Last month in London FactSet hosted a client roundtable event: The Challenges of Research Unbundling under MiFID II. Twenty individuals, representing 15 UK-based global buy-side firms, participated in a highly engaging dialogue. During the conversation five dominant themes emerged around the challenges of MiFID II. Here’s what to watch for and how other buy-side firms are addressing these challenges.
1. Managing Regulatory Risk across Competing Regimes
Regulatory risk is substantial, increasing, and it changes corporate behavior. The complex, cross-jurisdictional and constantly shifting nature of regulatory reform and oversight has combined to create a reluctance by firms to make big investments in systems, given that final compliance requirements may change.
There is increasing anxiety, bordering on anger, regarding the lack of clarity on final MiFID II guidance and mixed-signals from various national competent authorities (NCAs). Recent Level 3 guidance on inducements from the European Securities and Markets Authority (ESMA) and the FCA has raised new concerns and presented new challenges. ESMA Level 3 MiFID II Guidance. In ESMA’s Q&A on MiFID and MiFID investor protection topics on April 4, 2017, the authority was controversial on “Inducements,” siding with the FCA’s harder line rather than the more accommodative stance by French (AMF) and German (BaFin) regulators. Strong feelings and heated discussion among roundtable participants concerning budgeting, paying for corporate access, FICC, and macro-economic research payments were on full display during our roundtable.
2. FICC and Macro-Economic Research
ESMA raises the possibility that under certain circumstances FICC (fixed income, currency, and commodity) and Macro-Economic research could be deemed “minor non-material benefit” when it is “available to all investments firms or the general public.” If this is the case, investment firms would not be subject to the unbundling requirements of MiFID II.
However, FICC and Macro-Economic research could be classified as research under MiFID II in instances where a “material or service explicitly or implicitly recommends or suggests an investment strategy . . . that could be used to inform an investment strategy.” This would be particularly true in FICC research. ESMA acknowledged the differences between equity and non-equity instruments: equity trades on price while FICC instruments trade on spread. Therefore, when FICC and even Macro research was deemed research under MiFID II, ESMA suggested that firms could pay for it in the RPA through a “subscription” method or directly from the firms P&L. A subscription sounds remarkably similar to the accounting method (aka Swedish Model).
The controversy here is that there is no FICC “carve out.” The transactional method does not work for FICC, which trades on spread, not price. Questions around who makes the determination of “minor non-monetary benefits” are also a concern.
3. Research Budgeting
ESMA encourages investment firms to “set measurable ex ante criteria as to how it will value the types, level and quality of service.” These criteria would be “the basis for agreements with each service provider on the level of payment expected for the anticipated provision of services.” Asset managers can adjust research payments made to a provider at the end of a period based on actual services received, provided it is done in “a proportionate and predictable manner” supported by its ex ante criteria.
ESMA supports the increasing focus on research metrics by both the buy-side and sell-side, particularly where asset managers are allocating values to research inputs. ESMA gives the example of an asset manager having “its own internal rate cards or thresholds to adjust what it will pay individual providers for specified service levels.” The rate cards are used “to negotiate with suppliers to set ex ante expectations of payment levels.” By clearly linking payments to inputs and services, asset managers mitigate the “risk that research payments to providers could be perceived to be rewarding other non-research benefits.”
The problem, as we heard it from roundtable attendees is, in “ex-ante” language the buy-side must base budget on the forecast of future value and pricing of research without knowing sell-side pricing model. This is daunting for the buy-side, as it becomes the “price maker”, no longer the “price taker.”
4. Corporate Access
ESMA says arranging a meeting on the surface is not providing material or services, because it does not “explicitly or implicitly recommend or suggest an investment strategy and provide a substantiated opinion as to the present or future value or price of such instruments or assets.”
Corporate access across the EU has not be considered research, but rather, a separate service paid for commercially. Although, corporate access in the form of arranging meetings could involve the allocation of valuable resources by the provider and could influence the recipient’s behavior. ESMA expects firms to assess whether corporate access services facilitated by an investment firm are material or of minor non-monetary benefit, and therefore, whether these services can be accepted.
If the investor road show is free and open to the public including analysts from investment firms and other investors, it may be considered acceptable minor non-monetary benefit, making this are potentially grey.
5. Research Payments
Under MiFID II, investment firms will no longer be able to accept research for “free.” Firms will pay either for research directly (aka P&L method), charge clients alongside a transaction through an RPA (aka transactional method, or by employing an accrual method through use of an RPA (aka the accounting method).
Initial discussion expectation of most firms using the transactional method to pay for research products and services evolved into a consensus view among the roundtable participants that the P&L method will prevail across the industry after several years. As one participant summarized, investors have always paid for research and they will continue to pay for research in the future. MiFID II will provide more transparency into the ROI of research resources consumed.
Article by Fran Reed, FactSet