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Has Mifid II research unbundling experiment succeeded or failed?

Many of the early predictions were dire: boutique fund managers faced an ‘existential’ threat, warned Euro IRP, a trade body for European research providers; research quality would diminish following a drastic reduction in spending from fund management groups; areas such as small caps and fixed income could see worrying falls in coverage.

Initially, many of these problems appeared to be coming to pass.

In late 2019, a majority of providers surveyed by Euro IRP reported flat or falling revenues, with two-thirds of providers saying they had cut prices in the past 12 months.

But a report from the European Commission in September last year appeared to show minimal impact.

It said: “Mifid II reduced research budgets and lowered equity research prices particularly for larger investment firms. Research coverage and volumes for European equities have trended down for several years. Mifid II coincided with an increase in this decline for European SMEs although some of the decline may reflect cyclical effects.

“Research quality has not been systematically affected by the introduction of Mifid II unbundling.”

The report admitted that some structural shifts had been seen in the fixed income market, where published research volumes were lower and some providers had moved towards a strategy-analyst approach and reduced their use of publishing researchers.

Apart from that, it suggested, the system was working well.

If it ain’t broke…

Yet, more recently, there has been discussion of a phase four approach to commission management on research, which hints that there were more layers to the unbundling story.

In particular, changes are proposed that would create an exception to the unbundling rules for small caps.

This begs the question, if it is working so well, why change it?

Robin Hodgkins, president of regtech specialist Castine consulting (MPI is its European implementation partner), is clear that the system has not worked well in some parts of the market: “Coverage is declining, quality is declining and the feedback from corporates is that they are not getting as much coverage.

“We are also seeing research groups move from senior experts to more junior analysts because they can no longer afford them. This may be a training opportunity, but it means historic knowledge and expertise is lost.”

He suggests that the decline in quality and coverage has been particularly acute in the small cap areas, which is why there is talk of changing the rules. Also, he believes smaller fund management groups are suffering compared to larger fund groups, who have deeper pockets.

“Larger fund groups can afford to bring in the analysts they need, but it’s tough for boutiques. That, in turn, is problematic for innovation in the investment management industry.”

A buyer’s market

George Lagarias, chief economist at Mazars, is also clear that the market has changed in some areas. He says that on broader strategic research, “which is thought-provoking and a good-to-have, but not something asset management companies would necessarily pay a lot of money”, traditional brokers have lowered their prices significantly and forced independent analysts to follow.

“This makes it a buyer’s market. A lot of that research is still available in one way or another, and we haven’t seen evidence of fund managers suffering either a lack of research or imposing greater fees on clients to obtain it.”

He adds: “As far as specialised research goes (equity, bonds), many of the larger asset managers feature in-house analysts. Those who couldn’t afford a team might have had to pay marginally higher for research, as prices aren’t too expensive, but still we haven’t seen material changes in fee structures which would imply a disrupted business model.”

However, Robin Hodgkins believes the problems may be reflected in performance rather than the fee structures. Fund managers may choose to scrimp on research costs rather than pass higher costs onto their customers. However, they may lose out on the stronger performance good research can provide.

This is difficult to disaggregate in a noisy year like the one just seen, but Hodgkins says it may be a problem in the longer-term for private banks and wealth managers across Europe.

Increase in outsourcing

Chanakya Dissanayake, senior director and head of investment research at Acuity Knowledge Partners, says the impact is clear: “The roll-out of Europe’s Mifid II legislation reduced the availability of research and increased costs for private wealth managers.

“According to the regulations, private wealth managers need to have a formal view on the securities they advise on. This, coupled with customer demand for in-depth coverage of securities listed globally, has significantly increased in-house costs of producing this research.”

This, he says, has led to more outsourcing, particularly in certain areas.

Dissanayake adds: “We expect research demand from niche areas such as macroeconomic research, ESG-focused research and small-/mid cap-research (areas with less sell-side coverage).”

There are parts of the market where Mifid ii has had minimal impact – for larger fund managers, on larger cap research and, for the most part, for investors. However, as predicted, it has been tougher for boutiques, for smaller companies, for fixed income and for private banks/wealth managers.

Ultimately, in the longer term, it may also be reflected in performance.

New moves to rollback on some unbundling are a hint of these problems.

Part of the Mark Allen Group.