Money managers are grappling with the new realities of their relationships with brokers and access to investment research, as the dust settles over implementation of trading rules in Europe.
The Markets in Financial Instruments Directive II came into force Jan. 3, bringing with it a raft of new transparency requirements.
One of the most onerous rules for money managers is the mandatory separation of payments for trade execution and investment research. Firms spent much of last year deciding first how to split out the payments, and then whether to absorb the cost of obtaining research from brokers and banks or pass the fees on to clients.
Many money managers decided to pay the cost themselves, with a number of firms reporting the impact of MiFID II research payments in their half-year updates ended June 30. Janus Henderson Group PLC reported a $19 million estimated MiFID II research cost for 2018. Man Group in its half-year update acknowledged unspecified "cost increases from MiFID II," but in its full-year 2017 report it said ongoing costs associated with MiFID II would add about $10 million to $15 million to the firm's cost base starting in 2018.
Now some money managers are reflecting on the decisions they made and the ongoing impact of the rules, leading them in some cases to overhaul the way they work with their providers.
"It puts into question how managers use research and the quality of this research," said Luba Nikulina, global head of manager research at Willis Towers Watson PLC in London. "When you have research wrapped into overall costs of execution and doing business, you take it as a free data point and calibrate it with everything else in your own research. The overall feeling in the market is that the level of third-party investment research has reduced or moved elsewhere outside of Europe, but not that there's a significant challenge for the asset management industry because they are now missing this additional data point. At the moment it is a bit of a readjustment, with the industry that provides research trying to figure out its new business model and price discovery for their value-add in the investment process, and I think it is quite healthy for the industry," she said.
Making MiFID II an advantage
About 15% to 20% of AMP Capital Investors Ltd.'s business is subject to the rules, said David Allen, global chief investment officer, equities, based in London. "We took a view a year ago to use MiFID II to our advantage, due to the benefits for our clients and the recognition that this European regulation is a strong indicator of where regulation is heading globally. We took the decision to unbundle all of our payments for research from trade execution globally" and renegotiated research contracts with all of the firm's providers. AMP Capital reduced total research spending by 40% and the number of providers by one-third.
"It makes sense for clients; by reducing costs and by taking a global approach, we minimized impact on the investment process globally," Mr. Allen said, adding he thinks global MiFID-type rules will be in place in the next few years.
But the move to unbundle globally has come at a steeper price than simply absorbing research costs.
"In Europe we have retained very good access to research because MiFID II pricing pressures are front-of-mind in the market. But in Asia-Pacific we stand out as doing something ahead of the regulation, and in the U.S. we stand out as the majority of our competitors are not unbundled. We are adjusting pricing as necessary to ensure that we retain sufficient access to research," he said.
One source working in the money management industry, who asked not to be identified, said there is a question whether European managers are at a disadvantage to U.S. managers when it comes to research constraints related to MiFID II.
She said there is ambiguity in the industry about how to value and pay for research, and banks have in some cases valued one hour of analyst time at $1,500 to $2,500.
"Compared to a lawyer, that's quite a high rate," she said, acknowledging analysts do spend a significant amount of time researching and writing reports on companies.
For some managers, the past eight months under MiFID II have been "uncomplicated" when it comes to understanding how relationships with research providers have changed.
Chris Perryman, senior vice president and head of trading, emerging markets fixed income at PineBridge Investments in London, said the firm has "absolute freedom" when it comes to choosing counterparties for trading illiquid assets; in fact, the counterparty list is growing "because of banks' constraints, and we are able to explore and explain" other sources of assets. (See related story online.)
However, Mr. Perryman also has seen some confusion, with "some salespeople (feeling) constrained, that they can't talk to us if we haven't taken their research. They haven't quite worked out what they can tell us. We're very clear — they can tell us factual information about trading flows, but not ideas," Mr. Perryman said. "So for us, from a trading and liquidity point of view we are still able to work with the banks, but information sharing isn't really there with some of them."
The firm signed 12-month contracts with providers, so renegotiations are probably on the table come November. By then the firm will have statistics and additional information on its partners, with details on the number of times they read research and documentation on meetings held.
"We are more able to quantify the quality of research we are receiving," Mr. Perryman said. Analysts are "very aware" they are being "scored" by the manager, and meetings are less relationship and more topic-focused.
The money manager source added that she hadn't anticipated an increase in the number of phone calls between managers and analysts rather than meetings, with money managers having 10- to 15-minute calls rather than "getting an analyst into the building for an hour."
Managers agreed that the quality and performance of research also has not changed post-MiFID II implementation. However, they are monitoring that carefully.
The first half of 2018 "has been a period of adjustment and learning with both buy and sell sides trying to be patient with each other as we navigate the realities and practicalities of MiFID II," said Eoin Murray, head of investment at Hermes Investment Management in London. "Internally, we regularly review our research relationships to ensure the service (and) value delivered is as expected and we are broadly operating within budget."
Allianz Global Investors is still in a price discovery period, said a spokesman for the firm. "At AllianzGI, we've moved from an all-you-can-eat pricing model to an a la carte model, so are naturally consuming less — our analysts and portfolio managers have consumed less external research. We will revisit things at the end of the year and then look to enter into sustainable agreements with our partners on the sell side. As important providers to the ecosystem, they need to plan for their business, as we need to for our P&L," he added.
And some managers are enhancing the way they work with their research partners.
"There has been a move toward more corporate access," meaning the arrangement of meetings or other access between a money manager and a corporate issuer by a third-party such as a broker. "That has always been very important for us, but a couple (of managers) have stopped consuming research and written comment and are focusing mostly on corporate access," the money manager source said.
Corporate access services must not be funded from research budgets under MiFID II.
"That shift toward corporate access is important — banks are speaking more and more about how (it) is becoming more important, and ... that managers may have to pay more for that," the source said.
Other managers are choosing to improve their own research capabilities, said Jonathan L. Doolan, principal and head of Casey Quirk Europe, Middle East and Africa, based in Frankfurt.
"There has been an increased focus on research, with (money managers) orienting the organization around building out the team to have more proprietary research. The other thing is a professionalizing of the research function," with firms eager to show employees that analysis does not only have to be a step on the path to becoming a portfolio manager.
"Essentially (research) was a way station until you could become a fund manager. Now we are seeing firms realizing that the institutionalization of research has become part of the value proposition, to be able to do that they need to incentivize people, pay them more and show it as a good end point — not necessarily a way to become a fund manager," he said.