Fund Managers Await Research Unbundling

Shanny Basar

European portfolio managers are expecting to buy more research using hard currency as regulators in the region propose changes to payments for research.

Buy-side institutions in North America are watching developments closely, as changes have the potential to reverberate across the Atlantic and affect how U.S. and Canadian asset managers execute order flow.

The proportion of portfolio managers expecting hard currency payments to increase exceeds the proportion expecting a decrease in hard currency payments by 45% In the latest annual European Equity Investors Study by Greenwich Associates. The consultancy interviewed 200 European equity portfolio managers and 185 European equity traders between March and May this year.

The European Securities and Markets Authority has proposed that under MiFID II, fund managers will have to pay for research using direct payments out of their own revenues or a separate research payment account, which can be funded by a specific charge to a client, in order to avoid conflicts of interest. The Financial Conduct Authority, the UK regulator, has created controversy by saying it believes that Esma’s proposals are incompatible with the continued use of commission sharing arrangements.

Last month Instinet, the equity execution arm of Nomura Group, received regulatory approval to allow clients to pay for research in cash rather than using trading commissions.

The Greenwich report said the use of CSAs is nearly ubiquitous among larger institutions and among UK accounts and this has not changed despite the regulatory uncertainties.

John Colon, managing director of the market structure and technology practice at Greenwich Associates, said in the report: “With their status uncertain, little year-over-year change is evident in either usage or the proportion of commissions flowing through CSA programs.”

ohn Colon, Greenwich Associates

ohn Colon, Greenwich Associates

Smaller institutions and European accounts do note use CSAs as much and this is reflected in their differing views on the research proposals. Colon said: “The proportion of UK institutions expecting hard currency payments to increase or increase significantly is 64 points higher than the proportion expecting a decrease in hard currency payments.”

Greenwich Associates estimated that investors generated €3.4bn in cash equity commissions for the 12 months ended June 2015, with 52% directed to pay brokers and third-party research providers.

“While €1.7bn is a considerable sum, it is nonetheless far below peak levels and is currently where few brokers view cash equity research on its own as a profitable endeavor,” added Colon. “If regulatory changes reduce drive down institutions’ overall expenditures for research, even a modest reduction likely will have a substantial impact on the availability of research.”

Peter Wright, founder of custom research platform Dodilio, told Markets Media last month that the MiFID II regulations will be a catalyst for transforming global research consumption. He said: “I have been talking to large buyside firms such as Fidelity and Wellington and they said that if MiFID II changes are approved in Europe, they will make changes globally.”

Wright said broker-dealers need to make four changes to their research business to stop losing market share. The sellside needs to be more selective as firms produce too much research; access to corporates will become more important and investors will be willing to pay for access; research will also become more quantitative and the sellside will have to provide unique data.

“When portfolio managers are asked what drives their allocation of research payments, service in the form of access to analysts is the principal driver, followed by service from research sales professionals,” added Colon.

Greenwich Associates believes that the current broker vote processes and commission sharing arrangements give fund managers a high level of access and flexibility and protects the interests of their clients.

“Current proposals appear set to impose dramatically higher administrative burdens on all involved, to raise the effective cost of research for investment managers, and ultimately to drive down the availability of research products and service,” said the report.“There will be a particularly detrimental impact on mid-sized and smaller investment managers least able to compete for sell-side resources and absorb administrative costs.”

Feature image by Comugnero Silvana/Dollar Photo Club

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