Much investment bank research kyboshed by Mifid II - CFA Institute

Jonathan Boyd
Much investment bank research kyboshed by Mifid II - CFA Institute

Research published by the CFA Institute suggests that up to 78% of buy-side users of investment bank-sourced research may reduce their use of this source of investment ideas in the wake of Mifid II.

In contrast, some 43% of those buy side professionals surveyed for the research said they may source “relatively more research” from in-house under Mifid II

The figures highlight changes expected to flow from the introduction of new regulations via Mifid II, which seeks to break the bond between inducements and research relied on to make investment decisions.

In its report Mifid II: A new paradigm for investment research, the CFA Institute found that most asset managers are looking to absorb the costs of research rather than pass it on to clients.

However, that objective in turn is seen as posing an existential threat to smaller and mid-sized managers, particularly as the research also found that a fifth, 21%, of those firms surveyed are still unsure how they will cover the research costs.

There is a clear correlation between size of manager and propensity to absorb costs, the report further states: some two-thirds of those with AUM over €250bn said they would do so, versus 41% of those with AUM below €1bn said they would.

The findings are based on a survey of both CFA Institute members and non members, working at the 400 largest European asset management businesses. Final respondents were screened out to ensure that they only involved those using, producing or buying research, and representing the buy side of the industry. That resulted in some 365 valid responses from 330 firms in 28 European countries.

The research has also uncovered expectations around the actual costs of research – whether it is charged to the customer or absorbed.

The estimate is that equity research will cost 10bps, or €1m per €1bn of notional AUM.

For fixed income, currencies and commodities, the cost is estimated at 3.5bps, or €350,000 per €1bn.

The report’s author Rhodri Preece, head of Capital Markets Policy EMEA at the Institute, suggested in his analysis that managers may be willing to pay more for equity research, because of the alpha drivers that research can uncover in contrast to fixed income markets, which may be driven more by macro factors, thereby reducing the value of research done.

Commenting further on the findings, Preece’s colleague Gary Baker, managing director, EMEA for the CFA Institute, said that there are likely to be other, possibly as yet unknown developments in consumption of research sparked by the regulatory changes.

While the biggest managers may be using research on up to 800 firms across Europe, they are likely to prefer to pay for their research on a ‘buffet’ basis, because of the administrative challenge of paying for each individual piece of research.

That also suggests that mid-sized providers of research, which may have experts in a more limited number of fields, would be ignored once Mifid II kicks in. And that in turn raises questions around incentivisation of researchers, and how to retain the better analysts.

“What you are actually doing is using an analyst’s time,” Baker argued.

“Once published, the research becomes instantly commoditised. But the value is the time the analyst spends out in market, talking to companies.

“There is an argument for a Dutch auction model, i.e., there is a good idea, we have this analyst, who wants to spend time with the analyst?”

“There will be innovation in pricing models.”

However, Baker added that the speed of innovation may depend on other factors in turn, suggesting clarity on this may not emerge for up to another couple of years.

Focusing on different services and pricing them differently will lead to advantages, such as being able to better identify which bit of research is useful, which suggests the industry will move further towards only pricing for things that are useful for the end investor.

Asset managers themselves will also have to instil a different discipline, Baker continued: this is likely to take the form of forcing portfolio managers, particularly ‘star’ managers, into using a reduced number of research sources – say, 25 instead of 100 previously. The possible upside is that the average quality of research being used should go up, because the ‘tail’ of poorer quality research disappears. However, it may take time for this to occur.

Another development is likely to be in the metrics of consumption of research, as both providers and users of research will want to better understand how exactly it is valued from the provider point of view as well as the customer point of view.

And then there is the question of unintended consequences, for example, how the outlook on a company’s performance may become similar if everybody on the buy side starts using the same five research providers when researching a particular equity security.

As well, it is currently uncertain how respective member state regulators will engage. Preece suggested that what the regulators are looking for is less matters of cost and more about methodology: basically, they do not want to see output offered for free, for example, to avoid investment banks instituting policies of pricing at zero, if there is actually something of value being offered.

“If there is value there, then it needs to be charged for, otherwise it will fall found of inducements rules,” Preece noted.

Certain content may be free, such as latest company earnings results, but the rules of Mifid II encompass information that is used in the investment decision process. To avoid falling foul of inducements rules, asset managers are going to pay. That said, it is still unclear what sanctions may be put in place.

Neither Preece nor Baker expect sanctions on matters of research to hit the industry on day one of the Mifid II regime – 3 January 2018 – rather, it may take some months for local regulators to initiate supervisory work that results in sanctions.

For the CFA Institute and similar organisations that train the analysts, there is another question mark around the numbers of analysts that will be required by the asset management industry going forward.

However, those who are CFA qualified work across a range of functions, so it is not as simple as saying that expectations of research role redundancies will hit the industry.

From the CFA Institute perspective, it has been clear to note that while it has a membership, as a professional body it must also see to what is best for end investors.

“Whatever happens in terms of Mifid II rules, the investment process is still there,” notes Baker.

“It still requires access to knowledgeable professionals. So, they need to be employed, whether buy side, sell side, or independent.”

Thus, while there may be a feeling that overall demand for research will not diminish as part of the Mifid II process, the question is where might the work be going forward.

Mifid II: A new paradigm for investment research may have identified trends leading to less demand for research in Europe, but as Baker notes there is significant increasing demand for research globally, and the biggest growth in numbers of CFA candidates are coming from areas such as emerging markets.


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