MiFID II fallout: Why progress on price discovery is needed

By Fabrice Bouland | 4 August 2017

In less than six months’ time, asset managers will be unable to receive investment research unless a commercial agreement is in place. MiFID II clearly stipulates investment research will need to be explicitly priced and cannot be linked to the volume or value of transactions executed by the broker – in other words, research charges must be divorced from execution. As the deadline for the new regulation races ever closer, investment firms are in the midst of a price discovery process, not to mention still figuring out how research is going to be financed – either by their asset owners’ money, or directly out of their own P&Ls. In any case, funds’ managers need to replace guesswork with hard measurement and metrics, while the sell side will clearly wish to optimise their sales efforts with a focus on the provision of quality content with more effective distribution methods.

Whatever decisions are made, we need to see some real progress with pricing and budgeting if deadlines are going to be met. We are just beginning to see sell side firms come forward with proposed pricing plans in preparation for MiFID II. Most recently, Barclays have outlined a system of tiered packages, starting at £30,000 for a ‘read only’ subscription to European research, rising to £350,000 for its ‘Gold’ package. The larger investment banks will, of course, charge more than their smaller rivals. Indeed, Canaccord Genuity Group’s sell side unit in the UK released a figure of £75,000 a year for full access to the firm’s investment research and analysts, including dedicated sales and analyst calls and customised research requests. Similarly Bernstein Research is quoting firms around $150,000 a year for access to equity analyst reports and other services.  

Discussions between the sell-side and the buy-side about research cost started months ago, with each side maintaining a staunch poker face, awaiting the other’s move. But without clear and definite pricing, asset managers are struggling with their research budget plans. While the largest funds have been heavily involved in the process, the tier-2 players are greatly ignored by the top brokers. This simply highlights a very particular market distribution of the research industry, where the top 500 buy-side firms account for 90% of the dealing commission amount financing investment research globally.

This explains why research unbundling will have such a profound impact, and why new models will emerge. Deutsche Bank has launched a new research operation within its asset management division in a bid to reduce its reliance on external research providers. Its ‘Research Institute’ has been created in anticipation of MiFID II but it remains to be seen if this type of arrangement will be replicated by other asset managers, or indeed if an internal operation can completely satisfy the research needs of all clients.

So how do firms tackle the mammoth task of pricing and budgeting in just six months? And how are they approaching evaluation and measurement? Clearly traditional methods of pricing and evaluation, namely voting systems, are going to be outdated in a digital world where technology can enable faster, bottom-up, data-driven decision-making, further impacting research pricing. MiFID II may have lit the fire for necessary change, but innovation and technology are fanning the flames and never more so than in the area of research unbundling and price discovery.

Technology has a key role to play in accurately assessing and pricing investment research, as well as demonstrating full transparency in order to meet regulatory requirements. As many of the pundits have said, MiFID II might be leading industry debate around research unbundling, but the way research is distributed and assessed has been hugely inefficient for some time and major changes are needed, with or without the regulatory impetus. In a recent study by Quinlan & Associates in March 2017, it estimated that over 40,000 research notes are sent weekly by the top 15 global investment banks. The same report goes on to say that less than 5% of these reports are actually opened. This excess has a negative impact on quality as well as being an additional hindrance for asset management companies trying to identify the best sources of alpha. 

Online Research Marketplaces (ORMs) are blazing a trail when it comes to enabling asset managers to better understand their consumption as they unbundle research from execution. New generation knowledge management solutions integrated with digital ORMs will more easily bring extensive but targeted research directly into the heart of firms’ investment process, giving them the best data from global sources, as well as supporting budgeting and payment decisions in a more detailed way. We, and many others, estimate overall research spend will shrink post-MiFID II, indeed, McKinsey and Co. believes investors will slash more than $1bn of spending as they become more selective for what the pay for. With this in mind, there is significant value for buy-side firms in having an aggregated, one-stop shop solution for their investment research needs. Online portals will also play a role for research providers, helping them focus on the production and provision of quality content in formats that best suit their customers’ needs. 

When it comes investment research and price discovery, the process was never going to be easy – especially when you consider the current volume of research which is being churned out. Greater evaluation is critical in order to place a true and accurate value, and we need to replace traditional methods and guesswork with smarter decision-making and measurement. Time is not on our side, as most asset managers will tell you, so rapid progress in terms of determining pricing models is vital over the next few months. Opinion is mixed as to who will be the winners and losers of research unbundling. Some say that firms will choose to allocate their reduced budgets to fewer, bigger investment firms but we believe the winners will be those firms who embrace technology, and give asset managers access to a wider pool of world-class research and the option to interact and give feedback on their research in real time to boost quality.