MiFID2: Research

MiFID2: Research

Darren Fox

Catherine Weeks

FI & AMIF Autumn Legal Update 2017

11 October 2017. Simmons & Simmons is an international legal practice carried on by Simmons & Simmons LLP and its affiliated partnerships and other entities. © Simmons & Simmons LLP

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Inducements under MiFID 2 Existing MiFID1 inducements rule retained for all MiFID firms (MiFID 2, Article 24(9))

Additional, new rules on inducements for portfolio managers and independent financial advisers (MiFID 2, Articles 24(7) and 24(8))

When providing the services of portfolio management, MiFID firms must not (i) accept and retain fees, commissions, or other monetary benefits or (ii) accept non-monetary benefits paid or provided by a third party, in relation to the provision of services to clients

Key exception: minor non-monetary benefits – Capable of enhancing quality of service – Of a scale and nature so as not to impair compliance with firm’s duty to act in best

interests of client – Subject to a disclosure obligation

Implemented in UK via COBS 2.3A.16R


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The status of research Commission Delegated Directive 2017/593 (the “L2 Directive”)

Confirms that “research” received by a MiFID firm is a non-monetary benefit; so receipt of research is within the scope of the prohibition in Article 24(7)/(8) of MiFID 2

However, research falls outside of Article 24(7)/(8) of MiFID 2 (and can, therefore, be received by a MiFID firm when providing portfolio management services) if the research is paid for: – Directly by the MiFID firm out of its own resources; or – From a separate research payment account (RPA) controlled by the MiFID firm and

funded by the MiFID firm’s client(s), provided various conditions are met (Article 13 of the L2 Directive)

Impact? An end to bundled research

Article 13(9) MiFID firm providing execution services to other MiFID firms shall identify separate charges for – Execution services – Each other benefit or service

Requirement applies even where no obvious inducement possibility (e.g. research providers with no execution capability)


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What is “research”? Research is in scope if it:

– Concerns one or more financial instruments, assets, issuers or potential issuers (or a specific industry/market which informs views on instruments assets or issuers in that sector); and

– Either: – explicitly or implicitly recommends an investment strategy and provides a

substantiated opinion as to the value or price of such instruments; or – otherwise contains analysis, original insights and conclusions based on new or

existing information that could be used to inform an investment strategy and be relevant and capable of adding value

This definition includes both written materials and interactions with staff at the research provider (e.g. conversations with research analysts)


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What are minor non-monetary benefits? COBS 2.3A.19R

– Generic or personalised information about financial instruments or investment services

– Written material commissioned/paid for by the issuer to which it relates (and clearly disclosed as such)

– Conferences/seminars/training events on the benefits/features of a specific financial instrument/investment service

– Reasonable, de minimis hospitality – Research relating to an issue of securities produced before the issue by the

underwriter and made available to prospective investors – Research received during a free trial period of not longer than 3 months

Generic information includes: – Research published on a website available to all – Short term market commentary (or information on upcoming releases or events)

containing a brief summary of the author’s opinion, that is not substantiated and does not include any substantive analysis (e.g. trade ideas or flow commentary from sales & trading)

– Deal roadshows open to a large number of investors (ESMA investor protection Q&A)

Are research and minor non-monetary benefits mutually exclusive concepts?


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Research v minor non-monetary benefits

- Issuer sponsored research

- Underwriter produced research

- 3-month free trial research

- Free research published on a website

- Generic information (incl market commentary/trade ideas)

- Reasonable, de minimis corporate hospitality

- Conferences, seminars and training events etc

- Deal roadshows available to a wide group of potential investors

ALL OTHER RESEARCH

RESEARCH

MINOR NON-MONETARY BENEFITS


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Decisions, decisions… 3 models

– Pay using an RPA – Pay from own resources – Pay using a mixture of own resources and RPA


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Use of RPAs Two models

– Collection alongside transactions – “Accounting” method deduction from client’s assets

RPA conditions (L2 Directive, Article 13(1)(b)/COBS 2.3B.4R): − The RPA must be funded by a specific research charge to the client − The manager must set and regularly assess a research budget as an internal

measure − The manager will be held responsible for the RPA − The manager must regularly assess the quality of the research purchased, based on

robust quality criteria and its ability to contribute to better investment decisions


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Procedural requirements

Create a written policy (COBS 2.3B.12R) setting out how – The manager will comply with the RPA conditions – The purchased research will benefit clients’ portfolios – The manager will allocate costs fairly among clients

Provide copy of policy to clients (COBS 2.3B.12R)

Set a budget for the budget period (COBS 2.3B.4R(2)) – Can be for group of clients who benefit from the same research (COBS 2.3B.14R) – Increase in budget only if clearly notified to clients in advance (COBS 2.3B.8R(2))

Agree in the IMA (COBS 2.3B.8R(1)) – The research charge as budgeted by the manager – The frequency with which the research charge will be deducted from the client’s

assets over the year


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Operation of the RPA and disclosure Operate the RPA and research charge collection arrangements so that

– Amount collected does not exceed budget (COBS 2.3B.7R(1)) – Any transaction based research charge is separately identified from transaction

commission (COBS 2.3B.16R) – Surplus at the end of budgeting period is rebated fairly or offset against next budget

(COBS 2.3B.8R(3)) – RPA balance is spent only on research (COBS 2.3B.17R)

Generate audit trail showing (COBS 2.3B.11R) – All payments made to research providers – Reconciliation of amounts paid to the “robust quality criteria” adopted by the manager

and the manager’s research policy

Disclose – Annually to the client the amount spent on research – On the client’s request

– The providers paid and the amounts paid to them – Benefits and services received by the firm – Total amount spent v budget for the period


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Other RPA-related issues Research charge belongs to the manager (not the fund or the broker) – COBS 2.3B.15G

Third party administrator permitted (COBS 2.3B.18R and 19G) – 30 day sweeping – Manager retains full discretion – Ring-fencing of monies – Third party administrator has no rights of recourse against the monies in the RPA

Agreement in IMA – Does a one-way agreement without objection suffice? – What if some clients won’t agree/object?


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Paying from own resources

Simpler than using an RPA

No need for a budget or client agreement/notifications etc

However, some residual steps to take – Still needs a valuation process – Seek comfort from RPs as to break even costs? Exceptions? – Unsolicited research (see later slide) – Group/international issues (see later slide)


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UK AIFMs and UCITS Mancos FCA gold-plating

– Research and inducements rules apply to AIFMs and UCITS Mancos with some modifications (COBS 18.5A, 18,.5B and COBS 18 Annex 1)

Modifications – IMA consent requirement applies only if the AIF/UCITS has its own governing body

but – Disclosure of research policy detail is made to the fund investors (for a UCITS, this

must go in the prospectus; for an AIF, FCA suggests it could go in the Article 23 document)

– Pre-disclosure of budget and research charge must be made to investors/prospective investors

– Annual disclosure of research costs must be made to investors (for a UCITS, this must go into the annual long report; for an AIF, FCA suggests it could go in the Article 22 annual report)

– AIFM/UCITS Manco must provide further disclosure information to AIF/UCITS investors on request.

UCITS funds – requirement for FCA approval and 60-day advance notification to investors


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Industry-wide issues Price discovery

Fixed income/macro

Research valuation process

VAT issues

Equity swaps/CFDs

Unsolicited research (ESMA Q&A, Q 3)

Paying hard to US broker-dealers

Delegation of portfolio management to third country entities – FCA/AIMA correspondence – “Equivalent investor protection outcomes”

Global groups – Sharing 3rd party research between affiliates – Issues with global execution models


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Other non-monetary benefits

- Issuer sponsored research

- Underwriter produced research

- 3-month free trial research

- Free research published on a website

- Generic information (incl market commentary/trade ideas)

- Reasonable, de minimis corporate hospitality

- Conferences, seminars and training events etc

- Deal roadshows available to a wide group of potential investors

ALL OTHER RESEARCH

RESEARCH

MINOR NON-MONETARY BENEFITS

EMS/OMS Bloomberg screens

Market data

Corporate access Prime consulting

Cap intro

Q&A

This document is for general guidance only. It does not contain definitive advice. SIMMONS & SIMMONS and S&S are registered trade marks of Simmons & Simmons LLP. Simmons & Simmons is an international legal practice carried on by Simmons & Simmons LLP and its affiliated practices. Accordingly, references to Simmons & Simmons mean Simmons & Simmons LLP and the other partnerships and other entities or practices authorised to use the name “Simmons & Simmons” or one or more of those practices as the context requires. The word “partner” refers to a member of Simmons & Simmons LLP or an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of Simmons & Simmons LLP’s affiliated practices. For further information on the international entities and practices, refer to simmons-simmons.com/legalresp. Simmons & Simmons LLP is a limited liability partnership registered in England & Wales with number OC352713 and with its registered office at CityPoint, One Ropemaker Street, London EC2Y 9SS. It is authorised and regulated by the Solicitors Regulation Authority. A list of members and other partners together with their professional qualifications is available for inspection at the above address.

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Documents

MiFID2: Research