Impact of MiFID II on the investment research market

This analysis is by Bloomberg Intelligence analysts Sarah Jane Mahmud and Alison Williams. It originally appeared on the Bloomberg Professional service. 

Investment Research Disruption Ahead If Unbundling Rules Passed
European Union proposals would require investment research to be paid for in one of two ways: from a fund manager’s own account, recoverable by raising management fees, or via a client research payment account. Regulators have yet to clarify the rules around using dealing commissions to fund such an account. An unbundled model, where commission use is limited, would be most disruptive and could be applied by the industry globally. The proposals are part of MiFID II’s clampdown on third-party inducements.

Impact: Changes in payment for investment research will affect both asset managers and providers of investment research, including investment banks and non-bank research houses, operating in the European Union.
Unbundled Pricing Models Could Transform Investment Research
Banks are reported to be devising new pricing models for investment research in view of EU proposals that could prevent research from being paid for using dealing commissions. In an unbundled world, where payments are separated, competition for equity and credit research may increase as asset managers look beyond traditional sources, which may trigger fragmentation. They may also move research inhouse. The U.K.’s FCA, which is driving the debate, has endorsed the EU proposals.
Impact: Global banks that provide investment research, including Barclays, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan, Morgan Stanley, Nomura and UBS, may need to adjust their pricing models if EU regulators require the unbundling of research from commissions.

Europe’s New Research Commission Rules May Drive Change Globally
Non-EU regulators have yet to issue proposals to separate research costs from dealing commissions. Without international convergence, EU companies that would have to charge or pay for research may become less competitive than overseas peers that would be able to accept or use commissions. Global companies could deploy the EU system on a worldwide basis in order to minimize operational strain. This may encourage non-EU regulators to adopt the EU approach.

Photographer: Jasper Juinen/Bloomberg

MiFID II Could Trade Commission-Sharing for Payment Accounts
Under MiFID II, portfolio managers in the EU would only be able to pay for research directly or via a ring-fenced client research payment account, which would be subject to stringent conditions. The proposals consider current commission-sharing with brokers as a conflict of interest. While the plans don’t state if commissions may be used to fund such an account, they say there should be no link to transaction volume or value. This may pave the way for a system that is effectively non-commission, “hard-dollar”-only.

Impact: Asset managers, including Aberdeen, AllianceBernstein, Allianz, Axa, BlackRock, Henderson, Prudential and Schroders, would have to pay for research via cash or a research payment account if EU regulators require the unbundling of research from commissions.

A La Carte Investment Research May Rise in New Unbundled World
The price and underlying value of investment research will be subject to close scrutiny starting in 2017. This is regardless of whether regulators permit a modified form of commission-sharing agreement in the form of a research payment account that could limit or restrict the use of dealing commissions. Asset managers may become more selective about what they buy, choosing tailored coverage instead of paying a lump sum for a wider bundle of research.

Dealing-Commission Proposals May Cut Research Spending by Banks
EU plans to separate research from execution spending could cause banks to streamline their research offerings. Larger banks, which can cross-subsidize research and offer a wider range of ancillary services, may thrive in a more competitive market, along with established smaller providers. Those in the middle could be more at risk in an unbundled market, though they may see an opportunity in providing research on small or midsized companies that may receive less attention from larger competitors.

Impact: Large investment banks providing investment research include Goldman Sachs, Barclays, JPMorgan and UBS. Smaller research providers that are able to provide niche offerings include Liberum, Numis and Shore Capital.

Cost Revamp May Open Doors for Non-Bank Research Providers Competition in the investment research market may increase under MiFID II proposals that seek to separate payments for research from dealing commissions. Portfolio managers would likely be more selective about the research they purchase and could “shop around” from multiple providers. If so, independent research providers would more easily be able to compete and gain access to the multibillion-dollar equity research market, which until now has been the near-exclusive domain of investment banks and brokers.

Impact: Non-bank research providers, including Autonomous, Morningstar, Markit and Edison, and exchanges providing stock coverage, such as LSE and Deutsche Boerse, may be able to compete more easily with banks and brokers in an unbundled research market.

MiFID II May Pressure Portfolio Managers’ Research Spending
Under MiFID II, asset managers would only be able to pay for research directly or via a research payment account. Regulators have yet to confirm that dealing commissions can be used in such an account. If not, discrete costs for research may pressure margins, likely increasing operating costs, which could make active managers less competitive than passive managers that don’t rely on research. Asset managers, especially smaller ones, may struggle under either scenario, leading to less spending on research.

Cost Revamp May Open Doors for Non-Bank Research Providers
Competition in the investment research market may increase under MiFID II proposals that seek to separate payments for research from dealing commissions. Portfolio managers would likely be more selective about the research they purchase and could “shop around” from multiple providers. If so, independent research providers would more easily be able to compete and gain access to the multibillion-dollar equity research market, which until now has been the near-exclusive domain of investment banks and brokers.

Impact: Non-bank research providers, including Autonomous, Morningstar, Markit and Edison, and exchanges providing stock coverage, such as LSE and Deutsche Boerse, may be able to compete more easily with banks and brokers in an unbundled research market.

Research Rules Spark Debate on Implications for Bond Spreads
The U.K. FCA has said that bid and offer spreads should tighten across credit markets as a result of EU proposals that would see research decoupled from trading spreads. In fixed income, the cost of research is typically embedded into the spread, which helps pay for the trade, and so has been treated as part of a wider service. Brokers, many of which maintain that spreads won’t change given they are competitively formed, may face regulatory pressure to reduce spreads from 2017 when MiFID II comes into force.

Key Points:
  • Estimates are not available for the value or size of the fixed-income research market, likely because research is embedded in the spreads.
  • Most fixed-income investors conduct research in-house, though may still benefit from tighter spreads.
  • The proposals would increase transparency in the bond market, making it easier to ensure best execution.

Research Commission Rules Likely to Be Clarified During 2015
Final rules on separating research costs from dealing commissions will unfold in 2015. At the EU level, the European Commission should adopt its position on EU securities authority ESMA’s proposals in 3Q, when it may clarify the rules around using dealing commissions to fund research payment accounts. The U.K.’s FCA, and the EU’s other 27 national regulators, will likely start to consult on changes to local regimes in 4Q. The new rules are scheduled to take effect across the EU on Jan. 3, 2017.

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