MiFID II: Story of the first year
Little more than one year has gone by since the mammoth of a regulation, Markets in Financial Instruments Directive II (Mifid II), with its more than 1.4 million paragraphs of text is enforced on the investment firms in EU. The regulators certainly had the best interest of investors when they enforced the requirements, in particular, the unbundling of research from execution.
This was meant to provide more transparency, reliability and accountability to the end investors and everyone in the value chain. That was the intent.
The reality, as we all agree, is that the aggressive pricing by the bulge bracket banks has left swathes of researchers in doldrums, who are struggling to sell the research at price level as before MiFID II. While buy-side firms were happy with this new era of pricing last year, they have now started asking the fundamental question, “are we consuming the right research that can help produce alpha?”
Research spend last year
The majority of the buy-side firms have decided to absorb the cost of research. This obviously meant shrinking of research budgets for the most. There have been some cases where firms have completely eliminated research budgets and moved it entirely to their in-house teams.
In terms of overall research spend, the firms that are passing the cost of research to their investors are spending more on research. Financial Times reported that such firms are spending as much as 7.5 times more on research than their counterparts who have absorbed the costs.
Under MiFID II, research costs are a significant spend for asset managers, where some find it to be second biggest expense after salaries. That is a significant chunk!
Liquidnet survey done at the end of 2018 found that 61% asset managers had shrunk their research lists. The Financial Conduct Authority in the UK estimates that the shrinking research budgets has already been translated in at least £180m (€200m) ‘saved’ by buy-side in the UK alone.
The market liquidity has also been affected adversely, with London Stock Exchange reporting average liquidity reduction per stock by 15.5%.
Trends emerging from the impact of MiFID II
The evolving pricing models which have squeezed the smaller end of the market, have resulted in increased consolidation and mergers of research firms to stay competitive.
From a buy-side perspective, while the end-goal continues to be producing alpha, the uncertainty in the overall research space is changing the way research is perceived. Asset managers are also actively looking at alternative sources of research (77%) and investing in quant/ data science within their firms (59%) according to the LiquidNet survey. There is also a rise of Online Research Marketplaces (ORMs) such as Alphametry and Substantive Research that can offer efficient ways of discovering and managing research under MiFID II. It is predicted that ORMs can capture ~30% share of the research spends globally by 2025. There is a growing trend towards consumption of written research over interactions with analysts.
Pricing of research
Historically, more research has been produced than that is consumed. Top 15 brokers have been estimated to be producing ~40,000 research notes weekly – out of which only a negligible number were read (approx. 1%). Under MiFID II, the quality of research is going to be much more important than the quantity and so is its thoughtful consumption which is expected to go up.
That brings us to the pricing of research. The pricing models for how research can be charged for is evolving. On one end of the spectrum, JP Morgan has thrown everyone a curve-ball with their buffet pricing. The other end is covered by Independent Research Providers (IRPs) who charge annual subscriptions for uncovering niche investment opportunities as well as charge per report. The commissioned research is another area emerging as a new trend within the IRPs.
What to expect in 2019?
The emphasis in 2019 will be on two things – compliance and competitiveness.
Both the buy-side and sell-side are looking for technological solutions that can improve their competitiveness while complying with the unbundling requirements. Many (from both sides of research) have taken strategic routes to have a digital content management architecture to help them stay ahead of the curve.
Brexit has created another void for speculations to spawn. The UK is the biggest market for research in EU (in $ terms) and what FCA chooses to enforce in place of MiFID II will be crucial. It may choose to enforce a full replica of MiFID II or may even make it more stringent?
MiFID II is also expanding globally in spirit. The desire for transparency is crossing the Atlantic. And, in near future similar regulations can come into play around the world.
How can we help you stay competitive?
MiFID II makes for ruthless, cut-throat competition among sell-side. While research quality can be judged to an extent, its historic performance is not fully utilised by the buy-side while deciding which research provider or analyst to pick.
It can be quite challenging to gather the historic performance of research across several analysts, firms, asset classes and markets. This results in the status-quo of selecting research providers based on reputation and relationships, which are not necessarily bad criteria but an objective overlay on top can compliment it very well.
Our cloud-based solution – Invisage – gathers all historic recommendations and builds institutional quality indexed portfolios so that buy-side can easily visualise the performance of research at research firm level, compare research firms and analysts based on the historic performances. Such performances can be compared against market indices and any other benchmarks of choice.
We have developed a methodology, “Smart Conviction” that extracts the alpha producing capabilities of the research and reflects it in the indexed performance series. We do this painstaking exercise so that you get the most reliable, objective and meaningful evaluation to pick the research that can help produce alpha.
We currently capture research on over 3000 stocks across 50 countries and 120 sectors. Take full advantage of such a tool that puts the power of research evaluation in your hands, when you need it the most.