MiFID II Regulation: Payment Model and Compliance Standards

In October 2024, the European Securities and Markets Authority (ESMA) released significant amendments to the Markets in Financial Instruments Directive II (MiFID II), focusing on enhancing transparency and flexibility in payment models for investment research. These updates, introduced under the framework of the European Listing Act, allow investment firms to make joint payments for both research and execution services, lifting previous restrictions tied to issuer market capitalization.

Under the new MiFID II regulation, this shift includes robust guidelines on the remuneration process to ensure research charges align with best execution standards, providing necessary transparency around costs and mitigating potential inducement concerns. With new requirements for research quality assessment, conflict of interest management, and client disclosure, the amendments aim to revitalize the investment research market while safeguarding investor interests.

Source

[1]

ESMA consults on amendments to MiFID research regime

Home

[2]

Consultation on the technical Advice to the European Commission on the amendments to the research provisions in the MiFID II Delegated Directive

Responding to this paper ESMA invites comments on all matters in this paper and in particular on the specific questions summarised in Annex 1. Comments are most helpful if they: respond to the question stated; indicate the specific question to which the comment relates; contain a clear rationale; and describe any alternatives ESMA should consider. ESMA will consider all comments received by 28 January 2025.

Home

MiFID II Research Provisions

Introduction of a Joint Payment Model for Research and Execution Services

A pivotal change in the amended MiFID II regulation allows investment firms to opt for joint payments for research and execution services, regardless of the market capitalization of the issuers involved. Under the previous structure, only firms covering issuers below a €1 billion market cap could use joint payment options. Now, joint payments are permissible for all issuer sizes, provided firms comply with strict conditions under Article 24(9a), which requires that firms structure payments to avoid inducement. For example, firms must engage in formal agreements detailing remuneration methodologies that avoid excessive charges and promote transparency. This shift, driven by the European Securities and Markets Authority (ESMA), provides firms with new flexibility, although they must meet specific conditions to ensure transparency and avoid inducements that could compromise client interests.

Revised Compliance Requirements for Research Payments

The updated MiFID II framework requires that research provided by third parties to investment firms be structured to ensure client interests are prioritized. Investment firms may now choose from three payment methods: joint payment for execution services and research, direct payment from the firm's resources, or through a separate research payment account. Each method must comply with specific transparency and fiduciary obligations to prevent conflicts of interest and enhance the objectivity of research. Under the revised Article 13, investment firms that utilize a research payment account must meet additional requirements, such as maintaining a transparent audit trail and providing clients with detailed information on incurred research costs, ensuring compliance with client-centric standards set forth by MiFID II regulation.

Mandatory Annual Assessment of Research Quality

To maintain high research standards, MiFID II now mandates an annual evaluation of research quality, usability, and value, focusing on its contribution to better investment decisions. Firms are encouraged to compare their existing research providers against alternative options, including those offering free trials, to identify potential improvements in research quality. In alignment with Article 24(9a)(c), firms must now consider comparing the value of research services from competing providers to mitigate reliance on any single provider. This annual assessment ensures firms retain flexibility while committing to cost-effectiveness and continuous quality improvement.

MiFID II Amendments: Technical Requirements and Regulatory Implications

The new amendments to MiFID II outline several technical conditions for firms using the joint payment model to ensure fair pricing and adherence to best execution standards:

Transparent Remuneration Methodology

Firms opting for joint payments must establish a clear and fair remuneration methodology. This model should include mechanisms, such as tiered tariffs or fee caps, to avoid overcharging clients for research. ESMA suggests the use of tiered fee structures where research costs per transaction decrease after a specific number of transactions, or regular fee assessments to prevent excessive charges. Additionally, under the new Article 13 provisions, remuneration structures must be set up to prevent significant cost variances compared to direct payment methods, aligning with MiFID II’s focus on price transparency and value for clients.

Client Disclosure and Conflict Management

Firms are required to disclose their chosen payment method to clients and provide detailed information about their research payment policy. For joint payments, firms must explain how they manage potential conflicts of interest. The aim is to foster transparency, allowing clients to understand how research charges are structured, and how firms ensure unbiased, high-quality research is provided in their best interest. Under MiFID II regulation, firms must provide clients with their full payment structure details, including the criteria for research quality and methodologies for cost attribution, reinforcing the commitment to transparency and informed client decision-making.

Best Execution Requirements

Ensuring compliance with best execution obligations remains a priority under MiFID II regulation, especially as ESMA strengthens standards for joint payment arrangements. The joint payment model could complicate this requirement, as bundling research and execution services might obscure cost visibility and introduce risks in aligning costs with actual service value.

As a result, firms must verify that their total charges under joint payment agreements do not hinder their ability to fulfill best execution duties, particularly by avoiding any inducements or excessive fees that may impact trading decisions. ESMA further requires that remuneration methodologies be structured to avoid firms incurring charges that surpass the actual value of research, with options such as tiered fee arrangements or transaction-based discounts. Firms are thus encouraged to maintain regular reviews of these costs and the quality of research to confirm that best execution and client interests remain safeguarded.

Cost-Benefit Analysis of MiFID II Amendments

The regulatory modifications under MiFID II aim to balance investor protection with the revitalization of the investment research market. However, these changes entail both costs and benefits for various stakeholders.

Costs

Firms may incur limited recurring costs associated with conducting the mandatory annual assessment of research quality, as required by Article 24(9a)(c) of MiFID II. This assessment must include comprehensive metrics on usability, quality, and overall value, along with, where feasible, a comparison against alternative research options. Additionally, establishing a compliant remuneration methodology for joint payments may involve initial one-time costs as firms align with the new ESMA guidelines, such as implementing transparent fee structures and setting up mechanisms to prevent inducement risks. However, these expenses are deemed minimal compared to the potential benefits of access to high-quality research.

Benefits

By promoting a diversified research market and mitigating over-reliance on single providers, the new MiFID II amendments foster a competitive landscape for research providers. For investors, these changes translate to better value and potentially higher-quality research, as firms must now validate that their chosen providers offer optimal cost-benefit outcomes. MiFID II regulation also offers a framework that allows investment firms to explore bundled payment models without compromising on research transparency or quality, ensuring clients benefit from more accessible and enhanced data for decision-making.

MiFID II Requirements: Future Impact and Strategic Implications

Increased Competition Among Research Providers

The requirement for an annual assessment of research quality and a market comparison will likely stimulate competition among research providers. Firms will be incentivized to explore alternative providers or negotiate better terms, thus broadening the research landscape across the European Union. This increased competition is expected to drive improvements in research quality and offer investors better, data-driven insights. In addition, ESMA’s expectation that firms consider free trials or comparable research services introduces a practical mechanism for firms to evaluate value, encouraging continuous quality enhancements within the investment research sector.

Enhanced Investor Protection Through Transparency and Accountability

The emphasis on client disclosure and the mitigation of conflicts of interest underscores a regulatory push for greater investor protection. Clients can now expect clearer information about how research costs are structured and how conflicts are managed, enhancing accountability. These efforts align with ESMA’s objectives to safeguard investors and reinforce the integrity of financial markets in the EU. As MiFID II regulation mandates that firms clearly document payment arrangements, clients gain greater insight into fee structures, ensuring that research costs are transparent and aligned with service value.

Flexibility for Small and Mid-Cap Companies

The amendments under MiFID II could boost research coverage for small and mid-cap companies. By offering flexible payment options, the updated regulation enables firms to allocate resources more efficiently towards analyzing smaller issuers. This shift is anticipated to benefit small-cap issuers, offering them greater visibility and encouraging investment diversification within the European markets. Through increased research accessibility, MiFID II regulation also promotes a diversified investment landscape that supports emerging market players, ultimately strengthening the EU’s capital markets.

Regulatory Harmonization and a More Streamlined Framework

With these amendments, MiFID II seeks to harmonize payment structures across investment firms. By providing high-level requirements for compliance, the regulation leaves enough flexibility for firms to tailor their policies while ensuring a consistent standard across the EU. This harmonization aims to enhance regulatory clarity, reduce administrative burdens, and support the free flow of capital and research across borders within the Union. As ESMA’s revised framework under MiFID II regulation consolidates disparate payment practices, firms benefit from clearer compliance paths, allowing for reduced operational complexities in managing research and execution costs.

Conclusion

The updated MiFID II research provisions represent a transformative approach to managing the costs and quality of investment research within the EU. By allowing joint payment models and enforcing stringent compliance requirements, the amendments aim to balance investor protection with market competitiveness. These changes are expected to impact investment firms, research providers, and investors by encouraging transparency, reducing potential conflicts of interest, and fostering a competitive landscape for research. As firms and regulators adapt to these requirements, the MiFID II amendments will likely influence the European financial market's resilience, efficiency, and overall transparency, shaping the future of investment research for years to come.