MiFID II Unbundling To Spread Globally

Shanny Basar

The global adoption of unbundling requirements that cover the European Union is expected to continue over the next 12 to 18 month as investment firms use the opportunity to cut spending.

MiFID II, which came into force in January, requires asset managers to either pay for research themselves from their P&L or to use a research payment account funded by clients, where the budget has been agreed with the client. Asset managers can designate a third party to administer the RPA on their behalf but still have to track their consumption of research and assess its quality.

Only US fund managers who manage money for European clients must comply with MiFID II unbundling. However, a research report from Morgan Stanley and consultancy Oliver Wyman, Winning Under Pressure, said: “Many of the larger investment firms are using the opportunity to reduce spend across other regions; we expect this to continue over the next 12-28 months.”

A recent report from consultancy Greenwich Associates also found that many US investment managers are considering unbundling.

One US-based head trader said in the Greenwich report that pressure from clients to maintain the same reporting standards as European rivals had forced him to act. He said: “I believe it’s inevitable that eventually every global manager will pay for research out of their own P&L … I just didn’t expect the wheels to be turning this quickly.”

However, further action from the US Securities and Exchange Commission is required for widespread US adoption. In October last year the SEC issued a no-action relief letter, giving US brokers the ability to comply with the MiFID II research requirements without breaking US securities law for 30 months following the implementation of new regulation.

In January Frost Consulting, a provider of research valuation solutions, expanded its FrostRB database due to MiFID II unbundling spreading outside the region. FrostRB  gives asset managers the ability to compare their fund/strategy research budgets to anonymized indexes of their peers in similar products but does not provide access to research reports.

Neil Scarth, principal of Frost Consulting, said in an email to Markets Media at the time: “The product is being launched globally.  MiFID II is having an impact globally by focusing asset owners on research spending even in regions where it’s not required.”

This month Commcise, which provides end-to-end commission management, research evaluation and reporting software for investment management firms, said it is continuing to expand in the US. Amrish Ganatra, chief executive at Commcise, said in a statement: “We have observed a growing trend towards transparency in the industry and are working with our clients to implement this and to evolve their methodology of valuing and tracking research.”

The majority of fund managers have chosen to pay for research themselves, rather than having to administer research payment accounts. Greenwich said that for MiFID II-compliant institutions the median annual full-service budget is just over $200,000 for each bulge-bracket broker.

Morgan Stanley and Oliver Wyman also found that most investment firms have significantly reduced spending on content, in some cases by as much as 30%. They said competitive advantage in this new model is driven by unique analysis of primarily public data sources rather than by owning proprietary data and client networks.

“We expect content to remain an important potential source of value, but expect to see a shift away from traditional content and towards data-driven analytics, and for banks to face heightened competition from boutiques and specialists,” added the report. “Regulation can accelerate this shift – we estimate MiFID II research unbundling will knock around $2bn (€1.6bn) off cash equities revenue pools (10% off global cash equity pool of ~$20 bn), as the commissions paid for research through “high touch” pools are compressed.”

The continued growth of passive investing, and the broadening adoption of advanced analytics to inform investing strategies on the buyside, are also likely to weaken demand for traditional research and some aspects of high touch sales activity across asset classes.

However Morgan Stanley and Oliver Wyman also warned that only a handful of asset managers with truly distinctive talent models or sources of proprietary data/analytics will be able to use this to drive alpha. Most buyside firms are beginning to use alternative data, and creating specialist teams and hiring data scientists – there were 275 job postings at large asset managers at the end of last month, compared to 340 in the whole of last year and just 245 in 2016.

“But it is often unclear how they fit into the investment process: in our experience many analysts and portfolio managers are unclear on the role data scientists should play,” said the report. “Few firms have managed to build the required bridges.”

In order for asset managers to succeed in data and artificial intelligence, Morgan Stanley and Oliver Wyman said the buyside needs to  define upfront how new data-driven insights are embedded in the investment process and how they measure success; have technical expertise; have the financial ability to hire the best talent and acquire or generate proprietary data; and the ability to understand new risks such as data protection laws or potential infringement on patent rights.

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