MiFID II research unbundling: so what?

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Just over two months ago we entered a new era of financial reporting under MiFID II. The new legislation, which came into force on 3 January, was designed to make financial markets more efficient, resilient and transparent. It included the requirement to unbundle investment research from execution, a fundamental change to how the research market operates. Under the new regime, research must now be paid for separately by asset managers breaking from the traditional model whereby much of it has appeared to be provided free of charge, or at least bundled in with other costs such as trading commissions.

There was a lot of speculation prior to deadline day that firms would not be ready in time, as well as rushed announcements from asset managers about how they intended to pay for their research with most opting to absorb costs rather than pass them on to investors. So what’s the reality? Has everything gone to plan? Unfortunately and despite the well-meaning intentions of all parties, lack of preparedness and some regulatory backtracking has meant that this part of MiFID II has not had quite the impact it was intended too.

Despite the best of intentions and long lead time up to MiFID II on 3 January, most firms were not ready to implement the changes needed to be compliant. In terms of research unbundling, commercial agreements for research portals were put in place between the buy and sell-side, with the latter undertaking a price discovery process, but on 3 January and to the present day some market players are still discussing, and even still trialling some of the historical providers to keep pressure high within the negotiation process. The price of research services or “interactions” - speaking to analysts for instance - is in an even poorer state when it comes to pricing opacity. Calls and meetings volume have dropped for fear that investment firms will be charged outrageous prices to access the now valuable and “finite” time of a bank analyst. To make things worse, regulators have postponed some deadlines in other regulatory areas of MIFID II sending the wrong message to the market. If those enforcing the new requirements are indifferent to matters of compliance then asset managers are likely to follow suit.

Pricing

One of the unintended consequences of MiFID II and a problem that persists following the deadline in January is the fact that sell-side providers have set prices so low. Many asset managers are paying as little as $5-20,000 per year for access to one broker’s global research portal, often offering the benefit of multiple users at a time.. On this basis, buy-side firms are easily able to absorb the cost of a few different Tier-1 banks but it is a situation which is not sustainable if they want access to continued high-quality and specialist areas of research. It means that independent providers are being muscled out as firms, for now at least, opt for bigger, more generalist providers regardless of their research needs in the future. Rather than opening up the research market as MiFID II intended, it seems that under the new regime, niche research providers will only be considered if absolutely necessary – being seen only in terms of cost rather than a means of differentiation. 

In the early days of MiFID II, we have seen most asset managers following a similar trend, cutting out independent research sources and opting for the same few platforms and providers who are offering access at the cheapest price. Because of the decisions that have been made, there is unlikely to be much difference between the research asset managers are gaining access too – in other words, it is highly likely that everyone is reading the same reports. We can only hope this situation will change in the longer term, and rather than settling for providers based on short-term compliance objectives and cost, asset managers find more innovative ways to re-engage with the research market which has long provided a key point of difference for them, albeit that changes were needed to ensure they were being open with clients on the cost of research and how it was paid for.

What MiFID II set out to achieve has backfired in many ways, and although the legislation was put in place to ensure a more open market place, it is now restricting the amount and variety of research that asset managers can use to get the best return for investors. Prices are so low that this should itself be considered an inducement – a factor which regulators should have anticipated prior to deadline day back in January.

Regulation

So how do European regulators intend to address what is arguably and currently a worse market than we had before in terms of research? Asset managers have opted for the safe bet by absorbing research costs so as not to lose clients in the short term, but how will this play out in the long-term when research teams are cut off from the reports and analysts they need, not to mention potential falling quality of written research across the board? What is clear is that the impact of this new world where cheap but limited access to research works for now, will not sustain asset managers’ client bases in the long term. The need for high-quality research and interactions will not change but under MiFID II access to this vital resource has been cut significantly.

Embracing innovation

Another trend we will undoubtedly see in the medium-long term is the increasing use of technology to address the ‘problems with research’ that we are seeing in the current market. Things have got off to a slow start but the opportunity for research platforms that draw from multiple sources and enable the asset manager to fully evaluate the value of particular providers or analysts is an inevitability. For now, regulation seems to be less of a driver for the market, both in Europe and globally.

Evaluation must be bottom-up and data-driven if firms are going to establish where reduced budgets need to be focused, and which providers deliver the best ROI. New research platforms provide the opportunity for managers to better understand what they consume, as well as helping providers hone in on providing the most valuable and relevant content. In the longer term, the benefits of real-time data on research must surely be the main driver of research budgeting decisions, it is just unfortunate that the new regulation and its enforcers could not have provided more impetus for change and has, so far, succeeded only in creating a market which is actually less beneficial for investors who need high-quality and relevant research in order to get the best returns.

 

 

Ian Spittlehouse

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