FCA report on how investment research consumption has changed under MiFID II
Financial conduct Authority (FCA) recently published their detailed review of research unbundling reforms undertaken to meet the regulatory requirements of MiFID II. This FCA research is useful and timely as it highlights the key areas where regulations have led to greater transparency and efficiencies for end-investors. It also details areas where further efforts are required.
Research budgets are shrinking – may be more than expected
The FCA concurs with the common perception that research budgets have shrunk across the board. The FCA study estimates that there has been 20-30% reduction in research budgets for external equity research. This is significantly larger than the reported reduction of research budgets by CFA Institute report earlier this year, at an average reduction of 6.3% in research budgets. Firms managing more than $250 bn AUM have reported ~11% reduction in research budgets which is much less than the overall reduction.
The FCA found that In dollar terms, UK-managed equity portfolios saved ~£70 million under MiFID II in the first half 6 months of 2018.
Who is paying for research?
Most asset managers have decided to absorb the cost of external investment research. The FCA reports of few instances where the costs were passed on to the end-investor, which is more of an exception than the rule. Within the more than $250 bn AUM bracket all of them absorbed the costs.
The study demonstrates that whether costs are absorbed by firms or passed to the investors, research is subjected to similar levels of scrutiny by the asset managers to ensure they are procuring research that can help them outperform. Individual rate cards for different types of research and providers is mentioned as a good practice over broker vote or simple quantity-based pricing.
Bottom line – Robust evaluation frame work is the key!
The FCA suggested that the way buy-side values its research is a vital part of compliance with MiFID II, especially in cases where some providers are paid much higher than the others. FCA agrees that any assessment of research quality and value would require ‘judgement’ and that judgement should be objective and transparent enough to substantiate the payments to various research providers and any meaningful differences among them.
The FCA also acknowledged the lack of robust methodologies or tools to do so.
If we combine these observations with the original requirement of MiFID II research un-bundling, i.e. ex-ante and ex-post measures for research consumption and payment, clear underlying theme emerges from the study: robust research evaluation framework, beyond broker voting, is needed to choose the best research that can help in performing better and demonstrate its contribution to the performance ex-post.
Collaboration between investment and finance teams
The report also makes a note of inclusion of investment teams along with finance functions for the evaluation of research. We believe that this collaboration between investment and finance will grow over time and will be needed for driving alpha and efficiencies.
Price discovery is the last piece of the puzzle
While the FCA emphasised that they want buy-side firms to practice and demonstrate their approach to price discovery as rational and consistent. In this context, an ideal solution should not provide asset managers with just the tools for compliance but a way to use this opportunity to procure alpha-producing research.
We truly believe the purpose of research is to produce alpha. That’s why we build Invisage – a platform that highlights the alpha producing capabilities of research so that good research can be discovered and through our research attribution methodologies, contribution of research to performance can be demonstrated. This research operating model makes a robust evaluation framework for research, ex-ante and ex-post.
Reach out to us for any questions on the FCA study or if you would like your firm to have a robust research operating model.