It is widely assumed that tonight’s Mansion House speech will confirm the Treasury’s intention to adopt recommendations from Rachel Kent’s Investment Research Review, published today. BEST EXECUTION talks exclusively to Substantive Research, experts in research rebundling, about the potential impact.
With the removal of MiFID II’s requirement to unbundle research and trading as a key pillar of the review, the hope will be that this will stimulate the research market and increase liquidity in the UK capital markets. The rationale is that MiFID II’s rules went too far, causing a rapid decrease in research budgets and reduced access to differentiated insights and analysis, particularly on SME stocks.
But for these changes to have any effect at all, the FCA will have to walk a tightrope between ensuring that some transparency will still be required in order to be able to sell this transition to end investors, whilst also removing enough of the existing regulatory burdens so that asset managers are tempted to rework their now-established MiFID II processes and infrastructure.
The Tricky Client Conversation
According to Mike Carrodus, CEO of Substantive Research, “If the review confirms research rebundling, the Treasury’s gamble is that asset managers will feel brave enough to call up their clients and say “You know those costs we took away from you 5 years ago when MiFID II came in? The Treasury and the regulators are now saying that they are making it simpler for us to return those to you, and we think doing so will benefit not only our investment process but also the UK economy as a whole.” How pension funds and other asset owners respond to that pitch is the only question that matters. Asset managers are not keen to open up a discussion about fees in the current tough economic and investment climate, so these changes from the Treasury may need to wait for a bull market before anyone feels tempted to even have a try.”
It’s not the Unbundling, it’s the Funding
Unbundling research and trading by itself was not the cause of the reduction in budgets and the accompanying sell side analyst brain drain from the market, which has happened on both sides of the Atlantic. Unbundling undoubtedly increases the visibility of research costs, but many US asset managers are unbundled and they still maintain robust research budgets which are passed onto their investing clients. The more pronounced deflationary effects that happened in European research were industry-led: a few large asset managers in autumn 2017 decided to bring research costs in house and let their clients know the good news, and then their competitors felt that they had no choice but to follow. This is a commercial dynamic now. And while regulatory freedoms may bring welcome flexibility in the longer term, the tricky pitch from asset managers to asset owners on re-adding research costs will have to be undertaken at some point in order to bring any actual change to the market.
Carrodus adds, “What would help most? A prolonged bull market that makes end investors focus on robust performance numbers so that they might focus a little less about some returning costs. Without that backdrop, convincing asset owners will be a tough sell, especially in the short term. The research industry will welcome regulators getting out of the way in terms of how research is bought and sold, but the FCA will have a tricky job ahead ensuring that there’s enough transparency to help the pitch to end investors, but not too much that asset managers decide it’s not workable in practice.”
All Eyes on the FCA and the EU
The market will now wait to see how the ensuing FCA consultation plays out and how long it will take, with the assumption that it will be early 2024 before the detailed new rules are clear and in place. At the same time, this international industry needs to see the new EU Listing Act in place at the end of the year before it can gauge whether the two sets of rules are aligned. The Listing Act will almost certainly include rebundling language, and if both sets of rules are complementary then that may indeed spur the buy side to make some changes later next year. But before they do, they will need to be ready for questions from pension funds on why this makes sense, and what assurances and transparency can be expected that will verify that their money is being spent wisely.
The above article was written by Substantive Research and provided exclusively to BEST EXECUTION.
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