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Research could be next for trading floor

Pending regulations could be impetus for creation of market using financial tech

Valerie Bogard
Valerie Bogard believes aggregation technology could lead to a manager research exchange in the next five to 10 years.

The next commodity traded on an exchange could be manager research.

Buying and selling investment research in a market is seen by some industry analysts as a natural progression from the current trend of aggregating a variety of research through financial technology. Impending European rules that will require unbundling and disclosure of research costs is only accelerating this evolution, they said.

A manager research exchange “certainly could be interesting,” said Valerie Bogard, equity analyst at TABB Group LLC, New York, and co-author of a 2016 report on U.S. equity trading that included a look at research aggregation technology. “I think something like that could be possible in the next five to 10 years. One of the biggest hurdles in unbundling is quantifying the cost of research. An exchange would make that market-driven.”

Calling research “the purest form of fintech,” Raghav Kapoor, CEO and co-founder of research aggregator Smartkarma, Singapore, said: “The natural course of evolution in research is transparency in pricing. From a systematic way of thinking, the most natural progression in the financial industry is a shift from capital markets to digital markets. Look at the benefits — you replace the intermediary with direct trading and immediate processing. We've seen it happen in the last 10 years; trade execution has largely gone digital, with dark pools, algorithms, electronic trading on exchanges. Research will evolve the same way.”

Added Blair Livingston, CEO of Street Contxt, a Toronto-based provider of communications between managers and brokers: “Think of content as an asset class that entirely trades over-the-counter. There's no one place where it trades. The question then becomes, how can you make that content exchange-traded? The buy side could drive their performance further by finding that research from an open exchange; technology opens up this possibility. And that research would still be written by someone who's an expert. That system would change the game.”

The issue of how to price research is now at center stage as regulations under the Markets in Financial Instruments Directive II come into effect Jan. 3, 2018, requiring managers with clients or business in Europe to unbundle their broker research and execution costs. While there are no similar U.S. rules, managers in the U.S. are expected to follow MiFID II rules amid more clamor from clients for increased transparency in fees.

“Everything is on the table right now — how to consolidate capabilities, create more scale, (managers) aggressively asking questions on whether they need everything they have right now,” said Jeffrey A. Levi, principal at money manager consulting firm Casey Quirk by Deloitte, New York. “What's embedded in that is research cost.”

While Messrs. Kapoor and Livingston said a potential manager research exchange could operate like an equity dark pool, in which buyers and sellers trade stocks anonymously, TABB's Ms. Bogard said some questions would have to be answered before using that model.

“Would there be one exchange or would it be fragmented, like equity market structure is now?” Ms. Bogard asked. “With dark pools, there are 30 or 40 on the equity side. Would there be 30 or 40 dark pools for research? Would there be the same research on all of them? Would there be a way to arbitrage that research? What the structure would look like is an issue. This certainly could happen, but those things would have to be worked out.”

While the potential for a manager research exchange exists, the evolution of research distribution already has moved from one dominated by personal relationships with sell-side analysts and bundled commissions to a technology-based aggregation system in which managers can select research from providers, both traditional brokers and independent providers, based on content and price. Ms. Bogard said some providers refer to their offerings as “an Amazon.com of research.”

‘Uncharted territory’

Michael Stepanovich, CEO of ONEaccess, a New York-based research valuation provider, said using quantitative and qualitative data to measure broker relationships “is complex, ongoing, and on many fronts. It's uncharted territory. The good thing about MiFID II is, you can't argue with transparency. The more information that's out there lets managers double down on their research costs and value. For managers, part of the broker relationship has been qualitative. (Valuing research) also brings quantitative analysis to inform their vote process for broker selection and give it extra rigor, becoming best practice for managers.”

ONEaccess is a unit of Visible Alpha, a research platform created by Bank of America Corp., Citigroup Inc., Jefferies & Co., Morgan Stanley (MS) and UBS. The involvement of such sell-side investment bank giants points to how they want to stay ahead as research distribution evolves through fintech, sources said.

“I'm not surprised that bulge-bracket firms are joining forces on this since the amount of sell-size research — particularly on small caps — is reduced,” said Iain Douglas, head of emerging markets equity research at Willis Towers Watson PLC, New York.

Aggregation platforms can make it possible for smaller money managers that otherwise can't afford to cover the cost of research themselves — as larger managers have said they would do under MiFID II — to find affordable research, TABB's Ms. Bogard said. “Platforms like these can help managers pay for research themselves” if they can find less expensive research through them, she said. “It's also about the transparency of the cost as a specific price, which is what MiFID II will require. A lot of the buy side will take advantage of this.”

Smartkarma's Mr. Kapoor said the die has been cast for the increased development of fintech in research.

“Ultimately it's taking an illiquid, inefficient market and making it liquid and efficient,” Mr. Kapoor said.

“There's no going back. Investment managers loathe administration, filling out forms, compliance paperwork. All of that takes up so much time. Technology has shown that it can handle these tasks. There are ways technology will touch research. In the next five years, I think we'll see a complete transformation in the research medium itself. The technology is out there in different domains, but it hasn't really been touched.”

This article originally appeared in the April 17, 2017 print issue as, "Research could be next for trading floor".