Research unbundling rules came into effect just over a year ago as part of MiFID II requirements. The goal of these rules was to enhance transparency and investor protection and eliminate conflict-of-interest risks associated with research between the buy side and sell side. The industry is split as to whether this is a positive or negative outcome for the industry. In reality, this is just the start of necessary change in the production, distribution and consumption of research.
A recent global survey of market participants conducted to understand how research provisioning has changed since the introduction of the new Markets in Financial Instruments Directive revealed that as price transparency becomes clearer, firms are becoming more discerning regarding the type of research they consume as well as their method of access. Some critics claim that this risks negatively impacting research provision, particularly on small- and mid-cap companies, threatening listings and secondary trading volumes as a result.
On the flip side, proponents believe MiFID II has offered an opportunity to open up the research market and challenge the status quo regarding the implementation and execution of investment ideas.
It is clear from the responses that research unbundling is now starting to take off across the industry. More than half (53%) of all buy-side respondents indicated that they have already implemented a global policy, and a further 20% plan to do so within the next five years. While research unbundling in Europe is likely driven by regulation, the rest of the world is being led by perceived end investor demand and the practicalities of implementing regulatory policy across different jurisdictions.
For U.S. respondents, those firms that have been able to ring-fence Europe also have chosen to do so with an acknowledgement and fiduciary duty to treat all clients fairly, but a growing number of global firms are opting to align themselves to MIFID II.
Value-Add Research Matters
With that said, today’s dominant research providers remain the bulge brackets for now, with 69% of respondents indicating they chose global investment banks over regional specialists — but this may yet change. While firms initially intended to use Research Payment Accounts (RPAs) funded by a research charge to the client, the last quarter of 2017 saw an increasing number reversing their decision and opting to pay for research via their own P&L. When firms implemented the move to P&L, the primary concern was to make sure research agreements were in place in time for Jan. 3, 2019. Bulge bracket banks benefited from this due to their coverage and multiple touch points across organizations.
However, as there is increased transparency in all research pricing, selection of research providers will continue to evolve. The future sustainability of the sell-side business model is being called into question as buy-side firms revisit budgets and conduct broker reviews. In turn, the sell side is having to decide where to invest scant resources and which clients to service going forward. Bulge bracket brokers are still assessing what they can expect to earn from the continued provision of research; attempts to lower the minimum waterfront entry point appear to have been underestimated in the hope of continued higher revenue analyst access.
One result of this changing landscape with declining commission payments is that some asset management firms are being excluded from broker roadshows. In response, these firms are instead electing to engage directly with company investor relations departments.
By altering how firms gain access, new challenges emerge; consumers require servicing, and the companies that they invest in need to develop new methods to engage with investors, whether that is self-funded research or utilizing new portals. The increased use of data provides quantitative tools to match investors with assets and presents a wider selection of bespoke offerings — directly connecting asset owners with assets rather than automatically relying on a broker to act as an intermediary.
All of this is leading to changes in the production, access and distribution of investment ideas — and not just in Europe. The increasing focus on the end client is seeing a gradual adoption of research unbundling practices globally. Irrespective of their regulatory obligations in the United States and the Asia-Pacific region, some of the largest asset managers want to demonstrate their firm’s capability as a protector of client assets and are electing to pay for research out of their own P&L. This is creating a knock-on effect for other non-EU local managers and their research providers, regardless of where they are located and what instruments they cover.
Active managers globally must adapt and adjust their business models if they are to succeed in this increasingly competitive environment. With the growing adoption of index funds and automation to enhance decision-making in a globalized economy, successful asset owners must become more efficient in how they marshal big data and human insight to develop diverse investment strategies most suited for the millennial investors of today.
MiFID II was created to improve transparency over costs to deliver greater value to the end investor. It is clear that the industry is still evolving as we adjust the requirement for unbundling research, particularly in different global regulatory locations. However, one thing is certain — the ability to access value-add research continues to be critical; therefore, firms need to adapt their strategies to ensure optimal investor returns.
Rebecca Healey is head of EMEA market structure and strategy for Liquidnet in London.