Are research trial periods past their sell–by date?


“Sell by” and “use by” dates, found on all food items in our supermarkets, have made the headlines recently as many believe that the dates are overly cautious, and as a result too much food is being thrown away. In a similar way, investment research deemed no longer current is consigned to the virtual wastepaper bin, but does it too still have a useful shelf-life?

The advent of MIFID II, with research unbundling and regulated trial periods, means that if handled correctly, recently out-of-date research can be used as a first, easy step to making intelligent purchasing decisions.

European regulators created a major hurdle when they set the rules around research unbundling- as substantive research must be paid for, some sort of agreement must be in place before the delivery of any such research may commence. This created a major competition issue, namely that as research consumers would be unlikely to commit to buying research they have not tried before, as the risk is too high, they would opt for the safe choice of sticking with the same suppliers they used prior to MIFID II being enacted.

Regulators have tried to fix this issue by introducing a structured trial period. Similar to the RPA, the proposed trial process is excessively complex in administration terms, and unlikely to be adopted without significant adjustment.

The crux of the issue is that trial periods are over-engineered.

The fact that their duration is limited to three months, although restrictive, is not the main issue, despite the fact that many analysts’ recommendations cover a longer time period. The real problem is that a consumer of research cannot have a second trial period with a producer until a whole year has elapsed since the end of the first trial period.

The intent is clear enough, i.e. to stop asset management firms from avoiding the inducements rules by manipulating trial periods into endless “free” research that is subsidized by execution business given to the same sell-side that is supplying the research. In other words, no return to the status quo.

This sentiment is laudable, except the regulators seem to have forgotten that much of the high-quality research that was available for a fee in the pre-MIFID II environment was produced by independent research providers, and such fees are their only source of income.

This embargo year means that consumers are unlikely to try a new supplier until they are relatively certain that the offering fits their requirements, which of course defeats the object of a trial.

Some of the larger buy-side firms have already indicated to their sell-side counterparts that they will not force the ignobility of a trial period on them if they already have a research relationship.

This message has an obvious subtext – so long as the sum of your research and execution fees are in line with previous costs, we will continue to do business as before. Where does this leave the independents though?

Because of the one-shot per year rule, the decision to enter in to a trial period will not be taken lightly on either side. This means that although a portfolio manager may discover and be excited by a new source of potential alpha, by the time his or her investment manager, compliance officer and finance director have given their approval, any spontaneity and momentum is lost. Further delays can be expected as the research producer performs KYC and due diligence on their new prospect.

Another reason that the trial period is so awkward is because the research being trialled is current, sensitive and valuable. In other words, Substantive. But this is not a necessary condition.

If a portfolio manager wants to take a closer look at a research producer’s output, he or she does not need to see the most recent work. It is enough to see a few examples of relevant but less current research to form a view on whether to progress to a full trial period or subscription.

If the note or notes being trialled are no longer current, they cannot be judged as substantive. An extra safety mechanism would be for a producer to put a selection of notes that are literally past their “sell by” date into the public domain where anyone could access them, providing that they register first. This would ensure that the notes cannot be deemed substantive and therefore inducements.

It is true that such a process means that competitors could gain access to a limited selection of work, however at least the provider would know this due to the registration, and this surely is far better than the current set-up where there is no way of tracking where emailed notes are forwarded to or hard copies given out.

Alphametry will be rolling out its new pre-trial feature soon. Providers will be able to choose a selection of non-substantive notes that they feel best represent their work. These notes will be recent enough to be relevant, but not so recent as to be sensitive. Portfolio managers will gain easy access to these notes, without having to go through the rigmarole of initiating a full-blown regulator-approved trial period.

This way, the buy-side has instant access to enough research to make an informed decision about progressing, while providers control which notes are in the public domain and know who is looking at them.

For more information please get in touch with Alphametry here.

Ian Spittlehouse

A wholesale market expert (Eurex, Citi) with over 25 years of industry experience, currently heads Alphametry in the UK.