• Draft rules distinguish generic material from original insight
  • Investment managers can pay from separate account with budget

Banks and investment managers are set to win concessions in the European Union’s overhaul of the financial-research market, easing months of industry uncertainty.

Draft legislation prepared by the European Commission, the EU’s executive arm, distinguishes between “non-substantive material or services,” which an investment manager can accept as a “minor non-monetary benefit,” from research containing “analysis and original insights” for which the firm must pay.

Investment managers have to pay for research “capable of adding value” to its decisions on behalf of clients either directly from its own pocket or via a “separate research payment account” funded by charging its customers, according to the undated draft legislation obtained by Bloomberg. Payments for research can’t be linked to trading volumes or the value of the transactions, and must conform to a budget set for this purpose.

EU regulators are seeking to break apart existing models of paying indirectly for research to ensure it’s not used as an inducement to push other business to the provider. Managers will be banned from accepting such incentives from brokers under a revamp of an EU financial-markets law known as MiFID II.

The European Commission declined to comment on the document.

Bundled Payments

Regulators say trading costs and research have typically been paid for together through one fee -- the trading commission in equities or via the spread in fixed income. Critics say it’s difficult to tell how much the customer pays for each service. The Brussels-based commission seeks to make these costs more transparent.

The potential ban on so-called bundled payments has been among the most debated proposals in the EU’s overhaul of financial regulations under MiFID II. The rule change affects the business model that investment banks use to increase trading volumes and service clients, and may make some bank operations less lucrative.

The separate research payment accounts in the draft EU rules resemble a system that’s already widely used, known as commission-sharing agreements, or CSAs. Such arrangements allow money managers to direct their brokers to transfer money to a third firm to pay for research.

Some had worried that research payment accounts and CSAs would be banned entirely and that the only way to pay for research would be through a direct payment funded by the investment manager. The German, U.K. and French finance ministries wrote a letter to the commission, calling on it to water down the proposals on trading payments.

Fixed Income

Under the draft rules, investment firms must inform clients up front about the budget and estimated payments. Customers will receive annual accounts of their total costs.

Resistance to EU regulators’ unbundling plans was particularly fierce concerning fixed-income research, with banks insisting it’s cost-free for clients. Requiring separate payment would lead to extra costs for asset managers without the narrowing of spreads foreseen by the regulators, they say.

While the draft legislation doesn’t address these concerns head-on, the line it draws between generic information and more substantive, actionable research may help to assuage them.

“Short-term market commentary on the latest economic statistics or company results, for example, or information on upcoming releases or events, which is provided by a third party and contains only a brief summary of their own opinion” can be considered an “acceptable minor non-monetary benefit” that doesn’t violate the inducement rules, the draft shows.

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