Research Payment Accounts (RPAs)
Accounting issues have arisen from changes to payment for research costs, which were introduced by MiFID II in January this year.
Up until now, brokers have provided research data and interpretation as part of their brokerage services. So, when an investment manager placed a trade with a broker, the transaction fee paid to the broker by deduction from the investment manager’s client’s investment, is partly for execution and partly for research. Thus, investment managers have benefited from “soft commission” accounts with the brokers it used, and research costs have effectively been funded by the investment manager’s clients. There has been a balance on this account; the investment manager may be in credit or have taken more research services than the trades he has placed with the broker have generated. Industry practice has been that, this is off balance sheet and that the research costs have been “softed” with the balance on the soft commission account not recognised in the financial statements. It has also been industry practice that the existence and amount of soft commissions has not been disclosed in the financial statements either.
MiFID II has enforced unbundling of research costs and the investment manager now needs to pay separately for research services provided by brokers and banks. There are three ways of doing this:
- The investment manager bears the research costs;
- The investment manager charges its clients a fixed annual amount and pays this in to a Research Payment Account (RPA) held at a broker and on which the brokers can draw payment for the research services they provide;
- On each transaction a research charge is levied on the investment manager’s client by the broker in addition to, but separate from, the execution fee and this is paid in to the RPA and used by brokers to pay for research services provided.
There is one important factor; research is subject to VAT, but execution services are not. So, the broker will add VAT to invoices for research services and the investment manager will want to record the expense under each scenario in order to recover the input VAT.
In all three cases there is a charge to profit and loss and where method (ii) and (iii) are used, there is an equal and opposite credit to represent the recovery of the expense from the RPA; effectively the investment manager is paying for research and recovering the cost from their clients. The credit should be to other income; the research cost is a cost to the manager and should be shown as such and should not be netted against the recovery. The balance sheet position should also be shown gross with the unused balance on the RPA sitting on the balance sheet, as a current asset (it could of course be a liability if research services exceed amounts added to the RPA) and research costs paid for in advance by clients as a current liability.
This is a significant change; previously off P&L and off-balance sheet research costs are not expenses in the P&L with offsetting other income and the payment in advance for research costs by clients is an asset and a liability on the balance sheet.
There are further accounting issues under scenarios (ii) and (iii) where an RPA is used. The FCA rules in COBS 2 require the investment manager to give each of their clients information, on their share of the RPA, including the costs that each of them has incurred for third party research (COBS 2.3B.5.2) and, if there is a surplus on the RPA, the manager must have a process to rebate funds to relevant clients with a fair allocation of costs between them (COBS 2.3B.8.4).
If you would like to discuss the above subject further, please contact Deborah Weston, Head of Financial Services sector, or David King, Audit Director. Alternatively, you can send us an online enquiry.