How do MiFID II Research Unbundling Rules Relate to Transaction Reporting?
The Link Between Research Unbundling and Reporting
The Markets in Financial Instruments Directive II (MiFID II) is a major revision of the original MiFID regulation, which was implemented in 2018 to enhance transparency in European markets. One of the key changes in the revised directive was the introduction of research unbundling rules, requiring investment firms to separate research costs from execution fees. This reform intended to eliminate conflicts of interest and ensure fair pricing and transparency in research payments.
While the research unbundling rules mandated in MiFID II are not directly part of MiFIR transaction reporting requirements, they have a knock-on effect on how firms categorise and report execution costs. By enforcing greater transparency in research payments, unbundling indirectly impacts how investment firms assess and justify execution fees, which affects post-trade reporting and best execution analysis.
MiFID II Research Unbundling
Prior to MiFID II, investment firms would commission research from brokers as part of a bundled package where the costs of research and trade execution were combined into a single commission fee. This practice made it difficult for investors to determine whether they were receiving research based on its quality or as an incentive to direct large trading volumes to specific brokers.
MiFID II addressed these concerns by introducing unbundling rules that required investment firms to explicitly pay for research rather than having the costs embedded with execution fees. Under the new framework, firms can either pay for research from their own resources or create a Research Payment Account (RPA). RPAs are funded through client fees and have clear governance on budgeting and spending.
Impact on Execution Cost Transparency and Reporting
MiFID II’s research unbundling rules have resulted in increased transparency in execution costs, which has indirect implications for transaction reporting. Now that research payments are separate from execution fees, firms must be much more precise with how they categorise and report execution costs.
Under MiFID II’s best execution requirements, firms must always aim to achieve the best possible results for their clients when executing trades. This means firms need to justify their execution fees based on real market conditions rather than by factoring in research incentives. With clearer cost structures, regulators can more easily assess whether firms are meeting these best execution standards and determine whether execution fees are reflective of market conditions.
Considerations for MiFIR Transaction Reporting
While MiFID II’s research unbundling rules were not designed to change transaction reporting requirements, they have indirectly increased scrutiny over execution cost reporting. This has encouraged firms to consider how these changes affect their MiFIR transaction reporting obligations, trade execution reporting and regulatory oversight.
Enhanced Data Reporting Requirements
MiFIR mandates comprehensive transaction reporting to ensure market integrity and firms are required to submit detailed information, including identification of financial instruments, transaction details and counterparty information. With the unbundling of research costs, firms must ensure that execution costs reported in transaction reports are separate from research costs. This improves the accuracy and quality of data submitted for MiFIR transaction reporting requirements.
Compliance and Oversight
The unbundling of research costs means that firms are required to revise their internal reporting systems to distinctly capture and report execution costs. These enhanced requirements are useful for regularly reviewing practices to identify and rectify discrepancies efficiently. Regulators benefit from the increased transparency and can effectively monitor trading activities with best execution obligations, helping to detect potential market abuses.
The implementation of MiFID II’s research unbundling rules has contributed to enhanced transparency in financial markets. The separation of research and execution costs also indirectly impacts reporting practices under MiFIR by improving cost transparency for firms, improving compliance and oversight, and encouraging firms to make operational adjustments for alignment with both MiFID II and MiFIR requirements.
