The introduction of MiFID II regulations around Transparency, BestEx and Inducements will change the relationship between buyside firms such as asset managers , and the sellside banks and brokers who service these clients (although non-financial clients such as corporates will be excluded). In particular, the regulations will lead to the ‘unbundling’ of research from execution, and the effect will fundamentally change the way in which buyside firms pay for, and consume research across all asset classes.
Traditionally, buyside firms have ‘paid’ for research through a Commission Sharing Agreement (CSA), whereby the executing broker would ‘retain’ a portion of the commission paid for the trade to use to pay for external research and other services for the client. Buyside fund managers would typically allocate commission attributable to research on the basis of ‘broker voting’. However, this was seen by the Financial Conduct Authority (FCA) (and more recently here) as an inducement to trade, as it could encourage buyside firms to over-trade in order to gain larger share of research budget, rather than considering value for money.
Under MiFID II, the rules on inducements and paying for research will mean that:
- Payment for research will be fully unbundled from payments for execution (or other) services
- Buyside firm will need to establish pre-funded research payment accounts that are funded either from:
- Their own balance sheet as a direct cost, or
- From fees charged to clients (and notified and agreed with clients in advance), which will impact their fund’s performance
The impact of these changes will have huge ripple effects across the market.
For one, buyside firms will have to consider which banks and brokers provide the most valuable research. It’s one thing to accept free research from your brokers (although it’s never been free, as costs were hidden in spreads), and even then only probably 5-10% of the mountain of research was ever actually read by buyside firms. However, once buyside firms have to explicitly pay for the research, then they will start to look at both quality, and value for money of the research they consume, and be far more transparent about the costs of that research.
It may well be that better quality/value for money can be found from independent third-party research firms, and in some cases buyside firms will look at producing research internally. Other services that will be impacted by these rules include access arranged by sellside firms for buyside analysts to meet with senior management of specific firms for whom the sellside are house broker.
These changes will more than likely result in continued scaling back of sellside research capacity, with sellside research concentrating on their own areas of expertise, be that equity company coverage, or credit sector analysis, or FX flows, with only a small number of sellside firms continuing to offer what is called ‘waterfront’ coverage, namely full research coverage.
As a result of the unbundling, there will certainly be the expectation among buyside firms that execution spreads should narrow, as the cost of research is no longer ‘bundled into the price’, although it will be interesting to see if expected spread compression materializes.
Ahead of these new regulations, a number of new platform initiatives have been launched to assist buyside firms as they transition to the new operating model of sourcing cost-effective research. Examples of the new breed of platform that have recently been in the news are Substantive Research and RSRCHX.
Substantive Research seeks to help investors find the best top-down research quickly by:
- Providing 2-minute briefing each morning that summarises and drives the market to the highest quality macroeconomic, allocation and strategy research. We do this qualitatively by looking independently for pieces from banks and independent providers which are refreshing and rigorous. (sample reports here)
- Running the research reports through an internal ranking methodology which provides a daily shortlist, based on a proprietary quantitative screening process. Based on a year of research, asking the buy side what qualities they like to see in the research that they receive.
They aim to be the ‘publication of record’ during the greatest transformation the investment research market has seen. Every month we will publish in-depth analysis of the regulatory environment affecting the research business and how institutions are responding. We will cover how business models are adapting to change and who is positioning themselves most effectively.
RSRCHX is in effect a research marketplace (they liken themselves to the iTunes of research). According to a press release from the company, the number of independent research providers on the platform has recently doubled to 100 providers.
- Providing searchable research from multiple independent research providers across asset classes
- Commercial pay per report, subscription models, and even sellside/analysts time are all for sale, with the research provider supplying cost matrix for all services
- RSRCHX will be free to asset managers, but the platform will charge a fee to the research provider
So, how will this affect bank single-dealer platforms where the clients are buyside firms subject to the new regulations? What research services will they be able to provide through their platform, and how will that change and what will they charge for that going forward? Thinking about the top tier platforms such as MorganStanley’s Matrix, UBS’s NEO , and others that have integrated their permissioning, and tagged research into the execution platform. What about platforms what have integrated quant based analytics into the execution platform, will that also count as ‘chargeable’ research?
Will be interesting to see how this develops.