Regulators should beware the potential for disruption that full unbundling could cause, particularly to smaller firms, according to Markit’s Tom Conigliaro.
Conigliaro, head of trading services at Markit, told theTRADEnews.com that the increasingly harsh stance on the use of dealing commissions to pay for research coming from the UK’s Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA) were worrying for both the buy- and sell-side.
On Friday, the FCA closes comments to its latest review on the use of dealing commissions. Earlier this year, it published findings that revealed many firms had made little improvement to their processes since its previous review in 2006.
The FCA has also thrown support behind ESMA proposals as part of MiFID II, which would require asset managers to pay for research out of their own funds, rather than using client money as part of a dealing commission, in order to create a fully transparent and priced research market.
"The FCA seems to be disappointed in the lack of progress to account for the use of commissions to pay for research, but taking the nuclear option of going for full unbundling could have some unforeseen consequences for the industry," said Conigliaro.
Markit, which offers a commission sharing agreement (CSA) management tool for both institutional investors and brokers, has recent met with its clients to discuss the potential problems full unbundling would cause in order to help present a unified view to the regulators.
Though full unbundling does carry benefits, such as full transparency over pricing, Conigliaro is worried that regulators have failed to understand the drawbacks of disrupting a model that has largely worked to the benefit of investors instead of working with the industry to find mutually agreeable solutions.
He explained, "A fully unbundled regime could do real damage to the business model of the sell-side, potentially reducing small cap coverage, as well as hitting smaller brokers and buy-siders particularly hard as they have the least capacity to absorb the potential costs of these changes.
“There's also the risk of regulatory arbitrage as the US is unlikely to go down this route and we still don't know how similar proposals in MiFID II will pan out."
Though the FCA’s findings were largely disparaging of the progress made, some of the asset managers it reviewed were found to be operating a transparent and robust research process, using CSA and setting research budgets to ensure they did not overpay for research and were able to properly award brokers that provided top quality research.
"I think a better approach would be to champion the work of those asset managers who are effectively managing their research budgets to demonstrate how it should be done. The FCA could also consider adopting a less principles-based approach to this, setting clear rules so that asset managers know what they need to do to comply,” Conigliaro added.