When the revised Markets in Financial Instruments Directive (MiFID II) takes effect in the European Union from January 2018, research provided to investment managers will have to be priced separately from execution/trading, meaning that investment managers will have to pay separately for research and trading services from banks. This will be a change to current practice, in which banks provide research to their investment management clients as part of a bundle of services, with no explicit charge.
Consultancy Oliver Wyman says that one of the implications of this regulation is that the total amount of research produced/offered to clients is likely to fall. There is also a question mark over who will be paying for the research, which the firm estimates is currently worth about $5 billion.
According to this report from Bloomberg, a growing number of banks are saying they won’t pass on the costs to clients. But a natural consequence of banks absorbing the expense of research is that they will try to minimise that cost. Oliver Wyman estimates that the additional costs imposed by MiFID II could lead investment firms to cut spending on research by about $1.5 billion – or, the firm says, as much as $3 billion in the event of a price war.
Impact for corporate treasurers?
Michael Turner, partner at Oliver Wyman, told CTMfile that research unbundling will not directly impact corporates, given the regulation's focus on the investment side. He said: "However, there are a few second-order effects that need to be considered, but unlikely to be of immediate concern." Some of the secondary concerns will take time to be seen in the market and are likely to emerge in 2018/2019, according to Mr Turner. They include:
- Reduced research coverage: As mentioned in the report, unbundling is unlikely to lead to wholesale withdrawals from research given the importance to other businesses and the barriers to exit. However, as providers focus on the highest value pieces they will reduce focus on the lower value areas. This will likely include smaller- and mid-sized corporates who are less traded and, as such, represent less available wallet for the providers. As such the reduction in research coverage could also lead to reduced trading and liquidity in these stocks.
- Potential rise of non-independent research: some companies who experience reduced research may need to pay firms to provide non-independent research.
- Linkages into advisory work: most equity capital markets offerings include independent research as part of the package of the deal. Corporates will need to assess the value of this research when considering who to choose to support them in the advisory work.
The key findings of Oliver Wyman's research, Research unbundling – revealing quality and forcing choices, include:
- research providers and investment managers expect to see a reduction of between 10-30 per cent in research spend, with some as high as 50 per cent;
- to reduce operational complexity, costs and compliance risks, many investment managers plan to take this approach globally;
- a key decision for investment managers is whether to pass on the 1-3bps cost of research to clients. If they do, they will need to justify the spend. Given the complexity of the decision, many are still undecided;
- we estimate a combined reduction of spending on research and execution of ~$1.5 billion, potentially rising to $3 billion if a full-blown price war emerges, with the greatest impact felt by lower-quality research providers;
- the overall impact is only a 1-3 per cent reduction on total equities revenues and not sufficient to lead to wide-scale withdrawals in research;
- while small, the revenue pressure from unbundling will be a further challenge to profitability in equities, in an industry that has become heavily scale-driven. We estimate that over the last three years the largest four banks have captured 70 per cent of all profits available, up from 50 per cent in 2012.
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