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MiFID II: The True Cost of Research Unbundling – Part Two

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Last week we explored the impact of MiFID II research unbundling on the sell side, as providers struggle to carve out their own space in a new and unfamiliar environment. This week, we take a look at the situation from the other side of the coin – how are purchasers handling the change, and how is this impacting price discovery from a commercial perspective?

The key question in today’s environment, as we touched upon last week, is how to value research? What is the content worth, and how much will people pay? This is the single biggest factor that will define the marketplace going forward. And it is not an easy question to answer.

The first step is to figure out who uses the research, who evaluates it… and who pays for it. In the post-MiFID II landscape, the problem is that these are not always the same. So who makes the decision about what should be bought and how it is paid for?

In that sense, the challenge lies very much on the buy-side, rather than with the research providers themselves. Until the fund managers themselves have figured out what it is they really need, they will struggle to place an accurate value on what they are paying for. It is imperative, therefore, that the buy-side establish effective processes through which they can not only determine what research they require, but measure the ultimate value that research will provide to their clients – and this can be more complicated than it first appears.

There is a tension right now within the buy-side firms between quality and quantity. The investment teams themselves, who are the quality consumers, are coming into ever more frequent conflict with the finance and compliance teams, who are monitoring the cost and attempting to meet the MiFID II requirement, and who measure research consumption by quantity.

Inevitably, with most buy-side firms making the decision to absorb research costs on their own P&L, commercial considerations are suddenly at the forefront – and different providers are taking different approaches. Some, for example, are attempting to reduce their spend and cut their list of providers – a risky move that can be fundamentally damaging to their clients. Now the investment teams are starting to ask their financial departments why they can’t buy what they need, or they are being told that they cannot take certain calls or have certain meetings – and they are starting to push back.

So what should they be doing instead? This is where the importance of research valuation comes in.

At its heart, what MiFID II ultimately provides is the freedom to buy whatever research you want. It means that buy-side firms can spend their dollars wherever they wish, without being tied into the bulge bracket banks. In theory, this offers an exciting new opportunity to help buy-side firms explore the long tail of research, rather than simply accept what they are given, as they have done for so many years.

So instead of having a finite list of research providers, buy-side firms should be looking to source research wherever value is provided. And from a provider perspective, RegTech firms should be helping them to do exactly that. But are they?

“It’s a chicken and egg situation at the moment,” says Glenn Bedwin, Chief Operating Officer at Absolute Strategy Research. “There are at least 20 or so RegTech firms attempting to offer services in this field, but they can’t get buy-side buy-in until they get research providers, and they can’t get research providers until they have buy-in. I think very few are commercially successful yet. They all see an opportunity, but they are not quite sure how to exploit it fully.”

There is undeniably a huge space for research as a valuable commodity. But because buy-side needs to define what that value is before they can achieve effective price discovery, the danger is that small and mid-sized research providers will get priced out of the market before that happens.

“Independent research firms have always been priced providers, and they know how to price their product,” agrees Bedwin. “In theory, they should be the long-term beneficiaries of MiFID II, but they are in danger of being driven out by a price discovery mechanism that is currently ineffective, because the market is still not established. We are only 12 months in, and I would estimate that it will take at least 18-24 months for the market to start pricing appropriately.”

At the end of the day, RegTech firms have to realise that they are not really competing with investment banks – they are an alternative intermediary.

“The way they can add value to the buy-side is through the identification of unique insights that buy-side firms can’t find anywhere else,” concludes Bedwin. “The ones who figure out how to do this effectively will be the ones who succeed.”

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