Unbundling Uncovered – Key takeaways from our recent eventWritten by Hamish Risk | November 8, 2015We 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.
Defining Best Practice in Investment Research Procurement
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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