EXCLUSIVE: MiFID II has made research market less competitive, finds new survey

The research found that competition for the provision of investment research has decreased due to MiFID II, with bulge-bracket providers dominating.

A new survey of the asset management community on researching pricing trends has revealed a number of notable challenges in the wake of MiFID II, The TRADE can exclusively reveal.  

Substantive Research, a comparison site that monitors and curates investment research and provides data-driven analytics on research spend to the buy-side, surveyed 40 asset managers across Europe and the US with AUM of between $2 billion – $800 billion. The findings show that regulatory changes designed to unbundle research to make the market more competitive have in fact done little to alleviate the massive concentration in research spend going to the core bulge-bracket banks.   

According to the research, 52% of research budgets went to the top 10 providers in 2019, decreasing to 51.6% in 2020. But in 2021, this jumped again to 53.1%, suggesting that the incumbents are actually getting more powerful, and competition is decreasing as a result of MiFID II.  

“If you look at all the benefits to competition that the regulator was hoping for, none of these have happened,” Substantive Research CEO Mike Carrodus told The TRADE in an exclusive interview. “There is a big focus on value now, but what hasn’t happened is new entrants managing to gain a foothold and encouraging competition, as that focus on value from the buy-side is what has constrained them to managing their existing relationships with brokers. 

“There is a clear message when you look at these numbers. To be honest, it’s not even about the top 10 – most of the spend is concentrated in the top three. The market is not fragmenting, it’s not deconstructing, as was hoped.”

Tight budgets 

The problem is that research budgets are being consistently slashed. Year-on-year, both US and European budgets decreased by 11%. And this is having an impact on provision. “On both sides of the Atlantic, asset managers have cut the tail,” said Carrodus. “This all speaks to resourcing and staffing. We lost 7,500 years of experience in the three years after MiFID II. Outside a small handful of brokers, people are maintaining a strict cost base when it comes to research. But you need this diversity, you need a market that encourages new launches and independent research. We don’t want to be like frogs being boiled – every year choosing from a more finite and more junior pool of analysts.”  

The problem is that although MiFID II had good intentions, the regulators underestimated the brokers’ propensity (and ability) to discount their product, subsidising their research provision internally in order to keep their clients. These meant that by comparison, independent providers looked very expensive, and the concentration towards brokers continued.  

Death of diversity 

“Top of any research list is those people who have managed to retain a cost base that manages to cover the most bases for most people,” said Carrodus. “But that doesn’t help diversity, depth and breadth in this market, which is arguably something clients also want to see. 
“In Europe, people have shrunk their budgets materially. And what was cut was optionality – the ability to call someone tomorrow that you don’t need (or pay for) today. People are only paying for what they need right now. But what happens when the market turns? How many people wanted to know about wheat, a year ago? Everyone is now scrabbling for new sources of information.”   

And suddenly, it seems the worm is turning. Now, in the current unprecedented geopolitical and economic circumstances, suddenly people are needing more varied research again, and they don’t know where to get it from.  

“MiFID II doomsayers predicted that the regulations would make the market much less competitive, and specialist, differentiated research would become less available in times of heightened volatility,” said Carrodus. “What we are seeing now with volatile markets is a stress test proving them right, where we do not have sufficient energy analysts, for example, and asset managers are defaulting to their core relationships, the handful of bulge-bracket firms which dominate market share. There are high quality independent providers who can provide real expertise in these areas, but they are struggling to get paid for their efforts.”  

ESG influence 

The research also noted that while spending on ESG research is increasing rapidly, it still commands less than 1% of the average research budget (up from 0.47% in 2019), suggesting that while the issue gets a lot of airtime, this is not yet being backed up by the budgets. Spend is also focused on data rather than external research, which remains under-developed.  

However, Carrodus believes that this will change – and that this is where European research providers have the chance to make their mark. “We’ll see big changes in the next 12 months as people look to ESG research to help support their investment decisions. The messages from the data can be inconsistent, so people will be looking to protect themselves by understanding what they’re holding at a deeper level, rather than just trusting someone else’s rating. So ESG is the one area where smaller providers might able to tap budget and take market share.”  

Looking ahead 

So what can we expect for the coming year? It looks like given current conditions, the shoe might finally be transferring to the other foot and, after years in the wilderness, research providers are snatching back a bit of bargaining power. And that, inevitably, is likely to influence prices.  

Seventy percent of survey respondents already anticipate cost pressures from the core research providers – who are already paid well. Brokers and independents understand that, in this more volatile market and with deep uncertainty around the geopolitical turmoil, “have-to-have” research providers gain greater leverage with clients – and will use the opportunity to reverse the pricing trends of the past four years.  

But not everyone is on the same journey or will reap the same rewards. In 2018-19 all research providers were in the same boat – budgets were going down, everyone was hit. Now the situation is rather different, and every provider is going through a different experience – some are seeing their pricing power improve, while others are spiralling in terms of leverage with their clients.  

“It’s a vicious or virtuous circle, depending on where you are sitting,” agreed Carrodus. “Research is being used more intensively right now than it has in a long time, and people are leaning hard on the providers that are hitting the right pain points. Some providers will get increasingly less relevant, but the people who stuck to their guns and retained highly ranked and tenured analysts will want their chunk of change.  

The end of this year could potentially see an interesting negotiation period. Up until now the supply side of the research market has just accepted the price pressures and blinked. But that dynamic could be about to change, as these providers start to understand their new leverage.