In the last few years, we’ve been hit by a pandemic, wars and out of control inflation, so you would think that governments and regulators would be targeting certainty and stability for 2023’s business and investing backdrop. But this couldn’t be farther from the truth – if you are in the investment research and/or data industries, this year will be full of regulatory confusion, uncertainty and potential opportunity, depending on where you sit!

Here are five key regulatory developments to watch out for:

1: The SEC will make life in the equities markets interesting this year with its plans to overhaul market structure and specifically best execution, but the discontinuation of the no action relief which allowed European asset managers to pay for US broker research in cash is causing chaos already. The latest meeting between the SEC and representatives of the buy and sell side did not inspire any optimism that the regulator would allow more time for a permanent solution to be found, so firms on both the buy and sell side will have to scrabble to figure out what to do from July 2023 when the existing relief expires. What will happen? The European buy side will try to pay local entities for their global research relationships, but this solution is not risk-free for brokers so it will be interesting to see how many are happy implementing this solution. US brokers without European entities may decide to just walk away from the region entirely to the detriment of diversity and choice in the research market.  

2. According to Jeremy Hunt, the UK’s Chancellor of the Exchequer, the UK’s financial sector is burdened by regulation which is getting in the way of growth. So will the UK’s MiFID II review on research unbundling show that Brexit freedoms can make the City more competitive? Not in the least. This ship has sailed. MiFID II’s research regulations drove asset managers to stop charging their research costs to their pension fund clients, and they can’t go back to them now and say “actually the UK government said it would be good if we could charge this all back to you, is that ok?!” This is especially true in a terrible year for investing for many firms. The irony is that the FCA pushed research unbundling onto Europe, not the other way around, so an ‘about turn’ like this looks bizarre. This is all too little, too late, and other reforms should be prioritized instead. An easy ‘New Year’s gift’ would be to include macroeconomic research in the fixed income research carve out that was announced this time last year – not including it in the carve out meant it was unworkable as a method of helping asset managers save money.

3. The EU’s latest December 2022 proposal is more about tweaking research regulations than a complete reversal, but similarly will only create confusion rather than any meaningful benefits to financial institutions or economic growth. The EU has proposed to allow research on SMEs with market capitalisations of under €10bn to be rebundled into trading costs and therefore passed again onto end investors, reducing costs potentially for asset managers in Europe – (previously the carve out was only €1bn market cap, which they now think was too small). But regardless of any of the details, on these reforms it’s the same problem: end investors don’t want to pay for these costs – they’ve got used to the new way and they won’t go back.

4. Regulatory developments in the market data industry (in the form of 2023’s FCA Wholesale Data Market Study) could be more welcome from the perspective of the asset managers and banks that have long been complaining about an opaque, oligopolistic market that ensures constant price inflation. In both the update on the timing and framework of the study linked above, as well as the Feedback Statement from January 2022, it is clear that the FCA will look at barriers to competition, opaque and complex contracts, and price inflation that may have decoupled from implications to the cost of production or client servicing. The key will be whether market data consumers can demonstrate that increased competition would help the end investor – as the FCA stated in January 2022, “if competition is working effectively in wholesale markets, we also expect retail consumers to benefit through lower costs and improved quality of investment products”.

5. Level 2 of the Sustainable Finance Disclosures Regulation (SFDR) will come into effect in January 2023, bringing clearer guidelines on sustainability-related disclosures. The Regulatory Technical Standards set out granular specifications for sustainability-related disclosures and will add a significant burden to fund managers, pushing them to rely even more on their data and research providers. We will also see what the consultation period for the UK’s Sustainability Disclosure Requirement unearths when it concludes in January 2023. The hunt for required external inputs will be challenging due to the lag of the reporting to availability in usable formats, which will in turn push the buy side to build more capacity internally. There is still the lack of consistency and regulatory standards in ESG ratings, making it difficult for the risk of greenwashing accusations to be totally eradicated, regardless of the best intentions. And with reports that the legal industry is raising funds to facilitate litigation in ESG-related matters, this will be a tough terrain to navigate in 2023! 

With all these regulatory factors influencing 2023, asset managers and their research and data providers face even greater administrative burdens and regulatory risks, but as with all market-wide challenges they also represent competitive opportunity. Firms that respond confidently and effectively will find the rewards are there – and rightly so, given the effort and investment required in what will continue to be a volatile investment climate.

At Substantive Research we’ve been proud to help our clients gain transparency into the research and data markets during a year when the need to invest and spend wisely was paramount. We will continue to expand the insights we provide into both markets this year, and we wish you all the very best for 2023!

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