It is impossible to accurately forecast how events will ultimately play out under MiFID II, but there is one certainty under the new regime – research services will have to be paid for more transparently. Whether these payments are made from Research Payment Accounts (RPAs) or from the buy-side’s P&L, the most important determining factors will clearly be value and price. Establishing exactly how to measure value, and introducing clear metrics by which to measure it, is very important and will drive innovation in the research market.
In my view, MiFID II only demands improvements that should have been initiated by the industry long ago. I speak as a former sell-side broker. The current system is by no means perfect. Far from acting as an inducement, the volume of research sent by the sell-side can, in fact, act as a deterrent to transacting. It certainly results in research being undervalued and underappreciated.
But the reason for this information overload is that the sell-side do not know what exactly they are being paid for. With little meaningful dialogue between the author and the recipient, delivering consistently original and pertinent research is near impossible. Producers of research cannot progress if they do not know what they are being paid for, or how they are being measured.
And so, although an unwelcome catalyst, MiFID II instigates much-needed corrections to a faltering system. In the simplest of terms, the regulators demand that the investment research market becomes more clearly transactional; that it adopts procurement procedures used by other businesses from time immemorial. Defining the requirement, negotiating price based on expected outcomes and paying on actual delivery will force research providers and consumers to examine what is actually of use and value to both parties. This is extremely positive because it will streamline delivery, increase competition and improve quality of service.
The mechanisms for valuing and paying for research have historically been inaccurate and opaque relying on the broker vote system. Aside from being vulnerable to temporal biases, arbitrary data and subjective choices, legacy broker vote systems do not address the more nuanced issues of valuing research. The worth of research fluctuates considerably depending on certain factors that are unique to each recipient. Such factors include the fund manager’s areas of interest and portfolio, the value of the assets under management and the underlying instruments, and the market’s movements. These factors can alter demand for research services and will differ hugely among recipients.
Assigning a fixed universal rate card or attaching fixed price tickets to each research category is not the right approach. The value of research is too varied and often too specific to the recipient. Furthermore, the regulators were never asking for fixed prices. The recipient must continue to have a say in the price, and prices need to remain negotiable as value is relative and will continue to be so for many years to come.
In order to maintain this methodology, independent, transparent and accurate research usage data needs to be generated inside asset management firms in addition to the sell-side creating their own data. If the buy-side solely use external sell-side data, it is a one-sided approach which will not facilitate accurate price discussions or take into account the nuanced valuation needs for research.
Paying for investment research from the P&L will not dilute the importance of generating accurate usage data required in the RPA route. Indeed, the value of knowing what research your firm is consuming and how it is being valued goes way beyond the research funding decision. From a commercial standpoint, firms with the superior datasets will have the strongest hand at the negotiating table and will be able to drive cost efficiencies.
As end investors increasingly demand greater transparency, having a granular understanding of your research consumption and being able to prove ROI will become a differentiator for on-boarding new clients. From an operational standpoint, it will enable a top-down understanding of a firm’s investment process, evidence trade justification and streamline internal processes. All this, while helping the sell-side fine-tune their services. While compliance may have been the unwelcome driver, there are innumerable by-product benefits of MiFID II from which the market can derive real value.