Unbundling Research: Canary in the Coalmine

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Critics claim that unbundling research from execution will negatively impact research provision, particularly small and mid-cap companies, threatening listings and secondary trading volumes in Europe as a result. Proponents believe this offers an opportunity to open up the research market and challenge the status quo regarding the implementation and execution of investment ideas.

As the first year of MiFID II draws to a close, we spoke to 62 market participants in a variety of roles across the globe—PMs, traders, sell-side, buy-side and independent research providers to understand just how the provision of research has changed since the introduction of MiFID II and whether the outcome has been negative or as positive for European capital markets as previously supposed.

The ability to access value-add research continues to matter in an increasingly competitive asset management industry. Headlines regarding the slashing of research budgets and culling of broker lists detract from the fact that as price transparency becomes clearer, firms are becoming more discerning regarding the type of research they consume, as well as their method of access. The production and consumption of research is ripe for change.

Although bulge brackets remain the dominant providers of research today, the future sustainability of their business model appears to be being called into question. As the buy-side revisit budgets and conduct broker reviews ahead of 2019 to select future providers of research, the sell-side are having to make decisions regarding where to invest scant resources and which clients to service going forward. Bulge bracket brokers are still assessing what they can expect to earn from the continued provision of research; attempts to lower the minimum waterfront entry point appear to have been underestimated in the hope of continued higher revenue analyst access. As transparency over cost and quality of research emerges, our discussions tell us that portfolio managers are not only becoming more selective regarding which analysts they access and what they are willing to pay, they are exploring new methods of accessing investment ideas as firms come under increasing pressure to lower operational costs.

Corporate Access is a case in point where some asset management firms are now being excluded from broker roadshows as a result of declining commission payments. In response, these firms are now electing to engage direct with company investor relations departments instead; even employing internal staff to manage this process globally. By altering how firms gain access, new challenges emerge; consumers require servicing and the companies that they invest in need to develop new methods on how to engage with investors, whether that is self-funded research, or utilising new portals such as Alphametry, Ingage, ResearchPool or RSRCHXchange. The increased use of data via companies such as Network Valuation Metrics Inc, provide quantitative tools to match investors with assets offering a wider selection of bespoke offerings—connecting asset owners with assets direct rather than automatically relying on a broker to act as an intermediary.

All of which is leading to changes in the production, access and distribution of investment ideas—and not just in Europe. While there is a current split between payment from P&L for MiFID firms and clients’ money for non-MiFID business, the increasing focus on end clients is seeing a gradual adoption of research unbundling practices globally. Irrespective of their regulatory obligations in the US and APAC, some of the largest asset managers are looking to demonstrate their firm’s capability as a protector of client assets and are electing to pay for research out of their own P&L. This is creating a knock-on effect for other non-EU local managers and their providers of research, irrespective of where they are on the globe and the instruments covered.

Active managers world-wide have to adapt and adjust their business models if they are to succeed in an increasingly competitive landscape. With the growing adoption of index funds and automation to enhance decision-making in a globalised economy, successful asset owners need to become more efficient in marshalling big data along with human insight to develop diverse investment strategies most suited for the millennial investors of today.

Irrespective of the size of individual asset managers, investment models have to take into account increasingly sophisticated risk and return systems and methods, while developing sustainability practices in a more centrally-managed way, as well as focus on multiple investment time horizons. This complex multi layered approach to investment today requires the provision of research ideas to follow suit. A mere replication of what has gone before at a lower price point will no longer move the dial. The adoption of technology is moving from execution to investment and the impact of unbundling on research provision post MiFID II is just one element of the process; like the canary in a coalmine, it may be the precursor to far greater change that lies ahead.

Key Findings

1. Research unbundling is already going global—53% of buy-side respondents have already implemented a global policy & a further 20% will do so within the next 5 years. In Europe the change may be regulatory driven, but across the rest of the world it is being led by end investor demand.

2. Overall research spend and number of research brokers engaged is on the decline but the buy-side are still consuming research. 61% of asset managers have reduced number of research providers but 55% still take research from more than 50 providers globally & 76% access small and mid-cap research from more than 10 different brokers.

3. The bulge brackets continue to dominate the top 10 research broker lists with 69% choosing global investment banks over regional specialists or independents. However, 61% still see the sell-side as viewing clients’ revenue holistically; as there is increased transparency in all research pricing, THIS situation may change.

4. While bulge brackets dominate for now, change is underway—77% are using alternative sources of research to traditional written research and 59% of buy-side firms are now investing in quants and data scientists as execution of investment ideas moves from the sell-side to the buy-side.

5. 38% of asset managers have seen a change in service levels by the bulge brackets, as the sell-side begin to select the clients and coverage they offer, adjusting the ability of portfolio managers to access ideas in the traditional manner.

6. 78% of asset managers see small and mid-cap research as more impactful in investment decisions. 46% believe there has already been an impact on small and mid-cap coverage—yet 43% of sell-side have not altered their coverage of small & mid-caps and 57% plan to increase coverage.

7. 52% of buy-side respondents now choose to access written research via platforms, often as a minimum entry access point to keep the communication channels open; but use of portals is also an efficient means of controlling access and tracking usage to ensure firms are getting the maximum benefit from research procured.

8. 46% think unbundling research has led to a change in how they source liquidity with 94% now having the freedom to select a more diverse range of execution providers where access to liquidity, particularly blocks, remains key for respondents.

9. Just 16% have chosen to increase their access to traditional high touch trading post unbundling. 53% are selecting brokers based on greater automation of workflows including data analytics in addition to algorithms, making low touch trading a more bespoke high touch execution service.

10. Increasing pressure on ensuring successful implementation of the investment strategy is leading to a growing partnership between portfolio managers and their dealing desks. Rather than relying solely on portfolio managers for investment strategy, 55% of asset management firms now recognise the role the dealing desk has to play in optimising alpha opportunities alongside longer term fundamental strategies.

We spoke to 55 firms between August and November 2018 to understand the implications of MiFID II on the unbundling of research and execution. 40% of the buy-side respondees were headquartered in the UK, 31% in the EU, 19% in the US and 10% in APAC; 65% are regulated as a MiFID II Investment Firm, 41% as UCITs and 21% are regulated under AIFMD. Buy-side interviews were augmented with interviews with sell-side and research providers to establish a full holistic picture of research provision post MiFID II.

If you are interested in reading the full report please contact your Liquidnet account manager or email mifid2@liquidnet.com.

Ellen Gordon