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The Commission Management Landscape, Post MiFID II

Peeyush Pachauri

 

Broker commissions are a significant cost of business for investment managers. Historically, commissions paid to the sell side often helped offset the cost of research and certain services for buy-side firms. Such arrangements were flagged by the European Union (EU) regulators and were suspected to foster inducement and were generally not in the best interest of investors, a thought that eventually led to the regulatory changes in the form of MiFID and MiFID II.

Regulators have since highlighted the positive effect of their legislation on the industry, but in general, there appears to be divided opinions on its impact. Nonetheless, since MiFID II was rolled out, we have witnessed a change in preference and prevalence for various commissions management practices, that continue to evolve.

In the EU, many funds found it cumbersome to maintain an audit trail of commissions and research spend and chose to pay for research out of their own P&L books, while others continued with their several hitherto prevalent CSA, RPA, and RCCA arrangements. The effects of the regulation have centered around the following themes:

  1. Perceived reduction in the breadth of coverage. Firms have raised the reducing coverage of small- and mid-size companies, though these have been allayed by the regulator the thought lingers on.
  2. Reduction in the number of research analysts.
  3. Concerns on Bulge Bracket brokers garnering an increasing share of the trade.
  4. Incentives to procure research from providers that may not necessarily provide execution services ESMA has maintained there is no negative impact of unbundling requirements. It will however consider relaxing these requirements for certain sectors to aid the post Covid recovery.

Over in North America, we have seen some induction effect of the changes happening in the EU, primarily focusing on the below themes:

  1. Increased investor awareness  Investors have been nudging firms for parity with the EU funds, which post-MiFID, offer intrinsically higher transparency and buoyed returns.
  2. Uniform commission and research management  Investment managers have continued with an all in bundled rate model for some of their local funds, using Soft Dollars in conjunction with Directed and Recapture Agreements.
  3. The rising share of US-based firms in global investment purse – with a clearer path to access research, US-based firms have been able to outperform and garner a bigger share of the market than their EU counterparts.

Not all investment managers can continue to afford the breadth of research if they began to pay for research from their P&L, as they will eventually face cost pressures. This may throttle the research expenditure, thereby limiting access to the wide array of research products, potentially causing performance negation in the long term. Several studies are alluding to this already - some even going to the extent of saying that EU firms that pay for research via P&L have ceded ground to US firms.

As investment managers try to evaluate more than one commission and research management solution, they are often confronted with the dilemma that most solutions are not as agile as they are. At SS&C Eze, we have channeled our decades of experience in the Commissions and Research Management space into a new cloud-based solution: Eclipse Commission Management. To learn more about how Eclipse Commission Management can help your firm navigate the commissions landscape, download our product sheet here.