5 things You Need to Know About Regulatory Change in the Research Market

New regulations covering research procurement (taking effect on Jan. 3 2018) will change how portfolio managers and buyside analysts in Europe can access, share and value external research. Therefore we thought we’d shine some light on why your operational colleagues look so stressed and why they want you to make some tough decisions ahead about how you evaluate and consume research

  1. Charging clients for research has become more complex for asset managers 

From much of the early reaction to the FCA’s September 30th consultation paper you’d think that European asset managers were being forced into paying for research themselves. The fact is that they can continue to charge their clients for the research they use within the new Research Payment Account structure. However, a host of new transparency and governance procedures need to be put in place. This piece from Sandy Bragg at Integrity Research Associates is balanced and covers all the main points. Integrity Research Associates: UK Regulators Offer Moderate Interpretation Of MiFID II Unbundling

2. Sell side fixed income research will no longer be free

If a piece of sell side research helps you make an investment decision, then you will need to pay for it. The main issues here are that a) fund managers (and their clients) have not been charged for FICC research until now, and b) all that stuff you received for free and that is considered substantive, now has to be paid for. Not much has been written on this tricky topic. We highlight a Euromoney piece from earlier in the year, but for anything up-to-date you’ll have to come along to the FICC research panel at our November 3 conference. Euromoney: Counting the cost of research

3. Client fairness – the dealbreaker for RPAs?

Asset managers will now have to manage multiple, segregated research budgets. Unless an asset manager is confident that they won’t get sued for sharing research across those budgets, it will have to instead pay out its P&L. We write about this crucial issue here:

 4. European asset managers won’t be able to pay a US broker for research.

Investment research in the US remains bundled. US brokers who want to accept direct payments for research from European asset managers would have to register as Investment Advisors, which they won’t do. The Investment Association covers this issue on page 7 of their “Approach to research under MIFID II” paper, which is accessible for members here.

 5. PMs and analysts need to ”buy in” to this new process to reap the benefits  

The key point in this piece from RapidKD is that without the right stakeholder support any new processes will only fulfill compliance goals. PMs need to embrace the changes in order to realise the benefits of a streamlined process. So get involved! RapidKD: MiFID I implementation in the real world

If you have any comments, questions or suggestions please email us on info@substantiveresearch.com

Client Fairness – the dealbreaker for RPAs?

In our consultations with over 50 buyside firms since May this year it is clear that the stigma associated with continuing to charge end investors for research is dissipating. Both the AMF and the FCA consultation papers legitimised the use of CSAs. Whilst the FCA have added new controls and procedures it is clear that this is a viable funding route, at least theoretically. So what will make more firms join those already paying for research out of their P&L instead?

The areas of greatest concern vary depending on the size and business model of the asset manager you are speaking to. The largest firms talk about managing multiple research budgets, and the dynamic process of moving some of the CSAs funding those budgets to execution-only whilst others continue to allocate to research. Many small and medium size firms cite comprehensive consumption tracking as the largest potential headache.

However if there is one dealbreaker for the RPA/CSA route it is this: a lack of clarity in how much sharing of research is acceptable. Where should buyside firms draw the line and how can they implement the necessary controls?

It may sound sensible to implement a straightforward delineation between published research and any bespoke interaction with a provider. So if a PM takes a bank’s thematic publication into an investment committee meeting the other participants do not have to make the choice between shielding their eyes or passing him a tenner.

However if a PM from a desk which doesn’t contribute to a particular research providers’ bill attends an external analyst’s visit, the research budget his fund is housed within will need to contribute and the interaction will need to be valued.

That may sound terrible in practice, but even this may not work if the end investor doesn’t explicitly agree to this delineation. The legal departments of asset management firms will need absolute confidence that they are not laying themselves open to lawsuits from pension funds that feel they have paid for research that others have benefited from for free.

At Substantive Research we are embarking on a two-month consultation process with pension funds to see if a consensus can be reached on this issue. Once we’ve completed the consultations we will publish our findings as an Appendix to our existing draft RPA Code of Conduct, which will be housed on researchpaymentaccounts.com from December 10th and free to view.

If you have any comments, questions or suggestions please email us on info@substantiveresearch.com

Credit and macro research amid regulatory change (video)

How will research unbundling impacting credit markets and research coverage

Substantive Research interviews leading executive from credit research firm, CreditSights

on how research unbundling will impact the business of credit research.

Unbundling Uncovered – Key takeaways from our recent event

We would like to take this opportunity to say thanks to the more than 200 delegates that attended our inaugural conference: Unbundling Uncovered, on November 3. We would especially like to thank our panel participants for sharing their industry insight and knowledge on this topic.

Here is a summary of the key takeaways:

1) How prepared is the buy side for regulatory change?

-Most panelists and participants agreed that it was right that regulators look at research given the size of the market and that client money was used. While not uniform across the market, some asset managers present were very confident that their current process would stand up to regulatory scrutiny. This process includes fixed budgets, reviews and an assessment process that was complemented by a voting process, that ensured that they remained flexible in what they prioritised as the research markets changes.

-The biggest growth area in the research procurement/management space is around reporting obligations. How can the buy side get as much detail as possible, build an MIS, communicate through various internal management committees?

-This requires identifying all of the inputs coming into the organisation from providers. It was noted that historically payments for research via CSAs was dealt with by the trading business, but today, portfolio managers, compliance officers, and CIOs are all interested in how research is being consumed and paid for. This was a fundamental change in thinking for the buy side; Much more attention to detail.

Fundamental change is already underway. Indeed CSAs have been in place for years – which have largely been used to pay Independent Research Providers (IRPs), – but some buy side panelists said they intended to go fully unbundled in future. This process had slowed recently due to regulatory uncertainty. Commission payment providers note a 35% increase in the use of CSAs by fund managers over the last two-years, as well explosive growth of CSA aggregation to reduce administrative burden, which grew 5-fold in the past two years. Payments to IRPs have been incredibly stable, while sell side payments are coming down in average payment size, but frequency is increasing. This could be a sign of better goverance and fluidity in quality assessment of research. They converge somewhat.

2) How engaged are asset owners, end investors?

Clients care about performance, not cost. So spending time and money on assessing value ex-ante can be a distraction. Some panelists and audience members thought that there was no benefit for investors to be flooded with information they don’t have the time or inclination to process. The focus perhaps should be more on enforcement and sanctions when firms don’t behave correctly

This topic of research payment is difficult to understand and rather opaque, so many clients don’t care. But opinions differed as to whether that meant that regulation was more or less necessary. Some thought it was right that regulators assess this market and prescribe rules, because it is a market that doesn’t naturally self-regulate.

-There is a growing trend among Sovereign Wealth Funds (SWFs) to implement this burgeoning budgeting process internally What will be the implications for asset managers who they farm 80% of their funds out to? This could have consequences for the  asset managers themselves.

Some panelists argued that unbundling was ultimately being driven by the fund management industry, not the regulators. If some of the major fund managers decide to switch to a hard dollar regime, and then advertise clean fees to differentiate themselves, that will present a challenge to the rest of the industry. So in that sense, the industry is the driver of new market structure, not the regulator.

3) Will fund managers face additional costs with unbundling?

-This depends. In the unbundled world, investors have benefited from using the services of sell side firms to replicate some of the background work that is still needed by many firms. If banks stop doing that work then firms will each have to bring costs on to do it, and so the client will end up paying multiple times for the same job. If the market has to go hard dollar then it is possible it becomes less transparent for the client, and costs still will get passed on.

-The budget for IRPs is likely to rise. Panelists thought that the number of large bank relationships would decrease and there will be an increase in the number of boutiques being used and paid for. 

4) What happens if fixed income research is unbundled?

-The most controversial issue of all of the unbundling rules, and one of the key reasons for the delegated acts has been delayed. Sell side panelists warned there would be unintended consequences if the proposed unbundling rules were applied to fixed income research. They argued that there was a possibility of fundamentally changing the commercial relationship between the buy side and the sell side. The bottom line is: The regulator is essentially trying to unbundle something that is not bundled, because the costs are funded by the sell side firms themselves.

-The argument goes like this: If you assume that the model for fixed income research is not paid by the customer, then you’re asserting a model on investors that is going to change their outcome. It’s going to change their outcomes by applying a cost where it does not exist today, while also narrowing the consumption options.

-Consumption options don’t just mean research, because a lot of buy side – sell side dialogue could be around derivatives, structuring ideas, trade ideas, perspectives on different parts of the curve or different parts of the product spectrum.

There’s a real possibility that some of those dialogues are prevented because they are somehow labelled as an inducement and are banned under the proposed regime. This issue is being considered separately as part of the proposals.

-Therefore fixed income research is struggling with the twin challenge of applying the cost that doesn’t exist today and restricting the dialogue versus where the market is today. There is some hope that ESMA has taken account of these reasonable views.

-Buy side participants were less concerned about unbundling of fixed income research. They observe that more and more FI research is moving in house and will eventually leave the credit component of sell side FI research redundant. This is already in train with many sell side firms reducing their service in credit research for instance, although sell side macro strategists should remain in demand, as they are applied broadly across all asset classes. Global macro may be an even more competitive area for providers.

-There is a shift towards asset management firms creating their own intellectual property, to be able to prove that they’re adding some value, and more research is moving in house. Internal research budgets are in many cases greater than their external budgets.



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Defining Best Practice in Investment Research Procurement

Join us in November 2016 to hear industry leaders discuss their reactions to the new rules and benchmark your plans and priorities with your peers

Click here to register.

This Autumn the investment management industry will have greater clarity on the regulations for procuring and consuming external investment research.

Many of the proposed regulatory requirements are unlikely to be met with much resistance from asset managers. That’s partly due to the fact that the industry has already started to implement more robust procedures in the way it procures research.

Under the proposed new rules fund managers will need to set pre-agreed budgets for research payments, provide detailed audit trails of payments made to research providers, and also disclose transparent methodologies as to how they select and pay for research.

Unbundling Uncovered will allow asset managers to benchmark their plans and initial efforts to comply with the new rules, and provide end investors with the opportunity to understand how these changes will affect them. What best practice means within an RPA will need to be defined, and priorities set for the implementation of a practical and transparent process.


Crucially, it will be clear whether funds can charge clients for research or if research has become part of a firm’s P&L costs, and panel discussions will explore the likely implications for market participants will be.

One key area to address will be fixed income markets. It may be hard to classify any of this research as anything but an inducement to trade, and how the market categorises, values and charges for fixed income research will have market-changing ramifications.


Confirmed Speakers from 2015’s event included:

  • Peter Allen, Chairman, Euro IRP
  • Robert Alster, Head of Research, Close Brothers
  • Frédéric Bompaire, Head of Public Affairs, Amundi
  • Andrew Bowley, Head of Market Structure Strategy, Nomura
  • Chris Brown, Chief Investment Officer, IPS Capital
  • Mark Burgess, Chief Investment Officer, Columbia Threadneedle
  • Tom Conigliaro, Global Head of Investment Services, Markit
  • Nigel Cuming, Chief Investment Officer, Canaccord Genuity WM
  • Will Goodhart, Chief Executive, CFA UK
  • Alistair Haig, Fellow, University of Edinburgh
  • Christian Krohn, Head of Equities, AFME
  • Gianluca Minieri – Global Head of Trading, Pioneer Investment Management
  • Russell Napier, Co-Founder, ERIC (Electronic Research Interchange)
  • Neil Scarth, Principal, Frost Consulting & Advisory
  • Guy Sears, Interim Chief Executive, The Investment Association
  • Rudolf Siebel, Managing Director, German Investment Funds Association
  • Adam Toms, Chief Executive Officer, Instinet Europe
  • David Zahn, Head of European Fixed Income, Franklin Tempton Investments


Euro IRP sets up directory to enhance visibility of research providers

The European Association of Independent Research Providers (Euro IRP) has established a searchable directory for independent research providers to help investment firms locate a wide array of independent research providers while also helping research firms reach a potentially wider audience for their services.

The directory allows investors to search for providers based on sector or geographic coverage, asset class, type of research and business model, among other factors. The current directory is made up of 56 research providers that are currently members of Euro IRP, but the association hopes to expand this to more than 500 providers globally.

‘’This is an important first step for the whole independent sector,’’ says Peter Allen, chairman of Euro IRP. ‘’To date, there has never been a venue that allows investors to search for independent providers, whilst for the IRPs – many of whom have small operations that are producing high-quality research – it provides a useful way for them to reach a wider audience.’’

Currently listing in the directory is restricted to full members, but Substantive Research understands a separate category of IRPs who will just wish to list on the directory is under consideration, although they will still need to meet Euro IRP’s requirements as far as independence is concerned, as posted on their web site here.

The initiative is also important in the wider context of the new regulations for the investment research market, set to be implemented in 2017 under MIFID 2. The proposed regulations will require fund managers to set annual budgets for investment research spending, which will also probably need to be funded from their own account rather than passing the cost on to their clients. This is likely to lead to a more cost-conscious approach from investment firms on research spending, which could place IRPs at a competitive advantage because they operate on a lower cost base than typical bank research departments.

“As investment managers increasingly focus on the value of their research spend, this initiative will provide a valuable resource for identifying and sourcing the best possible independent analysis for their clients,’’ says Allen.

Unbundling research – the transition

The way that asset managers procure and consume investment research is changing rapidly. Regulatory change is set to accelerate this in the coming years. As things stand, there are concerns that the new regime could cause widespread upheaval and a slew of unintended consequences.


It all comes down to a handful of MEPs in Brussels who will determine whether research unbundling proceeds with clarity, and whether a variety of payment mechanisms are allowed – or not. Having spoken to Markus Ferber MEP, one of the key voices involved in MiFID II, it is clear he is aware of the risks of unintended consequences.

Reform has been a long time coming. The Myners report back in 2001 put in play a movement towards increasing transparency over the cost, price and value of investment research. The subsequent 14 years have seen a quiet evolution in the provision of investment research, especially in its relationship with volume of equity trades being executed.

The introduction of Commission Sharing Agreements (CSAs) in 2006 went some way to alleviating regulatory concerns, primarily over the conflicts of interest between execution and research provision. One of the key achievements of the CSA system, is that asset managers now have much greater diversity and independence in the research providers they use. Meanwhile, the link between research provision and execution of trades – which has been such a concern to regulators – seems to be in decline.

The complete unbundling of commissions and research payments contained within Mifid 2 is set to accelerate this evolution and clear any remaining conflicts of interest that still exist in the discretionary funds management space.

“It’s no bad thing that a light is being shone on the issue,” says Roland Spurr, business manager for equities at Alliance Bernstein. “As is the case with trading costs and best execution principles, the place of external sell side research in the investment process is a perfectly valid debate, where clients should be aware of what they’re paying for and what they’re not paying for.’’

Many of the proposed regulatory requirements are unlikely to be met with much resistance from asset managers. That’s partly due to the fact that the industry has already started to implement more robust procedures in the way it procures research. Under the proposed new rules, fund managers will need to set pre-agreed budgets for research payments, provide detailed audit trails of payments made to research providers, and also disclose transparent methodologies as to how they select and pay for research.

In the new, unbundled world, pre-agreed budgeting will provide the backbone of the new regime by severing the one-for-one link between the quantity of research investors receive and the amount of trading that they do. At the same time, a process of price discovery will need to take place, and it could take some time before an equilibrium price level is found. Moreover, finding a relative value across a range of providers is likely to be even more problematic.

‘’You can’t value sell side research (in an uniform way) because it depends on who is doing the buying,’’ says Robert Alster, who is head of research at Close Brothers, a London-based private wealth manager. ‘’You don’t quite know what research you’re after, and where you’re going to find the best ideas.’’

The initial price discovery will likely be a combination of individual firm value assessment, benchmarking to independent research providers and internal research resourcing. As the market transitions and settles in its new regime, asset managers will look for solutions to validate the prices paid for research.

Many large asset managers have already gone to great lengths to make their own assessment of value by building extensive data capture systems that record every interaction with sell side research providers. These include everything from the amount of research received and then consumed, to telephone calls, meetings and emails shared with analysts.

‘’In the future these physical data inputs be will ascribed values from which budgets will be set, which will then determine the hard dollar amounts we pay,’’ says Alster.

How do we pay?

Without clarification on how RPAs can be funded it seems that many asset managers will move to pay for third-party research out of their own P&L. Many fund managers conclude that it may be difficult to pass these costs onto their clients, and as such, there will be a significant drop in spending on research.

“Not many asset managers have pricing power in this environment and therefore they may struggle to pass on the costs,” says Alliance Bernstein’s Spurr.

“Regulators seem to be comfortable with capacity being taken out of the industry, both on the sell side and the buy side, and that’s fine,” adds Spurr. “But we’re not entirely convinced they know where the capacity will be taken out, and more importantly which end clients will benefit, which ones will be detrimentally affected.”

For instance, if the end result is a strengthening of the position of investment banks at the expense of smaller competitors, then it may not serve the retail client well, adds Spurr.

In a report released in March, TABB Group surveyed 50 global heads of trading of major buy side firms and found that 86% of respondents expected research payments to decline due to regulations. Just how that translates into a reduction in revenues, investors and research providers who spoke to Substantive Research in recent weeks suggest that it could fall between 30% and 50%.

The independent sector will be particularly hit, as it typically operates on lower margins and without the benefit of support from a trading business, meaning it is less equipped to absorb this sharp adjustment in revenues.

“If you’ve got a situation where all of the investment banks suddenly take a hit in relation to what they’re being paid, there’s a degree of cross subsidization that can absorb that in the transition period,” says Peter Allen, chairman of the Euro IRP, the trade body for European independent research providers. “If all of the independents take same hit, some of these guys will go out of business.”

This is not an argument for no change, but a suggestion that regulators should make a risk assessment of the potential ramifications of a sudden reduction in the capacity of investment research in the market.

Are regulators listening?

It seems that the door hasn’t yet completely closed on any reasonable arguments. MEP Markus Ferber told Substantive Research that a solution could be found that might limit the detrimental impact of a reduction in equity research coverage, in particular, when it comes to covering small cap stocks.

Speaking to us earlier this month Ferber made it clear that research costs provided a method of circumventing the ban on inducements, however, ‘’I do understand that there is some need to do something about the research issue, but it will be key to strike the balance right in order not to be in the way of SMEs. On the other hand, this problem confirms my point that a general ban on inducements is not the answer to the problems we are facing,’’ he said.

Kay Swinburne, another prominent member of the European Parliament and a member of the influential Economic and Monetary Affairs Committee, also appeared to offer a more conciliatory tone when she told Financial News this week, saying that the “political intent [was] never intended to prevent the bundling of the product”. She added: “It was only ever decided that we would force transparency on the market, as opposed to prevent it from happening.’’

Perhaps most tellingly she seemed to indicate that a slower transition might be the preferred option. “The parliament feels quite strongly that we shouldn’t be completely changing the model. If it happens over time because the market chooses to go in that direction, all well and good. But we are not there to force the model to change overnight.”

Why discard CSAs

If the slow-burn growth of CSAs are any example to go by the adoption of RPAs may take some time, and some fund managers fear that if they are forced to adopt a product that is not yet fully understood, they may just opt out and adopt a pure ‘hard-dollar’ policy. This could have dire consequences on research spend.

“Many of our members feel that to create and prepare the industry for RPAs with a January 2017 deadline is unrealistic,’’ says Guy Sears, of the Investment Managers Association, a trade group for asset managers. “I would imagine some firms will realise that they’re getting so close to the wire…the option between paying P&L and using RPA swings towards paying P&L.’’

The reasons for discarding CSAs seems a moot point. In a report published in March, Alistair Haig and Professor Bill Rees, from the University of Edinburgh, indicated that the introduction of CSAs had allowed fund managers to obtain a higher degree of independence in the advice they purchase, a wider choice of inputs and better value for money. And if breaking the link between execution and research payments is the ultimate outcome, findings of Haig and Rees suggest this seems to be happening by natural attrition anyway.

70% of the fund managers surveyed by the University of Edinburgh suggested research commissions to executing brokers declined in the period between 2010 and 2015, while there was a growing trend towards asset managers not charging their clients for the purchase of research, with 44% of those surveyed, affirming this trend.

Smoothing the transition

The industry now awaits clarification from the European Commission as to what the final rules will be, but those involved in lobbying regulators and politicians suggest some minor tweaks in the language could have a significant impact in limiting the disruption to the research market.

Some parties involved in the negotiations with regulators have proposed language that stipulates that payments on the RPA can be collected by the use of fees and client commissions, but those commissions would be called ‘’research commissions’’ as against trading volume-based execution commissions.

This would still break the link between the scale of those payments and the actual level of the trading that is taking place, while the use of commissions would be capped by the ‘ex-ante’ budgets.

Another option being debated is whether it is theoretically possible to create a quarterly charge based on daily accruals as to the research purchased but still use commissions to fund the RPA, according to a report published by the Tabb Group this month.

‘’At the moment it’s not clear how RPAs will be funded and how they might work, and given the short transition time, one should consider the existing CSA infrastructure that could do the same job, while still breaking the link with execution,’’ says another large UK fund manager.

And that seems to be the consensus industry view too. A recent survey of buy side professionals by Westminster Research Associates found that 88% of European-based respondents thought that regulations regarding CSAs should remain the same. In the same survey more than two-thirds of the investors said they would use less research if they were forced to pay cash.

Come June and the release of the delegated acts CSAs may become a thing of the past, yet it’s hard to see how CSAs couldn’t be part of the transparent, value-oriented market that the FCA and the European Commission envisage.