms must set research budgets on an ex ante basis to ensure that the total cost of research is no longer correlated to the total value of trading
Budgets have to come in; and some say that they will herald a significant reduction in expenditure on research

26. Conclusion
IMA is open to consider whether even with the enhancements being made by the UK industry, there may be a better global model.
Need a global solution to avoid losing business out of the UK / EU
Solution needs to be measured against IMA eight principles for a better market
New Model must Appropriately Serve:
Clients and issuers
Particularly SMEs