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Research Unbundling for US Asset Managers: ‘One Size Fits Nobody’

TradingTech Insight sits down with Joel Burnette, Solutions Consultant at Red Deer, to discuss the response to the research unbundling requirements of MiFID II and explore how US markets are handling the new normal.

TTI: What has been the most interesting thing about the North American research market’s response to MiFID II?

Joel: We have already started to see managers looking to make changes to their global processes as a result of their learnings from their MIFID II implementation, including better valuation and voting, better data capture and the resulting improvement in the quality and value of management reporting, and their relationship with research providers.

There is growing pressure on the regulator from several large US asset managers to harmonise the rules with the European Union (EU), with institutional investors in the US also backing this call in order to gain greater transparency around costs. The US has seen statements being released by SIFMA (The Securities Industry and Financial Markets Association) expressing the need for broker dealers to be able to charge separately for research with exemption from the Advisers Act. This shows a willingness from an industry body to promote transparency within the research consumption process.

TTI: How will it develop from here?

Joel: For global firms, operating a business under two or more different regulatory regimes can be challenging. The requirement to implement two separate processes for the US and Europe can pose a significant administrative burden and increase operational costs if not managed correctly. Equally, as European investors become more attuned to greater transparency and client accountability, US asset and hedge managers may face competitive pressure as investors expect the same level of transparency they receive from European managers.

Aligning both processes can deliver immediate benefits to firms, not least operationally, but also from the insights captured from the adoption of a consistent research valuation framework across sites.

We understand that the process of unbundling of payments in the US with hard dollars creates possible problems for the sell side, without addressing the current and future state 1934 Securities Exchange Act, section 28(e). The SEC, from now until the 3rd July 2020, has much to think about.

TTI: What is the most important decision that US asset managers need to make now?

Joel: An assessment of the potential cost and operational impact should begin today. Winning mandates from institutional investors could hinge on giving an informed response to this potentially significant change. Managers that are able to provide greater transparency around where and how funds are allocated can enjoy greater confidence from their clients. As EU firms have been through this process already, it is worth considering where investment firms tripped up and how to avoid that in the US market.

TTI: What advice would you give US asset managers?

Joel: Firstly, with the whole market going through the same process, it may be tempting to hang back and engage in the process late. The argument for doing this is that one has to wait for the final rules before complying. However, asset managers will find that institutional investors want to know how big of an issue this might be – even before there is certainty.

Asset managers that have not started assessing the impact – through analysis of research consumption, expenditure and other sell-side services – will struggle to answer the most basic questions. The key takeaway is to start early, and answer questions with confidence. There is definitely a first mover advantage here.

TTI: What learnings can US managers take from EU implementation?

Joel: Managing research in a commercial model

The big discussion point during the unbundling process was how to manage research in a commercial model, but this often put the issue of corporate access in the shade and some asset managers pushed this down the track. To assess both, firms need to build a single picture of use, cost and value. While banks are very willing to provide data for clients regarding corporate access and research consumption, there are practical challenges to using it which increases the buy-side workload. As sell-side firms do not provide data in a standardised format, each data set has to be manually gathered by the front office and then normalised to create a single set of data. It is possible to automate this process, however the data will still need to be standardised and aggregated prior to analysis.

A more efficient approach is for buy-side firms to collect their own data, reducing the interference in front office activity and enabling standardised data from the offset to combine corporate access and research consumption.

Setting a price

Another issue was the process of setting a price for research and corporate access. Where asset managers are informed on cost and value, they can work in advance and be a price maker. This helps the sell-side work out market value for their services and makes the price formation process more efficient. It is also valuable to look at the market prices in Europe, to consider the relative value of services.

One size fits nobody

The inappropriateness of setting trial periods in paying for research, over a fixed length of time, for a whole asset management firm was also an area of concern. As this created an artificial limit around the testing process, it meant buy-side firms struggled to assess value for all funds equally.

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