As the FCA pushes buy-siders to think more about the way they pay for research, the industry needs to start thinking about exactly how much research costs.
What’s wrong with pricing in the research market today?
The biggest problem in research provision today is a lack of explicit pricing, due to the bundled model, which has been commonplace. Currently, a buy-side will pay a commission to brokers based on their trading volume and from that, the broker pays for its execution, research and other services.
However, the Financial Conduct Authority (FCA) said this model means asset managers aren’t properly considering the actual cost of research and are therefore frequently over-paying for research services. For example, as firms executed more trades with a given broker, the bundled model means they would end up paying more for research without necessarily receiving more or better quality research.
Could this lead to a market where research is explicitly priced?
The devil is in the detail and until more information on the direction of the FCA’s consultation is released it is hard to say whether it will go for a full explicitly priced market. However, given that the FCA does want increased competition in the research market and for asset managers to think more about their research costs, it is certainly possible.
However, it could mean that buy-side firms are simply expected to justify and manage the cost of research better. For example, they could agree some sort of sliding scale with their brokers, so as they execute more the cost of the commission falls to reflect the more static nature of research received.
What are the challenges to explicit pricing of research?
There are several challenges the market will need to overcome in order to explicitly price research. The first is that no one is really able to say how much research should cost. Buy-siders will need to make assessments of their research spend but it can be difficult to judge the value of a specific piece of research, especially when based on market trends which can frequently be driven by sentiment and opinion as much as hard fact.
The second challenge is for the sell-side, which will need to decide how much of its current commission is used for execution, research and other activities. Dividing up the costs of a large business offering many services can be very difficult. As one industry expert told theTRADEnews.com, if you unbundled the cost of a five-star hotel room, how much would you allocate to the laundered sheets, to empty the bin in the room, or for pool access and would a customer really want to receive a bill like this? Brokers would need to consider the fair division of various activities currently bundled into commission costs and this could be very difficult to do fairly.