Consultation on re-bundeling research with execution fees

In a consultation paper released on 28 October, ESMA (European Securities and Markets Authority) proposed that investment research  be re-bundeled with execution payments. This marks a significant change, and a sensible one, from investment firms currently paying for research out of their own funds rather than clients funds. If you would like to read the consultation document you can do so here https://www.esma.europa.eu/sites/default/files/2024-10/ESMA35-335435667-5979_Consultation_Paper_on_Technical_Advice_on_MiFID_II_DD_research.pdf. If you would like to make a comment on the proposal you need to do so by 28 January 2025 by submitting online at https://www.esma.europa.eu under the heading ‘Your input - Consultations’.

By way of background, in January 2018 sell side firms were required to separate ("unbundle") the costs of investment research from trading execution costs The aim of ESMA was to increase transparency and reduce conflicts of interest in investment management. This was in response to sell side firms promoting corporates from who they received investment banking fees. Unfortunately, the regulators simply did not understand that buy side firms were able to see through sell side ‘promotional’ research and by meeting with a range of analysts with different views were able to get a deep understanding of investment opportunities. Buy side firms were unwilling to pay for research from their own funds and so the large funds increased their own captive research and small funds were left without the variety of research previously available from sell side firms. The net results was that sell side investment research became more reliant on investment banking revenues, more promotional than ever and of lower quality, which in turn reduced market information and, potentially, introduced inefficiencies into markets.

As a result of the original flawed decision by ESMA, in 2021, changes were made to the research regime, which introduced the possibility for joint payments of execution services and research covering issuers whose market capitalisation did not exceed EUR 1 billion.

The consultation proposes that joint payments for execution services and research will be made possible irrespective of the market capitalisation of the issuers covered by the research. However, whatever payment option an investment firm may choose in relation to its payments for research (out of its own resources, payments from a separate research payment account or joint payments for research and execution services), it should ensure that research is not an inducement to invest. In this regard, the consultation paper proposes that an agreement is entered into between the investment firm and the thirdparty provider of execution services and research, establishing a methodology for remuneration, including how the total cost of research is generally taken into account when establishing the total charges for investment services.

While the proposal is a welcomed reversal of current rules, it burdens firms with unnecessary bureaucracy. Perhaps the FCA can follow ESMA's lead but improve on the proposal!