* New rules to come into force in January 2018
* Many funds say plan to cut back on research
* Banks use research to attract trading business
LONDON, May 26 (Reuters) - New rules on pricing investment research are shaking up the European fixed income, currency and commodity (FICC) industry, with many funds planning to scale back or ditch a service that banks use to drum up business.
Investment banks and other brokers have long provided research to funds as a way of attracting them to their trading business, and there has never been a formal bill attached. However, they must break out the cost of the research and charge for it separately under the EU regulations, MiFID II, which come into force in the new year.
Many funds using FICC research are concerned this will simply land them with an additional cost. Eight funds spoken to by Reuters said they expected to reduce the research services they use as a consequence of the reform.
Their reactions supported the results of a poll of 270 fixed-income investors at a capital markets conference in London this month which found 59 percent had either not decided whether to continue using broker research or had decided to dispense with it altogether.
On the other side, the drop-off in demand could hit the investment banks, if funds consequently reduce the number of brokers they trade with. The new rules severely limit the amount of detailed research funds can receive for free.
The uncertain situation facing both banks and investors reflects the nebulous nature of the current arrangement in the FICC industry.
Unlike in some equity markets such as Britain, where funds already pay for research separately from trading, in FICC markets it is open to interpretation how investors pay for the service - or whether they do so at all.
"Given the fundamental differences in the infrastructure of the fixed income market, applying the same rules to FICC will create some difficulties," said Jon Howard, chief operating officer at London-based hedge fund Anavio Capital Partners.
FICC research includes insight on macroeconomic trends and interest rate movements, as well as on currencies, commodity markets and corporate bond and loan issues.
Many funds say the cost is usually included by brokers in "the spread" between the buying and selling prices of the products they deal in - and if a separate research fee is introduced, then the spread should therefore be narrowed.
Some banks, however, say research is just one of several factors influencing the spread and that any narrowing is unlikely under the new rules, according to industry sources.
Given that, fund managers say they fear they will be left with a new bill for research and no proof that the spread has been narrowed by the broker to compensate them.
"Historically, that research cost is in the spread. Now the Street (investment banks) is telling you 'we're going to charge you separately now', but that's not really going to make the spread change, I don't think," said Matthieu Duncan, chief executive at French firm Natixis Asset Management.
Gildas Surry, partner at Axiom Alternative Investments, which manages around $1 billion in assets, said the change would hit smaller fund firms harder.
"The cost of this adaption period will be dear for the industry ... It will generate more profits for the dealer community, but for smaller managers it will be even more difficult for them to grow."
Ten investment banks contacted by Reuters declined to comment on the matter. Two others, speaking on condition of anonymity, said the spread had only a limited relation to the cost of research.
"Typically banks write FICC research as a cost of being in business and to promote their capabilities. Trading and market pricing takes place in a competitive environment," said Julian Allen-Ellis, Director of MiFID at the Association for Financial Markets in Europe, which represents leading banks.
"The major factors influencing an instrument's spread include credit risk, market liquidity, volatility, the bank's inventory position, its capitalisation and many others. It would be impossible to isolate and remove a single factor from the spread and show a correlated change."
The European Securities and Markets Authority (ESMA), Europe's markets watchdog, did not respond to a request for comment on Friday. It has previously said that the new rules will increase transparency for investors and ensure they receive value for money.
It has given scope for "short market updates with limited commentary or opinion" to be classed as a minor non-monetary benefit and therefore be given for free. Some material commissioned and paid for by corporate debt issuer may also be given for free, it said.
How brokers and funds will value research is still up in the air.
Pricing models being discussed between funds and banks vary from a flat fee for basic read-only access to tiered access for more expensive services, said Axiom's Surry.
Given the complex nature of the discussions, any arrangements that are agreed could change over the next couple of years, fund and bank sources said. (Additional reporting by Vikram Subhedar and Alex Chambers; Editing by Pravin Char)