MiFID II transforms market for research
Unbundling here to stay; research goes on exchange.
Fintech startup RSRCHXchange launched a new online marketplace in September, built in consultation with asset managers and investment banks, to make it easier for them to cope with the transparency and reporting rules that come into effect in January 2017 under Markets in Financial Instruments Directive II (MiFID II).
There’s a lot of this about, of course. But this particular online marketplace is unusual: RSRCHX (just say it) is not one on which investors and investment banks will deal in financial instruments, such as bonds, equities or derivatives. Rather, it is a new exchange for the procurement and sale of research reports.
Asset managers are setting new research budgets and asking themselves what they need and what can they get within that budget
Vicky Sanders, co-founder of RSRCHXchange spent 10 years in equity sales at Goldman Sachs and Bank of America Merrill Lynch in London before joining a commodity broker and then setting out to create this new market place. She tells Euromoney: “Fund managers have grown used to being inundated with research reports, many of which they don’t read and for which they have no filter or means of grading. It’s a very inefficient market.”
The number often quoted around industry talking shops is that the leading banks across the world produce roughly 8,000 research reports a day, adding up to 3 million each year, of which maybe 5% are actually read. Analysts may argue they cannot produce that well-researched, impactful, counter-consensus call unless they are in regular contact with companies and also producing the low-value, regular earnings-release related research updates.
But asset managers’ view of paying for all this filler will change when they have to pay for it out of their own pockets and all they really want are the best hits.
While the final text of MiFID II has not yet been set, it is clear that it will bring profound change to the ways in which asset managers pay for research -– including fixed income, currency and commodity research, as well as equity – and account for those payments. MiFID II casts research essentially as an inducement to trade – which it has always been.
That’s why investment banks internally measure analysts’ performance on the basis of commissions and trading revenue they generate.
MiFID II insists that investment banks cannot pass research on as a supposed free service to asset managers and then have them pay for it in trading spreads and commissions that the asset managers neatly pass on to the customers investing in their funds.
Instead, the burden increases on asset managers to provide a transparent and auditable trail of payments for research procured, separate from payments of transaction costs. Between now and 2017, asset managers must decide how they are going to set budgets for research to be paid for by investors in their funds – so, potentially inflating the fund fees they must disclose upfront to investors and so reducing their own products’ competitiveness – and how much of the cost they are going to absorb in their own profit and loss accounts as a hit to margins.
“Asset managers are going to be much more rigorous about scrutinizing how their portfolio managers derive value from third party research and more rigorous about sourcing the best research they can at the lowest cost,” says Mike Carrodus, former head of institutional sales at independent firm Ned Davis Research (NDR) (owned by Euromoney Institutional Investor) and more recently founder and chief executive of Substantive Research.
A lot of good analysts are breaking away from the big banks and setting up their own shops
If RSRCHXchange is the equivalent of iTunes for buying research content, Substantive Research might be the Pitchfork Media, setting the agenda for where asset managers should be devoting their attention to the best pieces as they come out.
It publishes a daily thematic note for fund managers that highlights the best macro research from banks and independent providers. It is also launching online tools that help fund managers source and compare the best macro research for their particular process and preferences.
“We’re about curation and quality control,” says Carrodus, “and also about matching buyers and providers. Research is about so much more than getting price calls right. And asset managers of similar size and type look at research in very different ways. Some really value the detailed thought processes and modelling behind a call, some just want to keep an eye on insights about other investor flows.
"We are looking beyond just tagging content, to matching up the key considerations of asset mangers that drive their buying of research against characteristics of what different research providers produce.”
The marketplace is going to change from one in which investment banks push their full coverage onto asset managers, to one in which asset managers pull out only what they want.
Sanders says: “Increasingly, due to regulation, asset managers are setting new research budgets and asking themselves, what do they need and what can they get within that budget. As well as a regulatory push, there is a business rationale for changing the way asset managers procure research.
“Say a portfolio manager has a position in Daimler stock and is very interested in how developments in China might affect care sales there. He may need a combination of Chinese political and economic research, when the best may be provided by a small independent boutique; global automotive research, when the best may come from a bulge bracket investment bank; and a particular view on Daimler perhaps from a medium-size German bank.
"The asset manager doesn’t need long-term subscriptions to all three. Rather the asset manager needs a marketplace to pay only for the combination of pieces he needs. RSRCHXchange aims to be that marketplace, taking on from asset managers all the burden of checking and approving a network of potential research suppliers and organizing their content. Providers can then price their content, including just for individual reports; for three, six or 12 month subscriptions; and even price analysts’ time for those asset managers who want meetings with them.”
RSRCHX is free for asset managers to use and charges a distribution fee to research providers. They see the value in this. It had 50 research firms signed up at launch.
It seems like a reasonable bet that there will be less research in future, and perhaps that’s no bad thing if 95% of it goes unread. As much of that is PR for large companies’ investor relations teams, it may be that company-paid research may grow, despite all the obvious conflicts of interest.
But asset managers will still require research from banks and many of the leading banks are also reducing their own distribution lists and focusing coverage on their own biggest and best buy-side clients.
It’s also possible that analysts may find ways to profit from good primary research in areas that were neglected in the bundling of research with commission payments that pushed an excess of coverage on the big-cap, liquid stocks. It might extend coverage of smaller companies, even though commission capture is not large for trades in those stocks, if asset managers see these as a significant source of alpha.
Carrodus says: “A lot of good analysts are breaking away from the big banks and setting up their own shops. And many asset managers are now considering spreading their limited research budgets across a slimmed-down core of large banks providing waterfront coverage and these smaller specialist firms with insights into particular asset classes, sectors or countries.”