The UK Financial Conduct Authority said the pricing of research is still evolving since unbundling was mandated by the European Union, so the regulator aims to carry out more work in 12 to 24 months.

The EU MiFID II regulation required the unbundling of research payments from the beginning of last year, and most asset managers have chosen to pay for research out of their own revenues. Before MiFID II research costs were often ‘bundled’ into transaction commissions and paid by investors, with many buy-side firms not monitoring how much of their clients’ money was being used to pay for research.

The UK regulator estimated that investor savings from unbundling could reach nearly £1bn ($1.25bn) over five years. The FCA surveyed 40 buy-side firms, 10 firm across the buyside and sellside, met five independent research providers and engaged with corporate issuers through trade associations to assess the impact of unbundling between July 2018 and March 2019.

Rebecca Healey, head of market structure and strategy, EMEA at institutional investor block trading network Liquidnet, tweeted:

@TheFCA outcome on #unbundling (thread) 1. £70mln in savings for sample of 40 buy-side firms 2. BS firms still have access to rsh they need & majority have not seen decline in SME https://t.co/UsXhCgCizc

— Rebecca Healey (@_RebeccaHealey) September 19, 2019

The FCA survey said the quality of asset managers’ research valuation models varies and the UK regulator re-iterated that it expects buy-side firms to refine their models to ensure they are acting in the best interests of their clients. The report also said there are a wide range of sell-side research pricing levels.

“We will monitor for potential competition concerns in this market and will act if necessary,” added the FCA. “Firms are continuing to develop their arrangements and a market for separately priced research is still emerging. Therefore, we intend to undertake further work in 12 to 24 months’ time.”

Independent research providers expressed concerns that pricing is too low because large multi-service banks are internally cross-subsidising their research, making it hard for them to compete.

The FCA said; “We are aware of the potential negative effects on competition in the medium term if some firm’s loss leading prices drive out competitors, reducing choice.”

Budget cuts

The survey continued that buy-side budgets for externally produced equity research have fallen between 20% and 30% since unbundling was introduced. The regulator explained this was due to fund managers having a more targeted approach to procurement, fewer and more focused analyst meetings, as well as increased competition.

“Buy-side firms told us they are still getting the research they need, despite lower budgets,” added the FCA. “This implies that most savings reflect greater competition and market efficiencies, including firms better assessing how much and what type of research they need.”

Vicky Sanders, co-founder of RSRCHXchange, a marketplace and aggregator for institutional research that was acquired by Liquidnet, spoke about the research market at a FIX trading event in the Nordics:

https://t.co/QwBdEeRfjo pic.twitter.com/qSarIyvp7L

— Rebecca Healey (@_RebeccaHealey) September 19, 2019

Sanders said in email to Markets Media that the the buy side have struggled with research valuation.

“What’s important is that the valuation process is proportionate to the spend on research and some approaches which looked sensible on paper have turned out to be hugely time consuming in practice, she added. “I’d expect the tools available to help with valuation to continue to evolve.”

She continued that the issue of pricing remains very topical so she is not surprised that the FCA will continue to review this element of the research market.

“Price discovery has come a long way in a relatively short period of time but it has been difficult for the industry to set a price for a product which had always been seemingly free,” Sanders added.

The FCA continued that the majority of asset managers can still get all the research they need and are not experiencing a reduction in research on smaller companies.

“Our own analysis indicates limited change in single-stock analyst coverage levels for smaller-cap listed UK companies since MiFID II was implemented,” added the regulator. “We will continue to monitor SME coverage by periodically assessing the number of analyst forecasts reported on UK-listed SMEs.”

Better best execution

Healey also tweeted that unbundling has reduced the cost of investment and best execution is improving as a result.

The FCA added that unbundling has allowed asset managers to select brokers purely on their ability to provide best execution and that the number of counterparties used for execution-only services has increased.

“Several firms said that fully separating execution from research has allowed them to reassess their use of high-cost versus low-cost execution channels, eg electronic and algorithmic trading,” said the report. “This has resulted in them making more use of lower cost channels, and further client cost savings.”