Frost Consulting, a regulatory consultancy, has launched a platform to allocate research budgets to individual funds ahead of the unbundling requirements under incoming European regulations.
The MiFID II regulations, covering financial markets in Europe from 2018, aim to make payments for research more transparent across asset classes. The European Securities and Markets Authority has proposed that fund managers either pay for research out of their own revenues or set up research payment accounts for clients with an agreed budget – although the regulator may still allow asset managers to use commission sharing arrangements.
Frost Consulting has launched FrostRB which gives asset managers the ability to establish monetary values for specific unpriced research products and construct monetary research budgets for individual funds to meet MiFID II research spending requirements – but does not provide access to research reports.
Neil Scarth, principal at Frost Consulting, told Markets Media: ”In FrostRB, investment strategy plays a critical role in the valuation of research. The chief investment officer or lead portfolio manager sets the investment strategy for a fund and what type of research is necessary. Most broker vote systems do not operate at the fund level.”
Scarth gave the example of a global growth fund which may have a big weighting in technology, healthcare but nothing in utilities. The research budget would allocate money to the important sectors for the fund and the important providers in those sectors.
“MiFID II will require asset managers to apportion research budgets to clients so budgeting will need to done at a fund level, and introduce unbundling across asset classes,” he added. “The industry will no longer be able to subsidise fixed income research through equities commissions.”
The unbundling proposal has led to fears that fund managers will cut their research budgets, with smaller firms particularly hard hit, while small and mid-cap corporates will get less coverage. Frost Consulting said asset managers spend approximately $20bn annually on external research using commissions from their clients. A poll at a Bloomberg conference last month found that two-thirds of asset managers and research providers expect spending on research to decline over the next three years. The survey also found that 41% of the London-based attendees expected research spending to fall by more than 20%.
“The total amount spent on research is likely to decrease after unbundling and we have found that asset managers using our system look to harmonise prices amongst research providers,” added Scarth.
Although MiFID II only applies to the European Union, Scarth expects international firms to change their research payments globally and provide equal levels of transparency to all their clients.
“The transition from broker votes to setting research budgets is so massive that changes happen globally,” he added. “For example, a large fund manager with 40% of assets under management in Europe will change their process globally.”
Scarth continued that asset managers can use greater transparency and accountability as a competitive advantage.
“Asset managers analyse Trade Cost Analysis (TCA) to death but just one-third of commissions is related to execution,” he added. “Poor execution will impact performance but the affect of research is much greater.”
For example, asset owners such as sovereign wealth funds are becoming very interested in the impact of research costs on their returns and so will insist that external managers provide transparency. Last month Legal & General Investment Management in the UK said that from the beginning of April it will unbundle research costs and allocate a defined research budget to each of its active equity funds.
Scarth said: “The institutional investment research market is at the inflection point of the biggest change since the US Securities and Exchange Act of 1934. We are very encouraged by the levels of both interest and uptake in our FrostRB software, as it is the only solution of its kind.”