Defining Best Practice in Research Procurement
On June 13th 2024, we reunited over 400 leaders from the investment research industry at the Metropolitan Club in New York once again. Panels on the day covered the potential for regulatory alignment across North America and Europe, how research budgets are changing structurally in terms of demand and diversity, the potential that AI represents as well as the accompanying compliance and legal concerns and more! The key takeaways from the event are shown below.

Key Takeaways from Unbundling Uncovered USA 2024

These takeaways highlight the main themes running through the panel discussions on the day. Some of the insights may contradict each other, but that’s the nature of debate between the key stakeholders in this market!

1. Regulatory change in Europe raises the possibility of closer alignment between the US, the UK and the EU, but it’s going to be complicated (of course!)

Asset managers have studied the FCA’s recent Consultation Paper (24/7) with interest to assess whether the new regime will make a single global research funding and valuation model possible. Even with the final rules in place in a few weeks’ time, there won’t be perfect clarity in terms of how the new rules should be implemented. 

Global firms will have to match to the strictest set of rules, but could then operate differently across regions when it comes to disclosure and budgeting if needed. Many would have preferred fewer “guardrails” from the FCA to make this all simpler, but most aren’t optimistic about the final rules removing anything material from CP 24/7. 

Does the market want specific guidance and clarity from the FCA, or would it prefer to avoid overly prescriptive rules and make their own interpretations based on desired outcomes? Speakers pushed for the latter, highlighting the value of ongoing dialogue and underlining that existing processes already address most of what is being mandated. However, many will probably need to become comfortable with their own answers on what “an appropriate level of aggregation” means when it comes to budgeting, as strategy level budgets will be an obstacle for some. What the market does want asap is the ability to include UCITS in any new model, and also (but less likely) corporate access included as research.     

The SEC’s speech the day before the conference not only expressed regret at the previous decision to allow the no action relief to expire, but also indicated that there would be a wholesale review of research practices, which will build on their 2022 review. 28(e) may be working well (and speakers asserted this throughout the day) but would allow for the introduction of more disclosure requirements. These would only happen post-election, but some speakers thought that the UK’s new stipulations could provide the raw material for those considerations in the US in future! 

2. In order for there to be a surge in CSA adoption in Europe, the first firms who attempt to return to client-funded research budgets will need to show that the client conversation isn’t going to be painful.

Speakers ranged from the constructive to the sceptical regarding the adoption of new payment optionality in the UK and the EU. This issue brings in multiple stakeholders, including broker relations, finance, compliance, legal, the investment function and operations. For firms to make this transition it is essential that they know that everything won’t change again in a couple of years – it was expensive to respond to MiFID II and they will only invest once again if this time it’s for the long term. 

The FCA’s comprehensive guardrails are a potential obstacle, but some speakers stressed that it is the commercial conversation with clients that’s the potential block, especially if the goal is to buy more research and therefore increase budget. A global presence is helpful for this narrative, with a rationale of aligning your processes in order to treat clients fairly. For this reason a number of smaller firms in Europe are less engaged on this, as they don’t have “aligning client treatment across regions” as a rationale.    

What’s in the best interest of investors? Some speakers stressed that this is about returns to asset owners, and CSAs are aligned with the best outcomes for clients alongside good disclosure. They asserted that when markets were down in 2022, P&L budgets shrank at a time when external research would have been crucial for investment functions navigating choppy markets. Others stated that P&L budgets stabilised payments to brokers, and if budgets were client-funded again then providers would have to get used to lower payment floors and more variability in remuneration, with obviously the greater potential upsides. But this is all academic until the market sees how end investor clients respond to the idea of paying for their asset managers’ research again. 

3. AI is transforming the research industry, but generative AI is only one flavour from a variety of tools that firms are developing. 

The success of the big Gen AI brands has created the propensity for buy and sell side firms to engage with specialist tech solutions, and we are in a phase where firms are digging into specific use cases and solutions. While Gen AI may find accuracy in data a challenge, the transformer technology that enabled its creation also allows for other solutions and technologies that deal with data accurately and reliably.

Adoption is moving quickly but also carefully, as unrealistic expectations coupled with immature solutions can disengage an investment function from innovations. AI needs to align with existing workflows such as Outlook, Excel etc. across content and data discovery, distribution and modelling. From a provider perspective, entitlements, consumers’ portal preferences and user mapping are all still largely manual in the hands of salespeople who should move higher up the value chain.

AI can improve the efficiency of direct interactions by ensuring that investment professionals already have the context to make their direct questions to analysts more nuanced and penetrative. In the end it’s all about making PMs more efficient, and in future they could move to monitoring, responding and adapting probabilistic output from Gen AI, while transformer tech drives efficiency for their data extraction and manipulation!  

AI has pushed consumers from wanting some of a provider’s content to wanting ALL of a provider’s current and historic content. IP concerns need to be addressed for the value chain to work across providers, platforms and consumers, and it’s not clear who should pay for the new value that AI can bring to research relationships. Some value from discoverability and summarisation will come out in existing buy side valuation processes with the accompanying higher payments, but as treatment of providers’ content becomes more sophisticated there will be a conversation about who pays for these new efficiencies. 

4. The focus on data continues but is evolving from just getting more data to ensuring that the internal infrastructure is in place to extract value from the existing list of vendors. 

There is so much data available already – a key differentiator for buy side firms is how they integrate the data that they already have into their investment process. Firms have access to similar datasets so success is more about how they manipulate, digest and disseminate that data internally. Tools and analytics across research and data are becoming more important, and the right tech resources and internal relationships are essential, regardless of whether firms build or buy. But if new tech and data providers try to gain firm-wide adoption when pitching asset managers they are probably doomed to failure – targeting specific use cases amongst individual teams is much more likely to begin a relationship successfully. 

Discussion about data is now inseparable from tech, but the business needs to lead that conversation with their tech colleagues. Displacement of data providers for better quality or better value alternatives is becoming an increasing trend, and being on the Cloud helps to enable this. If firms aren’t creating processes where they have the ability to switch providers without breaking their business then they will be on an unsustainable cost path in the face of margin compression in the industry.

Many firms are integrating their research and data functions under one umbrella – it means you can look holistically across all the inputs that influence investment decisions, and also swap procurement best practices from both the research and data teams, even if the budgets remain very separate. Research procurement has historically been very focused on value, which has helped identify where the budget is delivering benefits to the investment process, but that is harder to do in market data which has been directed more towards cost control in the face of ever-increasing prices (e.g. budgets potentially doubling over a few years unless action is taken). For that reason market data teams have rigorous procurement best practices in place, but that value focus from their research peers can also reap rewards as this integration continues.

5. Corporate Access is booming in North America – especially conferences, but don’t forget how valuable NDRs are!

Corporates have to face off to investors with completely different structures, from decentralised firms where teams operate autonomously and request access as independent units,  to managers where research and access is shared across the firm. These both present very different challenges and opportunities both for brokers as well as corporates in terms of managing time, access and focus. 

Speakers cited stats which showed that on average the corporate access industry has conducted 5 Non Deal Roadshows per company, per year, but some companies do double that number. Buy side speakers estimated that 60% of meetings/calls come from the sell side, with the balance organised directly with the companies. Conferences have skyrocketed, up 51% since 2019 – and the average company is going 2.5 more conferences per year than they did in 2019. But the number of NDRs is going down – for example some corporates are doing fewer in a centre where they go to conferences regularly.

The buy side has become more proactive in terms of direct and frequent contact between sector analysts and the IR functions within corporates. So when they are interacting with broker-organised events then the C-suite is important for them, and if there’s only 15-1 meetings available at events then investment professionals may think a Zoom is as good or even better than that. Buy side speakers also endorsed the value of NDRs – especially for generalist PMs as opposed to sector specialists who attend specialised events. If everyone loves them, why are they happening less? If the incentives don’t align then perhaps buy side rate cards need to evolve accordingly. 

Corporates do not want to make headlines when they go to conferences  – they stay on script. They still commit to conferences and use their full management bench to attend those that make sense to attend, but they really value NDRs. To expand a shareholder base they have to pick carefully and prioritise direct meetings as part of an NDR that is targeted. 

Some North American corporates are going direct for their European roadshows – post-MiFID II some are finding some buy side aren’t as willing to pay brokers as before, and going direct has worked very well for them. On the other hand they can also find a lot of value in having the broker alongside them on trips, giving colour and context to the meetings in the calendar. When brokers align with topical themes and what’s driving alpha you really start to see the benefits of their involvement in these engagements.   

6. The research valuation and budgeting process is going nowhere regardless of potential changes in regulations and funding approach 

The buy side globally is committed to their sophisticated valuation approaches and the sell side needs the transparency output. Speakers underlined how the European post-MIFID II focus on data-driven conversations with the sell side has brought real benefits to the research process globally. The natural friction between the buy and sell side can only be helped with data that both sides can provide, and when there are differences in that data it can be illuminating if you dig deeper as to why that variance exists.

As regulations align so will budgeting processes and approaches. Firms may disclose differently but the underlying method of value calculation and budget allocation is increasingly consistent across regions. Consumption metrics, while not the entire driver for value and remuneration continues to be a core focus for negotiations.   

Budgets and pricing will not automatically increase if global CSAs become a reality, even if previously there was an exchange rate between a soft and a hard dollar. Asset managers are increasingly worried about underpaying versus their peers, but if Europe moved back to client-funded research then budgets would only materially increase if there was demand for new inputs and the “unit price” for existing research would stay the same. While there may be some greater flexibility at the margin, there would need to be a period of sustained performance over the mid term to allow for a structural shift back upwards. 

Transparency is essential for research providers to resource their businesses effectively. Some speakers hoped that in a more global CSA-led process we could move to greater transparency for providers in terms of what added value and why. Good transparency from a particular client encourages greater engagement and service from brokers, even if the client isn’t paying any more than another client that doesn’t provide that visibility. On the flip side, if transparency is provided to a broker that then communicates aggressively directly with PMs, that changes the behaviour of both the PM and the research procurement / broker relations function towards that broker in future.

Corporate access is really driving variable spend. Expert Networks are stabilising after the big jump in usage during the pandemic, analyst meetings still drive value and remuneration, and alt data spend continues to grow quarter over quarter. Over the last 2 years there has been a steady increase of accounts managed, but the number of contacts managed has doubled, with the acceleration in the sell side’s depth and breadth of relationships happening in Q1 2024. Whether that translates to payments at the end of this year remains to be seen! Votes are still being fine tuned to ensure the most valued formats and engagements have the highest weightings, and the valuation process continues to evolve regardless of the regulatory backdrop. 

We will be analysing all this in detail on November 6th 2024 at the Institute of Directors in London – come along and join us!