OPINION: MiFID II Delay Should Not Delay Unbundling

Shanny Basar

The incoming MiFID II regulations, covering financial markets in Europe, are likely to be delayed by a year to 2018 but this should not slow down the aim of making payments for research more transparent.

The European Securities and Markets Authority has proposed that fund managers either pay for research out of their own revenues or set up research payment accounts for clients with an agreed budget – although the regulator may still allow asset managers to use commission sharing arrangements. The proposal has led to fears that fund managers will cut their research budgets, with smaller firms particularly hard hit, while small and mid-cap corporates will get less coverage.

Sandy Bragg, principal at Integrity Research Associates, a consultancy on independent research, said in a blog that two-thirds of asset managers and research providers expect spending on research to decline over the next three years according to a poll at a Bloomberg conference on January 27. The poll also found that 41% of the London-based attendees expected research spending to fall by more than 20%. The Bloomberg conference  had over 170 attendees, split between asset managers and bank and independent research providers.

Timothy O’Halloran, co-president of Westminster Research Associates, a unit of broker Convergex Group, argued in a recent note that there is no such thing as too much research. He said: “While budgeting and cost controls make good business sense, are we enacting policy that incents investment managers to use less research?  Are regulators conditioning asset owners to worry about how much research their investment managers are using?”

O’Halloran added that while each single research input may not seem important in and of itself, in the context of all a manager’s research information, it can take on new meaning which may not be quantifiable.  “You simply can’t know,” he said.

However independent research platforms have launched specifically to allow fund managers to monitor the effectiveness of research that they buy.

RSRCHXchange launched last September as an online marketplace for fund managers to buy institutional research and by the end of 2015 more than 100 multi-asset research providers had joined the platform. Fund managers can pay by subscription, buy individual reports with cash, use commission sharing arrangements or the new MiFID II research payment accounts – and meet the enhanced record keeping requirements by measuring and monitoring consumption. Independent provider BCA Research has launched a customisable dashboard of content so fund managers can easily discover relevant research that is actionable, and that they can use to drive investment decisions.

Dan Davies, senior research advisor at independent provider Frontline Analyst, tweeted: “The FCA/ESMA have decided, on the basis of no discernible research, to believe an independent paid research industry is viable. I hope so (We’re now publishing on @rsrchx !).  Anyway securities research, much maligned but you’d miss it if it wasn’t there any more.”

However Davies also said research costs are higher than they need to be. “It’s possible to get a junior analyst in India for half of the cost of a second-year associate in London. That’s our business,” said Davies. Frontline Analyst builds and trains off-shore research teams across credit, equity and risk management for sellside and buy-side clients.

O’Halloran argued that pension funds do not hire fund managers based on how much they spend on research. “When was the last time that a pension plan hired an underperforming manager because they spent less on research than their peers?  Or, conversely, when was an outperforming investment manager fired because they overspent on research?”, he said.

However if fund managers are using client commission to pay for research, rather than their own P&L, pensions should ask them to justify that spend as even a small difference in fees can make a huge impact on returns for the ultimate beneficiaries – individual pensioners. Research has shown that pensioners paying an annual charge of 3% for pension funds can lose as much as two-thirds of their money to charges during their life while savers paying 1% could lose a quarter of their money to fees over the course of their life. For funds that do truly outperform justifying research spending won’t be a problem but the vast majority of active managers who have unperformed stock market indices for several years might find it to be more of an issue.

If active managers want to prove their value in the face of rising competition from far cheaper exchange-traded funds and robo-advisers they need to be show why they are worth higher fees – and increasing transparency as quickly as possible should be just the start.

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