The following is a guest article by Mike Carrodus, founder of Substantive Research, a curator of daily macroeconomic research from sell-side brokers and independents, which will be hosting a conference on the implications of MiFID II reforms for North America (see agenda here).
In Europe MiFID II has ensured explicit research pricing from banks, and unbundled research budgets separated from execution. These are big changes – a price now exists for a bank’s written-only research, and there’s another price when this is combined with access to analysts. This was unthinkable only a couple of years ago.
We will be addressing the implications for North America on June 12th in New York with experts from the UK regulator instrumental in formulating the research unbundling provisions and 23 industry leaders. (See agenda here.)
Will the US be immune from MiFID II unbundling?
The regulatory action from the SEC in this area has been a No Action Relief that now allows American banks to take a payment for research unaccompanied by a trade from asset managers in Europe. We could be forgiven for thinking that what we have in front of us – transformation in Europe and slow evolution in the US – is what the research market will look like in the coming years. Have we reached a new status quo with two dramatically different markets based on contradictory regulations?
No we haven’t.
Even if you believe that US asset managers can continue to recharge external research to clients despite European peers taking these costs onto their own P&L, there is no way that the US market continues unaffected. The SEC’s No Action Relief expires in April 202o – what happens then? If other banks follow Bank of America Merrill Lynch and become registered investment advisors then asset managers will have no operational obstacle to taking research onto their P&L. If the other banks don’t follow it is still possible for American asset managers to absorb these costs – albeit in a more complex way.
A missed opportunity
But clients don’t care about these minor costs which are dwarfed by performance, right? That’s what we thought in the UK until October 2017 when everything changed.
Has the move to P&L in Europe been a good thing? Many definitely think so – but unsurprisingly many asset managers would have avoided it if they could have. To quote one operational head at a global asset manager, “If the industry had got ahead of this issue earlier, displayed commitment to transparency and underlined the potential risks to performance (which definitely exist), then we’d have avoided the move to P&L in Europe and all of its unintended consequences.”
The American asset management community has a choice – ensure they create a transparent and rigorous research procurement process and therefore have a chance of continuing with the privilege of passing these costs on, or have an even more rigorous process demanded by their own CFOs when the costs hit their bottom line. Some journalists and market commentators think it’s too late for the first scenario – but given these budgets are multi-million dollar for any firm of size we expect many to think it’s worth a try.
Evidence from Europe so far
So if both scenarios create a stricter approach to defining and regularly assessing what is “have to have” external research, then how does that play out in practice? We have some evidence from Europe on this, admittedly greatly informed by the move to P&L funding for research:
- Bulge bracket firms price their written research aggressively low and ensure they stay on almost every asset manager’s list. (Although we suspect this has just delayed the day of reckoning as many on the sell side gradually lose their appetite for subsidising their research product.)
- Independent research providers find themselves the undeserving victims as asset managers look for some easy quick cuts in the short term. Valuation by volume of interactions makes this worse as budgets become more concentrated.
- The devaluation of the sales function continues apace, despite the fact that almost every PM values a handful of sales relationships extremely highly.
- Asset managers focus on rewarding and consuming research from a “pull” rather than a “push” perspective.
At least one of these can be argued to be negative for the end investor. However the last of these has the potential to bring benefits to both asset managers and their clients. Fund managers have traditionally discovered good research by accident in a market full of oversupply. When they find good work they cling to it and develop deep relationships over a period of many years, and who has the time to regularly check if there’s better research that they should be accessing?
Market infrastructure is emerging to make that search for better research as efficient as possible. We’re still in the early stages and all the normal barriers to change exist, but as with every market going through disruption the short term changes happen slowly but then gain momentum impressively, as various tipping points are reached. Greater efficiency through new technology will be the only way for asset managers to reap some reward from all this disruption.
We will explore all these issues in greater depth on June 12th at the Metropolitan Club, East 60th Street, New York and would welcome you to join us to become part of the debate. Email us at firstname.lastname@example.org with “ticket” in the subject heading to request a ticket, or visit our Eventbrite page.