The MiFID II unbundling exemptions in place for SMEs from 1 March 2022 are “unworkable”, according to many asset managers
London, 2 March 2022: Substantive Research, the research discovery and research spend analytics provider for the buy-side, today published findings of its latest survey on what the FCA’s changes to MiFID II’s unbundling rules, that came into force 1 March 2022, mean for asset managers and their research providers.
In November 2021 the FCA released PS21/20, which set out the UK’s reforms to MiFID II’s research unbundling rules effective from March 1st 2022. The original rules that were in place from January 2018 had originally been deemed a success by the FCA, resulting in “investors in UK-managed equity portfolios saving around £70m in the first six months of 2018 across a sample of firms”.
But it’s also clear that competition amongst research suppliers has actually decreased following these changes, benefiting larger brokers who had the ability to subsidise their research departments and price low, versus independent research providers (IRPs) that have had to rely purely on research subscriptions. With the new reforms coming into force on 1 March 2022 the FCA tries to foster greater competition while also accepting that FICC research operates very differently to equity research. Finally, the FCA is also trying to address concerns regarding the sufficient provision of research covering SMEs in future:
In their words, their changes outline that they will:
– Exempt research on small and mid-cap listed or unlisted companies (SMEs) who have a market capitalisation below £200m from the inducement rules. This means that research on firms below this threshold could be provided by brokers to asset managers on a bundled basis (where asset managers make a single commission payment to brokers covering execution and research) or for free and would not constitute an inducement under our rules.
– Exempt third party research on fixed income currencies and commodities (FICC) instruments from the inducement rules allowing it to be provided on a bundled basis and would not constitute an inducement under our rules.
– Exempt research providers from our inducement rules who do not provide execution services and are not part of a group that includes a firm offering execution services.
But how have asset managers reacted to these changes, and what will they do in response?
In January 2022 Substantive Research conducted a survey of 40 asset managers in the UK and their responses show a very muted welcome, in addition to frustration at the detail of the reforms, which make the unworkable for most:
– 60% of asset managers will change nothing at all – the SME exemption is “unworkable” according to many. These firms had originally planned to at least re-bundle their fixed income budgets in response to the FICC reforms, but the FCA has added certain caveats to these that mean that they now see this as also unworkable.
– 40% are looking to take advantage of the tweaks in certain areas, but none of them will change the way they pay and consume SME research as the costs of changing their processes outweigh any perceived potential benefits.
– Despite the complications perceived by the rest of their peers, 25% of respondents are either hoping or intending to change their fixed income research agreements in order to save money or repurpose it to other parts of the research and data budget.
– 35% of respondents will take advantage of the changes and relax the controls they have implemented regarding trialling new research. As long as a provider cannot provide execution services their investment teams will be able to trial IRPs as often as they wish.
Frustrations remain high
The overriding response from the survey universe has been irritation and frustration at the fact that macroeconomic research is not included in the FICC carve-out. In these new rules macroeconomic research remains a potential inducement to trade equities. Asset managers concede that macro research may sometimes be helpful to make decisions about equity trades, but they say in practice their brokers include macro as part of the FICC research offering, and fund managers do not reward macro research with equity trades so there was no problem there to begin with.
Mike Carrodus, CEO of Substantive Research said: “This leaves asset managers with two complications – firstly (if the broker is happy to send FICC research to them for free) how to split out how much to pay for just the macro research, and secondly how to ensure that some macro research doesn’t slip through alongside any free fixed income research they receive”.
Carrodus added: “The bigger asset managers are less interested in addressing these complexities in order to take advantage of this carve out – the savings may not outweigh the costs of implementing new processes – but small and medium size firms may give it a try. How their brokers respond is yet to be seen – not everyone wants to provide FICC research for free, and how to price a stand alone macro product may become ridiculous at places which were pricing their whole FICC offering as low as possible whilst obeying the rules.”
The relaxation of rules governing research trials is more straightforward
If the provider doesn’t have a trading arm, UK asset managers can now read their research for free without breaking any rules. Before these changes an asset manager could only trial an independent provider once a year, and that included all parts of the asset manager and all products from the provider. In practice this has meant that asset managers have taken far fewer trials since MiFID II came into effect.
This relaxation of the trialling rules for IRPs isn’t seen as a game-changer, but it is a welcome headache reliever for those asset managers that are keen to add to or rotate the research they use. Now, as before, it is simply up to the independent providers to decide how much of their product they wish to give away for free!
The big ‘but’: the SME liquidity problem is too deep and too complex for these carve outs to fix
The FCA states in PS21/20 that the outcome it is seeking from these changes is “to increase the research coverage of SME issuers”, but the SME carve-out is the only one that no one in our survey is going to respond to. The benefits that the rule changes will bring in reality are an easier environment for independent providers to market their research, and modest fixed income budget savings for some firms on the buy side.
Carrodus concluded: “It is understandable that the FCA is loath to create loop holes after having spent so much time and effort to make the research market more rigorous and transparent – but the SME liquidity problem is too deep and too complex for these carve outs to fix”.
Survey universe: 40 asset managers – 75% long only, 25% HF – AUM range: US$2bn – £800bn.