As the implementation date for Europe’s furthest-reaching piece of financial regulation looms, asset managers are trying to understand the significance of new rules surrounding research costs.
While there are many transformative elements of the new framework, few affect as many different market segments – and have such important economic implications – as research. It’s prompting managers to ask almost philosophical questions around the very nature of research and the underlying value of each piece.Addressing concerns that the bundling of all costs into one lump sum produced conflicts of interest and constituted inducements to trade, regulators want the buyside to establish research payment accounts (RPA), which introduce additional reporting, disclosure and auditing requirements and enforce an absolute research budget.
Asset managers will be required to either create RPAs funded by client money, pay for the research themselves, or stop buying research altogether.
Senior regulatory policy advisor at the European Fund and Asset Management Association Vincent Dessard said the multitude of options available is making it more confusing for the market to deal with. “From a pure compliance perspective they’re all suitable, but the authorities will also assess which is better over time. It’s fundamentally a business decision, though,” he added.
There is little to work with at supervisory level. Aside from the rules themselves and the occasional Q&A by the European Securities and Markets Authority, institutions are relying on approaches taken by national competent authorities – which, with Mifid being a directive not a regulation, are far from consistent.
- Asset managers are still struggling to understand the significance of new rules surrounding research payment within Mifid II;
- They’re required to create separate accounts for the payment of research, funded by the client, but this introduces multiple practical complications;
- The changes will transform the way research is produced, consumed and paid for – consolidation is likely and some managers may establish their own research departments;
- Firms have little to work with at supervisory level as national regulators are just as much in the dark and have so far taken contradictory approaches.
“It’s particularly difficult for the buyside, which is dependent on what the sellside does in terms of pricing but has limited visibility as to what it plans to do,” said Chris Leonard, regulatory partner at Akin Gump Strauss Hauer & Feld in London. “Competition concerns have caused a bit of a stalemate.”
In September both the UK’s Financial Conduct Authority (FCA) and France’s Autorité des marchés financiers (AMF) released conflicting reports outlining how they plan to approach research unbundling within the directive.
While the FCA favours unbundling, the AMF supports commission-sharing agreements (CSA), a sort of middle ground between the two whereby fund managers pay brokers for trade execution, with a portion of the commission allocated to a research provider. CSAs are fairly commonplace today, but their continued use after Mifid II implementation, and whether they can coexist alongside RPAs, is unclear.
“People are asking: what happens if client A wants a research budget of $10, and client B wants one of $50? Does client A get the benefit of the research anyway? The portfolio manager can’t exactly split their brain,” said Sidley Austin partner Leonard Ng.
“We’re all guessing, but I think the most realistic option is to agree an amount with brokers that applies across the board. The worst part is that we don’t know how it’s going to be enforced.”
What it means
In the longer term, managers will have to prove they’re being more careful about how they allocate client resources. Their research costs are likely to fall as they identify how to budget better, and periodic assessments of research quality will become more commonplace which should, in theory, improve the overall quality.
"Sellside firms now need to work out how their expensive analysts are going to become a standalone profit centre"
“An almost inevitable impact is that there will be a market for premium research and a market for the cheaper stuff everyone is getting,” said Leonard. “Sellside firms now need to work out how their expensive analysts are going to become a standalone profit centre.”
Dessard thinks there will be less research produced overall. Firms with smaller funding pots may resort to providing generalised data to catch more clients and there will be some room for niche boutiques, but consolidation is also likely.
“When the UK introduced the retail distribution review and clients started paying for advice, the consequence was that less advice was taken – which I don’t think was the intention,” said Peter Bevan, global head of Linklaters’ financial regulation group.
He thinks larger firms with more purchasing power will most likely have the upper hand, but the possibility of asset managers opening their own research departments is also very real. “Everyone’s response is going to differ depending on their business model,” he added.
There are also potential implications for the companies being researched. The reforms lump all companies under the same umbrella, and some are concerned that over time it will be less appealing to cover smaller enterprises that are of interest to a smaller pool of investors.
But Dessard doesn’t buy it. “They’re forgetting that there are many entities that finance at SME [small and medium-sized enterprise] level,” he said. “Not all banks are global.”
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