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Investment banks balk at EU fixed-income research payment plans

[BRUSSELS] Financial firms are resisting European Union regulators' plans to make investors pay for fixed-income market research separately from trades.

Regulators say the research fee is built into the difference between the price at which broker-dealers, such as investment banks, buy and sell securities, known as the bid-ask spread. The banks counter that research is cost-free for clients, so requiring separate payment would lead to extra costs for asset managers without the narrowing of spreads foreseen by the regulators.

"There is currently no pricing mechanism for fixed-income research," Andrew Bowley, head of market-structure strategy, EMEA, at Nomura Holdings Inc in London, said in an interview.

"The sell-side is not charging; the buy-side is not paying: there is no price," he said. "We could double or zero out research spend and the trading spread on fixed-income instruments wouldn't change."

Regulators argue that separation of research and trading costs is necessary to create a more transparent system whereby asset managers take more ownership of decisions on the research they buy, develop a better sense of its value and become more open to buying it from other sources.

The European Securities and Markets Authority, which brings together national regulators in the 28-nation EU, made market- research proposals to the European Commission in December as part of work to implement an overhaul of the EU financial-market law known as MiFID II.

The commission, the EU's executive arm, plans to publish rules by mid-year. The bloc's 28 national governments and the European Parliament will have six months to raise objections. If they don't, the final standards could be issued by year-end and take effect in 2017.

For equities research, the ESMA proposals would require changes to the current system whereby asset managers use dealing commissions to cover the costs of research, effectively passing the cost on to their clients. On the fixed-income side, no such straightforward fee exists.

"It is unclear how the ESMA advice could be applied in practice to fixed-income, commodity and currency research," said Christian Krohn, managing director of capital markets at the Association for Financial Markets in Europe, which represents investment banks such as Nomura, Deutsche Bank AG and JPMorgan Chase & Co that are key research providers.

The plan is "fundamentally inconsistent with the structure of the FICC markets where investment managers and their clients do not pay for research," he said.

Under ESMA's approach, asset managers would have the choice between a fully unbundled system where they expressly pay for research as a separate service, using their own funds, and a hybrid model where they set up dedicated "research payment accounts" funded by a specific charge to the customer, with the amount of this charge agreed on in advanced.

The size of the fixed-income research market is also hard to assess.

"Globally, equity research commissions are worth about $20 billion a year," said Neil Scarth, a principal at London-based Frost Consulting, which advises companies on market-research issues.

"Fixed-income is a much bigger asset class, but overall there is probably less research," he said. "The amount will be less, but it will be in billions." Britain's Financial Conduct Authority, a member of ESMA, says UK investment managers pay an estimated 3 billion pounds (S$6.25 billion) of dealing commissions per year to brokers, with about half of this spent on equities research.

"Evidence suggests there is much less research on the credit markets produced and consumed for fixed income than for equities, and levels of payments for it are likely to be much smaller for this reason" the FCA said in a report last month.

It's an area that is "more opaque than equity markets since research is entirely embedded in implicit transaction costs," the regulator said.

This contention is contested by the banks, which say the costs are based on a range of market considerations.

EU investment banks say that requiring separate payment for research would put them at a disadvantage because of best- execution rules that require trades to be executed with the party that offers the best price.

The bid-ask spread is "competitively formed," Nomura's Mr Bowley said. "It is the existing trading environment and structure which drive the spread formation. Those spreads are consistent globally."

Money managers are keen to see a narrowing of spreads if they're forced to pay separately for fixed-income research, Daniel Godfrey, chief executive officer of the Investment Association, which represents UK investment managers.

"If the buy-side starts to pay cash for a product that was previously part of a bundled service, then the residual part of the bundle should become cheaper," he said in an interview last month. While measuring a narrowing of spreads would be difficult, "we will need to demand that we pay less in spread if we're paying hard dollars for research."