Navigating China’s new research payment rules

On 1 July 2024, the China Securities Regulatory Commission implemented new rules which, among other provisions aimed at enhancing transparency, include removing the use of “soft dollars” to pay for research.

The move aligns with a global trend towards greater fee transparency, lower fees, and increased investor protection, and it shares similarities with the research provisions of the EU’s 2018 Markets in Financial Instruments Directive II (MiFID II).

MiFID II requires asset managers to explicitly pay for third-party research and brokers to price and provide research separately—an “unbundling” of research fees from trading commissions. The idea is to improve fee transparency for investors, reduce conflicts of interest, and level the playing field for research providers.  

Overview of China’s new research provisions:

• Trading commissions can no longer be used to fund third-party research.
• Securities companies must establish “sound” internal research systems, continuously strengthen research teams, improve research capabilities and compliance, and regulate research providers.
• Securities companies must prevent conflicts of interest between fund sales and securities trading and research.

By looking at the impact of MiFID II and how asset managers responded, we aim to provide some insight for Chinese firms facing a similar new landscape. 

Navigating the complexities of MiFID II hasn’t been plain sailing, as decisions with operational implications had to be made. It is worth noting that as the industry shifted to “hard dollar” payments (charging a specific fee for research), some firms chose to adopt MiFID II standards in markets where soft dollars are still permitted (such as the US), demonstrating their alignment with global best practices and reducing the risk of conflicts of interest. 

There were two main options to weigh up when deciding how to fund research:

• Paying from internal resources and incorporating research costs directly into P&L, giving greater control over research selection, but potentially impacting profitability.
• Establishing a research payment account (RPA) funded by explicitly agreed upon client charges, with stated rules, including record keeping.

Factors such as investment strategy, client type and research requirements had to be considered when choosing a payment method. However, some asset managers determined covering the payments themselves was preferable to disclosing research costs to clients. 

Choosing the RPA route required asset managers to explain unbundling requirements to clients and obtain their consent for how to fund research. It would have been necessary to implement processes to track and record research use, value, and payments, and allocate costs appropriately. 

Research ROI in the spotlight  

Against this backdrop, asset managers have been looking more closely at the ROI of their research. With research budgets tightening in the post-MiFID II world, there has been additional pressure on research firms to demonstrate the value they deliver. 

Prior to the implementation of MiFID II, research pricing was minimally transparent, and consequently, there was limited understanding of its worth. However, since 2018, innovation and differentiation in research have become key drivers of quality in the market. Investors focus on research that truly adds value to their decision-making processes.

With China’s new regulations setting higher standards of research capabilities across the sell side, we anticipate the potential for increased demand for support from quality research providers. We have seen significant growth in both Europe and the US since MiFID II was rolled out, a reflection of the increasing appetite for non-homogeneous research.