The Great Unbundling Fight — Are Regulators Preparing for the Last Round?

The long, slow warm-up

In 2001, British businessman and politician (and then Financial Services Secretary in HM Treasury) Paul Myners issued a report on institutional investment in the UK. The final point in its introductory letter to Chancellor Gordon Brown states:

“finally, an important cost to pension funds, namely broking commission, is subject to insufficient scrutiny. Clearer and more rigorous disciplines could be applied to these costs, which are substantial.”

The origins of the changes we discuss in this article thus date back 15 years. After protracted industry consultations, The UK Financial Services Authority (FSA, now the Financial Conduct Authority) started trying to define more precisely what research was. 4 years later, it drafted the following narrower definition of eligible research:

“We ... believe that ‘originality’ is an essential component of research which can be purchased with dealing commission. This is because we believe that research should provide new insights.”

In 2006, the Commission Sharing Agreement (CSA) appeared. Its mechanism of separating dealing commission from research fees was supposed to naturally assist asset managers to further comply with the FSA recommendation to also disclose research-related goods and services acquired with commission.

Against all odds, disclosure improved but very few pensions funds were actually making any use of the data. In a report commissioned in 2009, the FSA concluded that factors such as the level of commission rates, fees and research expenditure, were considered to be less important than manager’s style, expertise, reputation and past performance. Clearly, the whole investment management chain had little interest in changing direction.

A dozen years after the Myners report, in 2013, new Financial Conduct Authority (FCA) almost immediately reassessed the scope and definition of equity research again. Corporate access was to be "out" and commissionable research was redefined as “substantive”.

But beyond mere rewording, the FCA raised the possibility of an outright ban on paying for research with client commissions. Unbundling was back in fashion, this time more seriously.

Regulators enter the ring

The size of the UK investment management industry, the largest in Europe, puts the FCA in a natural position of influence. While the similarity of the European Securities and Markets Authority's (ESMA) views with the FCA are publicly known, the French regulator has expressed open disagreement on dealing commission use. The Autorité des Marchés Financiers (AMF) is a strong supporter of the CSA mechanism. Its desire to stick with CSAs implies that end-clients will continue to bear the cost of research, albeit with stricter transparency and reporting rules. In contrast, the FCA wants to implement the new Research Payment Account (RPA) scheme to ensure that end-clients no longer pay for research. Two major European regulators thus disagree fundamentally for now.

While the various other European authorities have been fairly quiet on the subject, most probably because of the lack of significant impact on their respective industries, the US investment community has been very closely following the European debates. Recently, the issue has garnered attention at the highest levels–in June, congressman Dennis Ross wrote to Mary Jo White, chair of the SEC, outlining concerns that proposed EU rules over the payment of research could:

“...disrupt research coverage for US small and emerging growth companies, as well as their access to the capital markets”

It was only a matter of time before US authorities joined the conversation, emphasising that Euro-MiFID II will have an impact worldwide. Diverging views makes ESMA's task politically complex and European voting mechanisms could jeopardise a unified approach. Indeed, the European Parliament and Council can choose to vote a “Directive” instead of a “Regulation”, leaving individual member states with the freedom to modify the new research payment regime in their jurisdictions. While some observers have jumped to the conclusion that this would be an elegant way to make the British and the French views compatible, it is unlikely to happen for several reasons:

  • voting the ‘softer’ Directive after such a difficult and lengthy consultation would deeply undermine ESMA–and European–credibility
  • to address accelerating markets globalisation, regulators worldwide need to converge on policy to avoid potentially devastating ‘regulatory arbitrage’ side-effects
  • lastly, the current European mood leans towards more political unity rather than exceptions.

MiFID II: the knockout?

In 2015, the unbundling saga will finally come to an end:

  • the European Commission is to adopt the ESMA proposals between July and September
  • the European Parliament and Council can object within a maximum of 3 months
  • the public release of the MiFID II rules is slated for early 2016

A few important rules have already been made clear and will definitely be in effect starting January 2017:

  • spending – research spending must be based on a pre-determined budget
  • purchasing – increased transparency will apply to research purchases which will have to publicly declare prices
  • value – investment firms will have to regularly report on how they assess the quality of the research they purchase (in writing)

While these rules go a long way toward improving transparency and leveling the playing field, the core issue remains unanswered:

“Who will be paying for the research?”

While awaiting a regulatory answer, the industry nevertheless seems divided–some players are eagerly expecting a favorable vote, while others are already moving ahead regardless.

And the winner is...

Many opinions have appeared in recent press coverage proclaiming that banning research payment via dealing commission will be very harmful to the industry. While there is much fear over the consequences of MiFID II, the reality is somewhat more complex.

The distribution of research consumption in the investment management industry is skewed. In other words, a few very large firms consume most of the research. This has significant implications for the upcoming changes, especially regarding price and quality.

The larger research consumers are already attempting to turn the upcoming regulatory changes into an opportunity. Increased pricing transparency is a chance to lower their cost of research acquisition. On the production side, the long tail of smaller research producers and brokerage boutiques have identified the new paradigm and market forces are at work–they're making a big push to broadcast prices for all their content. Investment banks will have to follow, UBS being among the first to already do so. Transparency is pushing research into a more competitive world and will inevitably–at least initially–lower prices. In addition, historical mispriced research will also likely be singled out.

Furthermore, information technology & data are going to play a pivotal role in research benchmarking. The global rise of distribution platforms triggered by European regulation will facilitate access to more research. Better yet, quality will become much easier to spot. So will poor content. Investment banks are already auctioning access to their analysts based on recently introduced internal rankings.

In its quest for returns, the investment industry is looking for the best opportunities all over the globe, forcing authorities to establish a internationally coherent framework of rules. Hence, regional regulatory rules are slowly but surely converging. The largest investment firms of the planet are building global compliance platforms fuelled with the best local practices, even if a regional authority comes across to be more lenient. Investment firms' and regulators' interests have never been so aligned.


It would appear that market authorities are eager to finally finish the job they started in 2001, when the UK government was already pointing out the conflict of interest between research and execution. After years of meager progress, regional regulatory policies are moving ahead and will eventually converge globally.

At the extremities of the investment chain, both large investment management firms and small research producers are the first to leverage the changing landscape. They have already started to comply ahead of the upcoming research payment rules for competitive reasons. As a result, the entire research industry has no choice but to follow.

The lost decade of research unbundling is coming to an end. Market forces are already preparing the outcome, with or without regulatory participation.

On July 17th, FCA Head Martin Wheatley stepped down, further confusing expectations: will the departure of the unbundling champion affect the FCA's hardline interpretation?