Europe is being rocked by radical reforms to the way the asset management industry pays for execution and research services that have remained largely unchanged for over 40 years, but its influence is being felt on far-flung shores.
Unbundling, where research and execution payments are separated, is rapidly becoming a reality as part of Europe’s Markets in Financial Instruments Directive II (MiFID II).
While the new rules might seem a distant irrelevance for Asian markets, Europe’s debate on changing the research business model is making waves across the world.
“On unbundling, we’re behind Europe but the buy-side is starting to move in that direction here in Asia,” says Shaun Bramham, CEO of Instinet Asia. “If you’re an international fund manager it’s simply too complex to have different buying processes for Europe, Asia and the US so many will look to implement unbundling globally.”
It’s thought as being highly unlikely that the US market will ever become formally unbundled as it would require an act of Congress and similar legislative proposals in the past have been rapidly shot down. Similarly, Asia’s fragmented market means wholesale regulatory change in the region isn’t coming anytime soon.
There have been rumours that Martin Wheatley, director general of the UK’s Financial Conduct Authority (FCA) and formerly of Hong Kong’s SFC, might influence regulators in Hong Kong to pursue a similar path, but as yet no formal proposals have been made.
But for the big international asset managers the local regulatory environment probably won’t matter all that much. If your European fund clients are being offered an unbundled service that ultimately puts their money to better use, then it’s going to be a hard sell to continue running a bundled model in other jurisdictions.
Internal momentum
Of course, the regulatory environment is just the latest driver of change. Some asset managers have long felt that the bundled commission model, which would see the cost of research directly linked to the cost of execution, was a bad deal for their end investors.
Many of these concerns where highlighted when the FCA conducted a review of the research market. It found that in many instances firms would pay as much as double for their research from one year to the next, simply because they executed more often, despite not increasing their research consumption.
The FCA also discovered many firms were failing to exercise any form of cost control and this was resulting in large quantities of low-quality research being produced by brokers, with suggestions that, as this money was paid directly out of funds, it was not impacting the bottom line of managers and thus they were not prioritising the issue.
Edward Stockreisser is one of many who is ahead of the pack in Asia and has sought to help the buy-side improve the way it acquire research. As co-founder of Seed Alpha, which provides tools to help firms make better use of their research, he says he wants to fix a longstanding problem with the market.
“The model was broken. Commissions are lower, research quality has declined and it’s becoming harder to allocate hard dollars,” he explains.
“We hear a lot of talk about best execution, but there’s not been much said about the concept of ‘best research’.”
That said, many asset managers have been unbundled for years entirely of their own volition, believing it offers a superior level of service to their clients and frees their trading desk to pursue the very best execution partners regardless of their research capabilities.
Recognising the challenge
The push towards unbundling in Asia seems to be strengthening and recently the Asian Securities Industry & Financial Markets Association (ASIFMA) established a dealing commissions working group to tackle the issue.
It was also a key topic discussed during May’s FIX Trading Community Asia Pacific Trading Summit in Hong Kong.
Speaking at the FIX event, Safa Sadigh-Mostowfi, vice president, Asia head of commission management, Morgan Stanley, said more and more clients were being highly selective with where they spent their research budget.
“More clients are using execution only rate cards in the past 18 months. Many say, if a broker ranks in their top five research providers they will get paid, but outside that they will get nothing.”
Momentum to unbundle certainly seems to be building, but that doesn’t mean Asia won’t have to grapple with its own particular challenges, in much the same way as the industry is currently in Europe.
The main driver for ASIFMA to form its dealing commissions working group was actually a fear of what impact international moves towards unbundling could have on the Asian fund management community.
Eugenie Shen, managing director and head of the asset management group at ASIFMA, said members expressed concern that European and US regulations to unbundle research and commission fees may impact the Asian region adversely.
She says: “The whole idea is that Asia may be different because it is more of an emerging market. It is less developed and it might be that more research is required.
“I do think Asia is different. If you look at China, Malaysia, there is not enough research. Who is paying for the research? It is tricky.”
Shen acknowledges that transparency is “definitely required” but says that fund managers operating in some parts of Asia don’t enjoy the same scale, meaning buy-side firms are often operating at much smaller margins than in Europe or the US.
A key concern is that, at least under the proposals currently made by European regulators, is that the burden of determining an appropriate price for research rests on the asset manager.
“The impetus is on the fund managers to value research and ascribe it a dollar price,” says Stockreisser, “but right now there is no data to show who is using what research.”
He adds that this should be something that is driven by the supply side. While some brokers do offer, or are looking at introducing, pricing menus, the buy-side will still need to think about the value any given piece of research offers.
Philip Hulse, senior execution consultant and head of Hong Kong desk, Bloomberg Tradebook, is concerned that unbundling will also come with significant additional costs at a time when margins are being squeezed.
“When costs increase they get passed onto the end client and unless the savings are outweighed by these new costs then that’s not going to be good for the buy-side or end investors.”
The calm before the storm?
So should Asian buy-siders be worried? A pool of delegates at the FIX Asia Pacific Trading Summit found most think reform of the research market is unlikely in the near future, with 53% saying they did not expect any rapid uptake of unbundling services like commission sharing agreements in the next two years unless there is a strong regulatory push.
But that regulatory push could be closer than many think, according to Instinet’s Bramham.
“The UK is driving a lot of the change in Europe and there’s a major Commonwealth footprint in Asia which has an influence on markets,” he explains.
“The buy-side are looking for direction from the bigger financial and the momentum for change will grow exponentially.”
Stockreisser agrees and said he expects Hong Kong, as the region’s major equities hub, to drive that change.
“Hong Kong will probably follow suit with that is happening in the UK as regulators here have been very focused on the buy- and sell-side relationship.”
In Europe the move towards and unbundled model of execution and research has been met with mixed feelings from the buy-side. Those firms that have already embraced unbundling of their own volition are, unsurprisingly, pleased that the playing field will now be leveled, and others are hopeful it will lead to improved quality of research and greater freedom for trading desks to pursue the best execution partners.
But many of the problems highlighted above are also the subject of debate Europe and, until some solutions are found, this will lead to uncertainty for any region that may seek to transition its research business model.
It’s unlikely that regulators in Asia will seek to impose anything as onerous as what European regulators are proposing but ultimately it may be client demand that is the real force for change. With a growing number of end investors taking a greater interest than ever before in execution quality, it could only be a matter of time before asset managers’ clients are demanding to know why they aren’t unbundled.