As regulatory changes are set to slash the research market, asset managers are set to see a swathe of new initiatives with independent research providers, new products and competition for top analysts as MiFID II comes into effect.
Asset managers could spend up to £750 million less each year on research in the UK following the implementation of MiFID II, according industry statistics and experts.
The UK’s Financial Conduct Authority (FCA) estimates that UK investment managers pay £3 billion of dealing commissions per year to brokers, of which £1.5 billion was spent on research.
MiFID II proposals on unbundling investment research from dealing commissions will profoundly change the way asset managers not only consume, but pay for research.
The FCA estimates that as a result of unbundling of research from trading commissions under MiFID II, the total spend by asset managers on research will halve.
These estimates go even further than those produced following research by The Trade and Markit in 2015.
A Trade and Markit survey of over 120 buy- and sell-side professionals found that 35% expect research commissions to fall by 10%-20%. A further 29% expected an even larger decline in research commissions, between 20%-50%.
These figures alongside previous estimates on the effects of unbundling suggest the research industry could decline by at least £300 million per year, following the introduction of MiFID II, but the FCA believes the impact could be far larger.
It has been suggested that smaller asset managers seeking research will be hit hardest when MiFID II comes into effects.
Small managers to struggle
A report from the New City Initiative published last summer claimed: “An outright ban on the cost of research being passed on to investors would clearly favour larger asset management companies – especially those that can afford their own in-house research services.”
“Smaller firms tend to be heavily reliant on external research, and would find it a lot more difficult to face this extra cost. A number of smaller managers may even be forced out of the market.”
The Trade spoke to the founders of independent financial research company, ResearchPool, James Woodley and Pedro Fernandes about the issues asset managers face in obtaining and consuming research.
Woodley explained: “The market anticipates a 50% drop in size of the research market. Banks and brokers, both large and small, need to decide what research to focus on, whether that be universal coverage or specialist research, so it’s likely we will see a rise in poaching of analysts and research teams.”
He added: “This focus on specialisation and expertise creates a more level playing field and therefore opportunity for independent research providers.”
The way asset managers consume and obtain research will be turned upside down amid MiFID II regulatory changes, but the debate surrounds whether asset managers are in fact scaling back on research.
Woodley explained the difficulties in the way asset managers consume research and how a scale back in research is inevitable.
He said: “Some large financial institutions can have up to 250 research providers, providing masses of research which simply cannot be consumed and quality control becomes an issue.
“It has been debated for a long time whether institutions are in fact scaling back on research as budgets are slashed and MiFID II implementation approaches.
“Every asset manager has a different opinion on this, but eventually a scale back in research will happen.”
A survey by TABB Group, published in March last year, spoke with over 50 asset managers trading European equities and managing a total of $25 trillion in funds about the consequences of research and execution unbundling.
The report found that 67% of participants believe research payments will decline, corroborating other surveys.
Unbundling research has, however, opened up market competition from bespoke research providers like ResearchPool, with TABB Group’s report revealing 35% of UK firms anticipate a flight to quality research.
Jeremy Davies, co-founder of RSRCHXchange, a platform set up to enable asset managers to source independent research, believes these specialist providers will gain market share post-MiFID II.
He said: “While it’s difficult to predict exactly how overall research spending will evolve in the short term, we feel very strongly that independents – those who already produce quality research, price that research, and engage fund managers on the cost of research – will gain market share long term.”
Saoirse Kennedy, a senior consultant at business and technology consultancy, GreySpark Partners, agreed the quality of research produced will be play a big part in how the market shifts.
Kennedy told The Trade: “It will come down to the quality of the research - the cost of research will increase but asset managers will also consume less.”
She concluded: “These regulations ultimately focus on transparency, but they will bring greater competition to the markets… Research unbundling regulation will become an opportunity to drive new products to market.”
Analysts in demand
RSRCHXchange's Jeremy Davies said he is not convinced institutions are scaling back on research but instead looking more closely at what research they purchase.
Davies told The Trade: “We do not get the sense that the buy side is looking to slash research budgets. We do get the sense that people are looking at getting more for their money, however, and shopping smarter for their content with price and quality being examined far more closely.”
He added: “I would expect some scaling back across the industry on average but what you may see is some research providers, bank or otherwise, being far more adversely impacted as they do not have the top analysts or the highly valued research amongst investors.”
Davies’ view was echoed by co-founder at ResearchPool, Pedro Fernandes who agreed analysts and research teams will be in high demand following regulatory changes to encourage better quality research.
Fernandes said: “Brokers need to hire good quality analysts and drive towards specialisation in order to attract asset manager customers. At the moment there is too much focus on providing research for all clients in every possible market.”
MiFID II is undoubtedly a catalyst for change in research consumption, but both co-founders at ResearchPool and co-founder at RSRCHXchange agree that this depends on the size of the asset manager.
Davies explained: “For bigger institutions I would expect MiFID II to improve their purchasing power and with increased visibility they should be able to improve the overall quality of the content they receive.”
He continued: “For smaller institutions they may find that their research budgets are stretched and that they no longer get access to the research platforms of the big banks and brokers. They will need to shop smart to reconstitute the coverage and focus more on the areas they think will add specific value to their process.”
ResearchPool’s Woodley agreed with this, explaining: “It’s all down to the element of size and involvement - larger asset managers have the luxury of an oversupply of research and good relationships, meaning they can pick and choose research. Smaller asset managers are at a disadvantage."
Pricing points
Fernandes highlighted the price of research as an important factor. He said: “What’s interesting is that research has historically been perceived to be free, but MiFID II will bring price transparency making it clear it’s a paid for service. We have discussed this with asset managers, and the price attached to research can make all the difference.”
Woodley added: “Asset managers will need to justify budget allocation to research to their clients, and will be scrutinised on how effectively the budget was used for research.”
Davies at RSRCHXchange believes the solution lies in technology. He told the Trade: “For the buy-side, overcoming the administrative burdens of MiFID II will be the biggest challenge. Technology must be used and workflows updated to avoid inefficiencies. For example, manually tracking research that is received in inboxes when it is opened, read and valued is time consuming and therefore expensive.”
He added: “I expect to see the buy-side adopt smarter, technology enabled systems which meet the new requirements. When it comes to what research is used by the buy-side, unbundling actually creates an opportunity for firms to find new research sources and pay for their content in the most suitable way.”
Industry experts agree that the regulatory changes following the implementation of MiFID II will transform the way institutions consume research, with smaller asset managers at risk of bigger costs attached to research.
Statistics suggesting the amount asset managers spend on research in the UK could be slashed by up to £750 million imply a shift in the financial research market is indeed likely.
ResearchPool’s Fernandes concluded: “A big revolution is about to take place in the market and it will affect everyone. Large and small asset managers need to get up to speed quickly. It’s all about preparation."