Sandy Bragg, principal at consultancy Integrity Research Associates, said European regulators should stop banks being allowed to distribute free fixed income, currency and credit research in order to prevent independent providers being undercut.
MiFID II, which came into force in the European Union in January, requires asset managers to either pay for research themselves from their P&L or to use a research payment account funded by clients, where the budget has been agreed with the client. Asset managers can designate a third party to administer the RPA on their behalf but still have to track their consumption of research and assess its quality.
The European Securities and Markets Authority acknowledged in a Q&A last week that FICC markets do not have explicit execution commissions and mechanisms that allow research charges to be deducted alongside transaction fees.
“Given the commonalities between some forms of written macro-economic and FICC research, ESMA considers that in some cases written FICC research could be capable of being priced and paid for through a subscription agreement,”added the Q&A. “However, firms would need to document how they arrive at their pricing structures and ensure there is no inducements risk.”
ESMA continued that research providers can also make FICC material openly available to all investment firms or the general public, or corporate issuers can commissioned and pay for FICC research and these are both allowed as a 'minor non-monetary benefit'. “Some types of FICC material may also lack substantive analysis and instead represent information about financial instruments and short-term market commentary that meets the minor non-monetary exemption,” added the Q&A.
However, firms need to have policies and systems in place to assess the nature and scale of any service, benefit or material provided by any third party to determine whether it can be considered as a minor non-monetary benefit or as research.
“For any third party benefits to be an acceptable minor non-monetary benefits, a firm should assess and ensure they are ‘reasonable and proportionate and of such a scale that they are that they are unlikely to influence the firm’s behaviour in any way that is detrimental to the interest of the relevant client’,” added ESMA.
The regulator gave the example that a detailed research report or conversation with an analyst cannot be considered as a minor non-monetary benefit, especially if such material is provided through a dealing desk rather than a research department.
Bragg said in a blog that the ESMA Q&A will do little to help independent research providers undercut by investment banks setting deliberately low research prices.
“As one example Crédit Agricole Corporate and Investment Bank slashed its FICC subscription fees nearly 90% last fall from its original €170,000 fees to €20,000,” added Bragg. “One month later, Crédit Agricole CIB lowered fees further to €5,000 for access to its FICC research plus another €5,000 for limited access to analysts.”
Bragg warned that the new ESMA requirement for firms to document how they arrive at their pricing structures will not be effective and banks will be able to justify their pricing schemes as long as they charge premium prices for high-touch services. He said MiFID II makes the problem worse by allowing research to be given away for free if it is broadly disseminated, and there are eight banks giving away free research.
“A more meaningful action by ESMA would have been closing the free research loophole altogether, but perhaps substantive changes to MiFID II must await the advent of MiFID III,” added Bragg.
At the AFME European Trading & Market Liquid Conference in London last week, panellists predicted consolidation amongst research providers.
Zoeb Sachee, the head of Euro government and SSA trading at Citi, said sellside firms want research to be part of a relationship with asset managers which is why they keep the price of research low. Sachee said: “Clients are in general absorbing the cost of research but we are not seeing demand for top analysts go down. However, there will be consolidation.”
Juan Landazabal, global head of fixed income and foreign exchange trading at Deutsche Asset Management, said as most asst managers had decided to pay for research themselves, rather than passing the cost onto clients, there is a risk that research could become narrower.
Christop Hock, head of multi-asset trading at Union Investments, said the asset manager had unbundled in equities years ago and also incorporated the broker vote in evaluating fixed income research.
“We have spent the last two years building infrastructure for research payments and evaluation,” Hock added. “There will be some consolidation of providers and more niche, specialist players will emerge.”
Daniel Carpenter, head of regulation at technology provider Meritsoft, said in an email that asset managers are now scrutinising every single penny of research and will be asking probing question, especially of their FICC broker research providers.
“Previously, FICC brokers got thrown a little bit of money from the bank, and knew they were getting some revenue and trading from it," added Carpenter. "But now they need to find a way to manage large numbers of global and regional research contracts/agreements. All this leads to a mountain of contractual paperwork and tracking of interactions. And this all takes up valuable time, and time is money.”
A sign of the transformation of research is HSBC investing this month in Visible Alpha, an investment research technology firm founded by Bank of America, Citi, Jefferies, Morgan Stanley and UBS.Visible Alpha raised $38m in January from the founders and new investors Goldman Sachs, Banco Santander, Exane BNP Paribas, Macquarie Group, Royal Bank of Canada and Wells Fargo.
The funds will be used to help meet the research valuation and budgeting requirements of MiFID II according to a Visible Alpha statement.
“More than 450 research providers are now actively participating on the platform, along with over 100 buy-side firms with a combined assets under management of $16 trillion,” added Visible Alpha. “In addition to investing in Visible Alpha, HSBC will be adding its research analyst models to the Visible Alpha Insights platform and contributing to Visible Alpha Consensus Data.”