Mifid II: what next for investment bank research?

IFLR reported in early January that fund managers were grappling with the rules and their potential impact – but now it seems plans are more advanced.

One poll by Financial News found that more than a third of asset managers are preparing to scale back their use of sellside research. Another from RSRCHXchange shows that 74% of respondents foresee an overall reduction in investment bank research.

“A lot of our clients have said that actually they’re not that interested in the notes all investment banks churn out on a regular basis,” said Akin Gump Strauss Hauer & Feld partner Chris Leonard. “What they’re really interested in is easy access to the top analysts with whom they can have a meaningful conversation.”

Persuading asset managers to re-examine their sources of research is one of the directive’s aims. But with little guidance from the regulators, a range of options available, and the added risk of potential competition law breaches if they speak to each other, many firms on the buy and sellside are muddling through the high level rules on their own.

KEY TAKEAWAYS

  • Polls of buyside firms suggest that fund managers will completely review their sources of research when new rules are introduced next year;
  • It’s likely to shrink investment bank research departments over time and will likely see in-house buyside research teams expand;
  • There’s also an opportunity for boutique research firms without the burden of execution;
  • EU firms using US investment bank research face a particular issue as to continue, the US broker would be required to unbundle the costs too;
  • It follows a slow decline in the size of bank research teams as it is as regulatory pressures and costs take their toll.

“Banks will have to accept that to some extent they’ll be producing these notes in the same way law firms do, for little immediate return,” added Leonard. “It’s almost inevitable that they will reduce the size of their research departments.”

There’s an opportunity for independent research firms, free of the regulatory burden on the mainstream banks, to disrupt the market here.

Ashurst partner Jake Green explained that preparation is even more confusing for European fund managers working with the US. From January 2018 onwards the manager can’t take research from a US broker if the broker won’t price the research separately to execution charges.


“It’s almost inevitable that banks will reduce the size of their research departments”


The European Securities and Markets Authority confirmed in a Q&A in December that EU firms must comply with the research rules regardless of where their research provider is located or how they’re regulated.

But for the broker to unbundle the charges, it would have to be authorised under the US Investment Advisers Act, which according to Green introduces conflict issues.

“We’ve been to the regulators on both sides to ask for exemptions, and no one seems to be able to figure this one out,” he said. “The view from the US is that they shouldn’t need to change their rules to accommodate ours.”

Investment bank research departments have been shrinking since long before Mifid II as regulatory costs take their toll. The slow decline dates back to allegations of biased research around the time of the dotcom bubble, and worsened in the cost-cutting drive that followed the 2008 crisis.

But while 38% of asset managers surveyed by Electronic Research Exchange are considering expanding their internal research teams, it’s far from a perfect solution as the buyside needs in-depth expertise at particular companies at different times.

“So one year a specialist analyst who follows a particular company might be super valuable to the manager, but in the following year the manager may no longer be interested in that company or sector,” explained Leonard. “Experts are always going to be favoured over generalists.”


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