It appears that a process that started over 15 years ago with Paul Myners’ recommendation in his March 2001 landmark report to HM Treasury, Institutional Investment in the United Kingdom: A Review, that, “[c]lients’ interests would be better served if they required fund managers to absorb the cost of any commissions paid, treating these commissions as a cost of the business of fund management, as they surely are” (Myners’ report at 61) is coming to fruition.
The Level 2 MiFiD II text doesn’t explicitly confirm if Commission Sharing Agreements may be used to fund the new Research Payment Account (RPA). Yet, the text could be interpreted as permitting their continued use. However, more and more buy side firms appear to be planning on avoiding the RPA scheme entirely and paying their research commitments out of their management fee. That was the finding at the May 26, 2016 Bloomberg Trading Solutions Buy Side Forum in London (Figure 1) when we compared responses to the same question we asked at the Bloomberg MiFID II: What to Expect and How to Prepare Conference on February 4, 2016.
It’s not surprising that with the increased expectation of research being paid out of management fees, 53% of respondents expected that their research spend would decrease (Figure 2).
Perhaps due to the expectation that the sell side research offering will contract as a result of a smaller wallet, leading many analysts to strike out on their own, the majority of participants at our session at the Buy Side Forum anticipated that there would be an increase in the number of research providers.
All of these changes were the reforms that Myners sought back in 2001, when he wanted more accountability and a break from the practice that saw research worth more simply because a firm’s trading activity increased, or that it was worth less because volumes declined. He wanted firms to value the research they were consuming and a process for them to determine if the value of the research was commensurate with what they paid for it.
Although Myners believed that greater transparency and clearly delineated permitted uses of client funds in the research spend was a step in the right direction, he ultimately wanted total accountability from fund managers managing consumption with their money. In his report, he wrote: “Fund managers would choose which services to buy and which to provide themselves. They would face a commercial tension between wishing to cut costs on the one hand, but wanting to achieve superior investment returns on the other. This is healthy. The pressure would be to purchase only those services which contributed to such returns, and to do so in the way which is most efficient.”
Some across the industry have argued for the status quo – that research, though not perfect, is an eco-system where the model cross-subsidizes research coverage. Trading more actively traded stocks supports the research in less active stocks. Shifting the model impacts the eco-system resulting in fewer stocks receiving coverage. Reduced attention in these stocks impacts the liquidity conditions in the lesser active stocks making them even harder to trade.