On 3 January 2018, MiFID II will be implemented into UK national law replacing the Directive 2004/39/EC (MiFID I). In preparation for the implementation, Laven Partners is publishing a series of newsletters entitled ‘MiFID II Series’, to help our clients and friends navigate the regulations and assess the impacts it will bring.
MiFID II brings hefty changes to the use of research, as the new regulations continue to force disclosure and the unbundling of costs. This newsletter examines what firms must do in order to prepare for purchasing research and how it could be priced for their clients. Once MiFID II is in place, investments must comply with the requirements principally outlined in, but not limited to, Article 13 of the Delegated Directive (MiFID level II).
Interestingly, at the time of writing, there is still very little information in the marketplace as to what brokers are offering as solutions to managers, or what managers can or should do in terms of deciding how much research is worth and how to use research going forward.
It is clear that if research is to be unbundled, then a price must be ascribed to it, and if that is the case, brokerage spreads should tighten, notably in the bond markets. Nevertheless, few in the industry expect spreads to come down. After budgeting for the value of research received today, managers could, over a period of time and possibly in connection with the new rules on best execution, seek to determine if spreads have come down, and if not, why? If costs can be brought down the Directive will have had the requited impact!
So far, the only market indicators we have taken note of are that some large asset management groups, such as Jupiter and M&G, have already stated that they will bear the cost of research and not add any new research budgets but rather take any such costs from their management fee. It may seem preferable for such managers that avoid complications this way, especially for managers that focus on the retail side, but knowing how close managers are to their management fees, it also implies that research is probably not very valuable. Managers will have to analyse therefore how valuable research is to their investment staff. This should be done very soon, through discussions with the relevant staff and by considering what happens to asset management quality if indeed a manager removes or reduces the availability of research from their investment staff.
Other market sources also suggest that much of the generic research that is available would not be worth paying for. Indeed, research in niche areas is what would seem to be much more valuable, notably in emerging/frontier markets, or covering specific sectors, such as new technologies.
Looking at this pragmatically with little time to spare until MiFID II comes into effect in January 2018, what should asset management firms do? We propose following the below main steps:
- Seek to understand from their investment team what research is worth paying for
- Contact their broker to see how they propose to price any research
- Decide on an internal valuation method for any research
- Determine whether any research that is received benefits from any exemption with regards to non-substantive research or corporate actions
- Conclude on the pricing model or absorb costs
Bearing in mind that any research budget to be agreed with customers must be set for the year and cannot be modified once decided, this is going to be tough.
If the rules are likely to directly impact your firm, some tips on how to organise the work include:
- Eliminating any research that your investment team has noted as ‘not adding value’. Wait and see if you receive complaints that it is missed.
- Tell your brokers to show you what their research was worth. Make them come up with a price for what they do. Give them deadlines and enter into these discussions now, so that this is resolved before January. You will still need time to put in place the right policies and prepare for the right disclosures and contract arrangements if you pay for research.
This will give you time to deal with the compliance aspects surrounding the matter and all the related disclosures you will have to organise in any marketing or legal offering documents. The disclosures should clearly state the approach the manager has chosen for research and communicate research costs or budgets, where relevant. Remember also that if you manage funds, the board of the funds must agree with the policy that you will have determined as asset manager, as they are the party that bears the costs as the client, and their clients (investors) bear any disclosed costs.
As an alternative to dealing with your brokers, if you do not accept research from them, you could rely on independent research providers. There are more and more on the market offering varying access to research sources at a cost. Some even offer a menu of research to purchase from time to time. You will still need a budget for your own customers to be agreed on in advance and disclosed.
If you do decide on a policy to price research, try to think of various valuation factors, for example:
- any possible weighting system
All of these points will cause a lot of discussion amongst your staff as they will probably debate the value of some research in terms of how much they use it and whether it is sometimes accurate or always useful to read. Some commentators have noted that some managers find that some of their staff have described some research as always inaccurate but still useful.
If you are reviewing policies or establishing processes in your firm ahead of MiFID II, we may be able to help you. We also have automated software-driven solutions for the MiFID II directive that relate to non-financial reporting, compliance processes, client categorisation and record keeping. Contact us here for more information.