This post was written by Shai Hill, Founder & CEO of Integrum ESG.

I had the opportunity to discuss how ESG inputs are being funded with Mike Carrodus and Neil Scarth - industry experts and Principals of Substantive Research and Frost Consulting.

Both these firms advise asset management firms on research budgeting, compliance with funding rules, and how to get the most from their research spend.

There was a lot to unpack, so I’ll do my best to keep this just to the most relevant takeaways.

How ESG inputs are currently funded, the regulatory view & the mechanics of commission sharing

🔹 ESG ratings are classified as ‘investment research’ by the FCA and ESMA

They are opinions that influence the investment in, and valuation of, traded securities - which is why both are advancing plans to regulate ESG ratings firms. Indeed, the FCA has responded directly to Frost Consulting to confirm that they see ESG ratings as investment research.

🔹 Around half of Frost clients pay for ESG inputs using research budgets, half using data budgets. Substantive however, currently has a clear majority using data budgets

🔹 The FCA now permits asset managers (Policy Statement 24/9) to make a ‘joint payment’ covering both execution and research costs, in the commission they pay when trading securities - with that payment charged directly to the asset managers’ clients

🔹 Of the overall % commission agreed, an amount would be specified as payment for execution and typically retained by the brokerage unit making the trade, and the remainder would be transferred into a ring fenced pool, to pay research providers

🔹 At the end of the year, or quarter, the asset manager tells the broker how to distribute this pool, listing its different research providers and the amount payable to each

This mechanism is known as a CSA (‘Commission Sharing Agreement’), and used to be commonplace, before the MiFID II legislation prohibited it in 2018. 

Why MiFID II triggered a collapse in research budgets, and how the FCA is now trying to reverse that

🔹 MiFID II did permit asset managers to charge the cost of investment research directly to clients, but only if the new RPA (‘Research Payment Account’) mechanism was used

However, the vast majority of asset managers across Europe found the RPA administratively unworkable, and decided to absorb the cost of investment research themselves.

🔹 This led to wave upon wave of research budget reductions, which the FCA, with government influence, concluded has structurally diminished capital markets and investment returns

It therefore follows that the FCA would like to see spending on investment research rise from the current low point, and is not looking to catch out asset managers on technicalities.

🔹 The rule allowing research costs (including ESG inputs) to be charged to clients, is already live in the UK, but will not go live in the EU until June 2026

However, both panellists thought national regulators in the EU would turn a blind eye to early adoption of ‘joint payment’ mechanisms.

🔹 Were asset managers already starting to charge investment research costs to their clients?

Absolutely. Both panellists were of the firm view that we had reached a tipping point; smaller asset managers had begun the shift because, lacking scale, they were feeling the most margin pressure - but larger firms were also now beginning to shift.

No one however was making press announcements; there was no upside to doing this; so all asset managers making the shift, do so ‘under the radar’.

🔹 Both Frost Consulting and Substantive Research said those clients who had moved to charging research costs to their investors, had experienced ‘almost no friction’

With an increased charge to the fund of, on average, 0.02% per annum, it simply was not significant enough to make investors think about withdrawing capital.  

Investor reactions, compliance challenges & what the future holds

🔹 The main hindrance to asset managers charging their clients directly for research, is their fear that clients will not accept the added cost, and move their capital to lower-cost funds 

This is hugely significant - but both panellists were now confident this fear was unfounded.

They reminded the audience that the FCA rule does not require asset managers to seek consent from their investor clients - it merely expects asset managers to inform their clients of the change.

🔹  By the end of 2026, Substantive Research thinks ~60% of asset managers (weighted by assets) will be charging the cost of investment research to their investor clients

🔹  The cost of ESG inputs might lag this 60% figure, but not significantly. Frost Consulting had a bolder view: the market had passed a tipping point, there was no benefit from absorbing research costs internally if clients were willing to, and thus ~90% of asset managers could be charging these costs to their clients by the end of 2026

🔹 The main challenges of shifting to the new ‘joint payment’ mechanism in the UK are two compliance requirements:

i/ costs like ESG inputs has to be fairly attributed at the investment strategy level; such that investors with no wish for ESG integration in their fund, would not bear ESG costs and thus cross-subsidise other investment strategies

ii/ asset managers had to be able to demonstrate ‘value for money’ when purchasing investment research. This could be challenging for ESG inputs, where costs varied significantly across different providers. 

🔹 The cost of investment research always used to be charged directly to the investment fund. ESG inputs, being relatively new, have not

But we could now be on the verge of significant change - with end-investors perfectly willing to shoulder the modest cost of ESG ratings & analysis, providing a proper price-benchmarking has been conducted. 

Thanks again to Mike and Neil for an insightful discussion. Both are recognised industry leaders, and their deep expertise in helping asset managers navigate research budgeting and funding compliance was clear from their insights.

If your firm is considering making the shift to charging ESG inputs to your clients - or already has - we would love to hear how you’re approaching it.