This is the first installment of two-part Q&A with Tom Conigliaro, Managing Director of Trading Services at Markit, who manages the firm’s commission management offerings including Markit Calendar, Vote and Commission Manager. Conigliaro was head of Merrill Lynch’s commission management services for many years before joining Goldman Sachs, where he founded the Hudson Street Services initiative to invest in and market independent research.
In this Q&A we talk about the effects of MiFID II on investment research, and how asset managers are reacting to MiFID II.
SB: What is your perspective on how MiFID II is changing the landscape for investment research?
TC: The European perception is changing significantly about the methods the buy side will have available to fund research, and some of those changes are fairly onerous from an organizational and workflow perspective. Responsibilities are falling squarely on the shoulders of the buy side, where historically research payments were a very collaborative process between the buy side and sell side.
SB: What are the funding options for research?
TC: There are three methods going forward, any of which require the buy side to make significant changes. First, asset managers can pay for research out of their own P&L. In this case, there is not much the sell side can do to help in the research payment process but they will play a primary role pricing research. Asset managers will need to have policies and procedures, payment methodologies, and technology to support the P&L system internally.
Second, asset managers have the option of funding the research payment account (RPA) with a separate, direct charge. Here, too, asset managers will have to set up supporting systems and/or outsource administration to a third party. Markit is well positioned to be a solutions provider. But again, in this second option, the sell side is not involved in the research payment process at all.
The third way research could be funded is what many would call the Enhanced CSA (Commission Sharing Agreement) method which will leverage existing CSA arrangements, but those arrangements need to be tracked at a much more granular level. There would be an increased burden on both vendors and the sell side to track research commissions and payments at the account level but at least there is a shared responsibility and existing procedures are in place between the sell side and the buy side to support the process.
However, one can make the case that in every option there is an increased burden on the buy side to structure a methodology that best meets their individual needs dependent on business model, organizational structure and the number of underlying clients they have. Lastly, the burdens for the buy side increase beyond the payment for research when you consider research evaluation, consumption tracking and client disclosure.
SB: There has been a lot of publicity in the UK about some fund managers deciding to pay for research from their own P&L. Do you see that becoming a broad trend or are these exceptional situations?
TC: At this point, I would say it is challenging to predict with any certainty. However, I will go out on a limb and say that it will probably be more firms than most people expect. Many believe there is an economic disincentive for asset managers to opt out and pay for research out of their own P&L. However, the counter argument is the significant burden and the disincentives created when an asset manager decides to fund research using clients’ assets.
Firms that have made the decision to opt out and fund research themselves have done so based partly on their organizational structure and secondarily based on a business decision aimed at positioning themselves as a market leader with respect to transparency and best practice. I believe they will make a case to their clients that they are taking the “highest road”. I’m not suggesting that statement is an absolute fact, but such a position will set a “high bar” and create peer pressure within the asset management industry.
As asset managers opt out and fund research out of their P&L, it will financially pressure industry participants, especially smaller to medium advisors who don’t have the resources to fund research out of their own P&L or in-source research more aggressively. The unintended consequence of this is that the largest and best capitalized asset managers will have the ability and financial wherewithal to take that “highest road” which in turn will potentially create an oligopoly where the biggest firms get bigger, and the smaller firms become increasingly marginalized
We have been in discussions with asset managers in the US who definitely took notice of those firms in the UK that have announced their intent to “opt out” and are now starting to further consider their options. It will be interesting to see how this all plays out.
SB: You mentioned earlier that Markit is positioning itself to be an administrator under MiFID II. Can you provide some more insight on what you’re doing in that regard?
TC: We’re already deeply involved in a MiFID II-focused workflow solution given the combination of our commission manager, research aggregation platform, broker vote capability and our calendar which tracks interactions between the sell side and the buy side. Each of those products has a pretty significant market share and we’re serving some of the largest asset managers globally.
We’re enhancing features and functionality to create a workflow solution that will enable asset managers to track consumption, evaluate research and ultimately make payments leveraging the technology embedded in our product suite.
We need to provide the flexibility that customers will require with respect to the three methods we’ve previously described: funding research from the P&L, via an RPA directly, or via an RPA funded through CSA programs
SB: Given Markit’s virtual CSA aggregation capability, do you see this becoming more valuable under MiFID II?
TC: I don’t know if it will become increasingly more valuable, but CSA aggregation will continue to be valuable for those customers who opt to use the Enhanced CSA model to fund RPA accounts. We believe our current product is very well positioned, but along with other industry participants, we will need to track payments and commissions more granularly at the customer account level.
With respect to facilitating payments for research from an asset manager’s P&L or funding RPAs directly, a new product design is required that will be distinct from our current commission manager platform.
In the next Q&A we will talk about the effects of MiFID II on broker voting, consumption metrics and the winners and losers from MiFID II.