Brokers operating in the European Union have only a few months to comply with new rules requiring them to set a separate price for the investment research they have been bundling with the trading services they sell to fund managers. Talks about a pricing have dragged on, with fund managers taking time to figure how much they are willing to spend and brokers worried about losing revenues and big clients. The changes could lead to job cuts for research analysts and some fund managers may lose access to research if they are not prepared to pay up.
Many brokers use access to research as a way to draw in trading business. The EU says these two services must now be priced separately so customers can decide if the bill for research is worth paying and to prevent conflicts of interest. Regulators elsewhere are expected to adopt similar rules, adding to pressure on fund managers as they compete with lower-cost funds that track a particular index.
“Historically, research has been a bit of a commodity; everybody has been producing it, oodles and oodles of it, in equities, fixed income, macro research, etc,” said Matthieu Duncan, CEO at Natixis Asset Management. “That was all fine, but now we have to quantify this, the bar from asset managers is going to be a lot more selective, in one way, shape or form.”
Spending on research is inferred as a cut of total commissions paid by fund managers to brokers for all their services. Consultancy Greenwich Associates says this is worth around $1.6 billion a year in Europe, around 44 percent of overall commissions. This figure could fall by $100 million over the next 12 months, according to a survey of asset managers by Greenwich.
“The greatest concern for research providers both large and small is that (the legislation) will prompt a substantial decrease in buy-side research spend,” said William Llamas, associate director at Greenwich. “When asked about how firms’ overall research budget will be affected, close to 40 percent of respondents predict a decrease.”
Just under three quarters of fund managers surveyed said they expected to cut the number of brokers they use.
FLAT FEE OR LIMITED ACCESS
Brokers are looking at several new pricing models to ensure they keep as much business as possible. Some plan to move smaller customers onto a model that would give access to written research only but no contact with the analysts, for as little as 5,000 pounds per person per year, fund managers and analysts said. They could charge more to small groups of clients for better access. Others are looking at a flat fee per fund firm that could cost millions of pounds a year, they said.
A survey of French asset managers by broker ITG found that most were in talks with brokers about the research rule but eight percent had yet to start talks. The rule is part of the EU’s MiFID II legislation which updates securities regulations to apply lessons from the financial crisis, such as the need for more transparency, better protection for consumers and to adapt to new trading technology.
Despite Brexit, Britain’s Financial Conduct Authority has stressed the need for firms operating in the UK to comply in full with MiFID II from next year. Without such compliance, it would be harder for the UK to agree a new financial trading agreement with the bloc after Brexit. Under the new rule, fund managers will be able to choose between paying for research or charging it to clients, which would then involve tracking how the research is used to make sure they are billed fairly.
A fund will have to set up a research payment account, funded by specific research charges agreed in advance with clients. Fund managers also have to regularly assess how the research has benefited the clients’ investment decisions. “(The choice will depend) very much on the investment style, some houses are very research intensive and others are less so. Some have huge in-house research teams, others have smaller ones,” said Lucas Wurfbain, co-founder of Feedstock, a fintech start-up which aims to help asset managers use research more effectively.
Companies that have said they will pay themselves include M&G Investments, the fund arm of Prudential, and Baillie Gifford. Spokespeople for both firms declined to give a budget. Jupiter Fund Management, which manages around 40 billion pounds, said it would spend 5 million pounds a year.
Others, including hedge fund Man Group’s GLG stockpicking unit, Henderson Global Investors and Schroders, said they plan to use client money for all or some of their research spend. Of the 87 companies surveyed by ITG, 31 percent said they had picked a research funding model, 28 percent said they would charge clients, 18 percent planned to pay for it themselves and 23 percent said they would use a mix of both.
Greenwich said it expects most companies will eventually pay for it themselves. Banks and brokerages have to decide if their research is good enough to sell. They may accept losing money on it if they can still recoup the costs by winning other business.
Smaller and mid-sized firms could develop a niche, by product or geography, while larger firms will likely provide higher-value services to fewer clients. “Many asset managers are receiving research from 20 of the larger investment banks, many of it not particularly differentiated,” said Connor Sloman, head of client solutions for Europe, the Middle East and Africa at fund research firm Morningstar.
“When you have to start paying explicitly for that research, there will be much more focus on the value the asset manager is receiving from that research.”