On 7 April 2016, the European Commission (EC) published the first of a series of long-anticipated delegated acts, designed to provide detailed guidance on the European Securities and Markets Authority’s (ESMA’s) final report on the revised Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instruments Regulation (MiFIR).
According to the EC, the overarching aim of the MiFID II/MiFIR regulatory package is to enhance the efficiency, resilience and integrity of financial markets. Among the raft of legislative standards set out under MiFID II, the unbundling of investment research and execution has been one of the most contentious. Put simply, the new rules state that brokerages providing both research and execution services will need to supply and price them separately. This reflects ESMA’s view that under the current research payment model (i.e. via a bundled advisory and execution commission), research can be seen as an inducement to trade and may give rise to a conflict of interest.
While the unbundling of research and execution payments may seem nothing more than a prima- facie formality of process, the implications for the industry are profound.
On the buy-side, it is widely recognised that investment managers are currently awash with an oversupply of duplicative research reports, much of which is considered of questionable value. Faced with the prospect of having to pay for ideas that (1) they did not ask for and (2) they currently receive for ‘free,’ demand is likely to suffer. We predict a decline in global research spend of up to 25-30% by 2020.
On the sell-side, the dilemma is even more acute. Investment research has traditionally been seen as a cost centre for brokers, often un-priced and given away for free in the hopes the trade ideas will generate trading commissions for the research provider. Consequently, the concept of running a research platform as a standalone profit centre is a completely foreign concept for many brokerages. A painful adjustment process awaits.
Taken together, we anticipate major disruptions to the competitive landscape. Brokers offering waterfront research – namely, the global investment banks – will need to narrow their coverage universe, given the inability to monetise lower-value content. Tier- 2 waterfront providers will find the new competitive environment even more challenging and may be forced out of the market altogether. However, given the low barriers to entry, we are likely to see a proliferation of independent research houses, led by one or more ‘star analysts’ specialising in particular sectors or geographies.
Although the EC has postponed the implementation of the MiFID II/MiFIR regulatory package by twelve months to 3 January 2018, we believe brokerages have a long way to go in preparing for the monumental implementation challenges that lie ahead. From product development and packaging to pricing, distribution, technology and operations, the list of strategic and operational considerations is extensive and will fundamentally reshape the way the buy-side and sell-side engage with one another going forward. We believe much more needs to be done and done now.
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