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Aon Hewitt Retirement and Investment Blog

What is MiFID II and who does it impact?

The Markets in Financial Instruments Directive (MiFID) is the framework of European Union (EU) legislation for investment intermediaries that provide services to clients on financial instruments, and the organised trading of financial instruments.

MiFID was applied in the UK from November 2007 but is being revised to strengthen investor protections. MiFID II will take effect on 3 January 2018. It is a wide ranging piece of legislation potentially impacting the trading, reporting, client servicing and technology of EU-based asset managers, principally aiming to ensure transparency and oversight within the investment industry. For an asset manager, understanding the impact on these business lines and preparing accordingly is a significant task.

It is expected that MiFID II could also impact asset managers operating outside of the direct jurisdiction of the new legislation. The new requirements could raise asset owners’ expectations, leading to increased pressure on non-EU domiciled asset managers to conform to the new standards due to a firm’s global client base. Similarly but more formally, those asset managers with operations across both the EU and non-EU geographies need to decide if they will implement the changes required by MiFID II across the whole organisation, or just across their EU operations. Aon Hewitt expects asset managers in this situation to be able to explain how MiFID II may affect the entire organisation, and decisions taken in implementing the necessary changes.

A key piece of the legislation – Unbundling research costs

MiFID II is a far-reaching piece of legislation; however, beyond assessing an asset manager’s preparedness only limited parts of the legislation require asset owners to form a view.

For asset managers, meanwhile, a key area that will require a choice relates to the unbundling of research costs.

Banks and brokers frequently provide in-house research on companies, sectors or economic themes to asset managers. Such research pieces are typically handed over “free of charge” insofar as asset managers do not pay for them explicitly, but in return for placing transactions via the bank or broker in question. This arrangement has existed historically and is commonly referred to as “soft commissions”. MiFID II will bring an end to this approach and require asset managers to split out or “unbundle” the costs of research and commissions paid for trade execution. This means that providers of research will need to apply prices to it and asset managers will need to pay for what they choose to receive, in a payment distinct from trading commissions.

Since the implementation of MiFID II began gaining traction in the press, estimates and suggestions of what research will cost have been wide ranging. There is still uncertainty surrounding issues like what different types of research that had previously been embedded in trading will cost, how different providers will structure pricing, and in some cases, what falls into the category of “research”.

What we do know for certain is that asset managers now face a choice. Investment firms can choose to either pay for the research that is directly received, treating it as a business expense, or the costs could be passed along to clients. If asset managers opt to pass the costs on, they must adhere to measures contained within MiFID II designed to ensure that these costs are transparent and clearly presented to clients.

Aon Hewitt believes that asset managers should pay for the cost of research themselves and are in favour of additional transparency related to costs incurred by investors. Up until now, it has not been straightforward for them to do so, with the culture and systems around soft commissions entrenched in the industry. Once providers of research charge for it explicitly, asset managers can deal with it in the same way as other input costs (such as staff salaries, data services and risk management systems). This approach would provide clients with a modest net performance gain, assuming asset managers do not try to pass on the costs elsewhere (such as through higher management fees or expenses, for example).

Several asset managers have already communicated their intention on whether they will absorb these research costs or pass them along to clients. Early observations suggest that the majority of asset managers plan to cover the costs of research. Some suggestions to the contrary by prominent asset managers recently caught the attention of market participants. We have already observed that some asset managers who had previously announced their intention to pass costs on to clients have subsequently reversed this decision and announced they will be absorbing the costs. Not all asset managers had communicated their intentions as of the time of writing.

The vast majority of Aon Hewitt’s Buy-rated managers conduct proprietary research. Third-party research from brokers tends to be used sparingly; often to appreciate broader investment themes or understand where the asset manager’s view differs from market consensus. However, the total amount of research received, including that which goes unused, could be extensive. The unbundling of research costs provides an opportunity for asset managers to review their current research budgets and providers. As a result of MiFID II, it is possible that some asset managers reduce or renegotiate the terms of broker provided research, or adopt a more targeted approach to their consumption of research.

Whatever decisions an asset manager makes regarding unbundling, Aon Hewitt expects them to be able to explain their thought process and evidence their engagement with research providers.

Howard Alford and Thomas Stork are equity research consultants based in London.

The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs. Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal, tax or investment advice. Please consult with your independent professional for any such advice. The information contained within this blog is given as of the date indicated and does not intend to give information as of any other date. The delivery at any time shall not, under any circumstances, create any implication that there has been a change in the information since the date of publication, or any obligation to update or provide amendments after the original publication date. The blog content is intended for professional investors only.


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