MiFID II & Listing Act: Unraveling the New Paradigm in Research Payments and Its Impact on Best Execution

The Listing Act and amendments to MiFID II aim, among other objectives, to promote research and analysis on investment target companies, especially those with smaller market capitalization.

What is the intended outcome?

Larger-cap companies often receive more and better analysis. The goal of the analysis is to ensure that investors, particularly retail investors, have access to as much information as possible.

What is to be avoided?

The aim is to avoid inducement, which refers to any commission, fee, or other monetary or non-monetary benefit paid or provided to an investment firm by a third party, or by a person acting on behalf of a third party, in relation to the provision of a service to a client. MiFID II sets conditions under which research is not considered an improper inducement.

How was this limitation originally regulated?

Initially, MiFID II only permitted research payments from the investment firm’s own resources or from a specific (segregated) account dedicated to research. The Research Payment Account (RPA) is a separate account controlled by the investment firm, funded by a specific research charge to the client, used to pay for third-party research. This is known as unbundling, the previously stricter requirement under MiFID II to separate transaction execution costs from investment research or analysis costs.

In 2021, as part of the Capital Markets Recovery Package, the possibility of combined payments for execution and research was introduced, but initially only for issuers with a market capitalization of less than 1,000 million euros.

How does the “Listing Act” affect research payments?

The Listing Act made combined payments for execution and research services possible regardless of the market capitalization of the issuers covered by the research, but under certain conditions: Firms must have an agreement with the provider establishing a remuneration methodology, inform clients about their payment choice and policy, and annually evaluate the quality, usability, and value of the research used.

How does the “Listing Act” mitigate the risk of inducement?

Regardless of the payment option (own resources, separate research payment account, or combined payments), the provision of research will not be considered an inducement if the following conditions are met:

• Existence of an agreement between the investment firm and the execution and research provider establishing a remuneration methodology, including how the total cost of research is considered when setting the total charges for investment services.
• The investment firm informs its clients about its payment choice (combined or separate) and provides its policy on payments, including the type of information that can be provided and how conflicts of interest are prevented or managed when applying combined payments.
• The investment firm annually evaluates the quality, utility, and value of the research used, as well as its ability to contribute to better investment decisions.
• If the firm opts to pay separately for execution and third-party research, the latter must be received in exchange for direct payments from own resources or from a separate research payment account.

What does the annual evaluation of research entail for investment firms?

The annual evaluation requires firms to analyze the quality, utility, and value of the research they use, as well as its effectiveness in improving investment decisions. This evaluation must be based on robust quality criteria. Initially, it was proposed to include a comparison with alternative research providers “where feasible,” but after feedback, ESMA decided not to include this comparison in its technical advice to avoid imposing excessive burdens, especially on smaller firms.

What implications does the combined payment option have for a firm’s “best execution” obligations?

When an investment firm opts for combined payments for execution and research, it must ensure that the remuneration methodology:

1. Prevents the firm from paying substantially more for the research component than it would if paid directly.
2. Does not impede the firm’s ability to comply with its best execution requirements.

To comply with best execution, which requires obtaining the best possible result for the client when executing orders, firms must be able to identify costs directly related to execution, thus separating the research component from execution costs in combined payments.

How should investment firms inform clients about their research and execution payment policies?

Investment firms must inform clients about their decision to pay for execution and research services either combined or separately. Additionally, they must provide clients with their detailed policy on these payments. This policy must specify the type of information clients can receive based on the payment method chosen by the firm and, in the case of combined payments, how the firm manages or prevents potential conflicts of interest.

What challenges does implementing this new research and investment payment regime present for ESI?

Challenges (Anticipated Costs):

• Investment firms are expected to incur limited one-time and recurring costs in conducting the annual evaluation of the quality, usability, and value of the research used, based on robust quality criteria. These costs are already anticipated under Level 1 regulation.
• Limited costs may also arise in establishing the remuneration methodology to comply with the requirements of paragraph 10 of the Delegated Directive. However, these costs are expected to be one-time and limited, directly related to Level 1 requirements.
• The additional cost of adhering to the robustness of the required quality criteria.
• The need to implement two separate pricing mechanisms, which may complicate marketing.

What benefits does implementing this new research and investment payment regime offer for ESI?

Anticipated Benefits:

• The introduction of paragraph 1b in Article 13 of the Delegated Directive promotes investor protection and could benefit firms by ensuring the use of robust quality criteria regardless of the payment method used.
• The introduction of paragraph 10 in Article 13 of the Delegated Directive also promotes investor protection by reducing the risk of investors being charged substantially more for the same research, depending on the payment method used. This ensures that the cost of research does not depend on the chosen payment method.
• The annual evaluation could also be an opportunity to reassess research agreements or find better value offers, potentially leading to long-term cost reductions.

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