Duff & Phelps' Nick Bayley is a managing director in the Compliance and Regulatory Consulting practice has partnered with Hedgeweek to provide a monthly blog series providing insight on this imminent regulatory change.
Prior to this, Nick was a Head of Department in the FCA's Markets Policy & International Division, FCA Senior Markets Adviser and was responsible for the UK regulator’s MiFID II Policy Project.
As a former exchange regulator, I have more than a passing interest in the mechanisms for price formation and price discovery. So, it’s interesting to see the start of what I think will be an extended period of price discovery for investment research, as the sell-side and buy-side try to arrive at a common foundation on which to value it, which is part of the unbundling exercise under MiFID II.
It will be fascinating to see how the sell-side will approach the question of what is the right price to access its research. These analysts are not cheap and some quite big numbers are likely, something that may stick in the craw of the buy-side. The figures being bandied around in the market vary widely – annual subscriptions of GBP 250,000 for entry level access are being mentioned, whilst the Financial Times recently reported that some houses are going to charge up to USD 10 million for investment managers to get the full panoply of services.
The sell-side community is now being forced to address how valuable its research is. Price it too high and they will inevitably lose clients. Price it too low, just to keep their material in front of managers and they risk setting a price point that will be unsustainable given the costs of paying all those analysts.
As the marketplace starts the price discovery dance, the buy-side must also take some tentative steps into the new world. I am telling my clients firstly, to audit what research they currently receive (and in MiFID II, that covers quite a broad range of material) and secondly, determine which research they really value and will be happy to pay for, and which they don’t.
Some of the smaller sell-side research houses will be fretting over this, as they worry about being squeezed off the desks of many key investment managers. Therefore, I suspect we will see some creative approaches being taken to price formation. Smaller providers will certainly not want to price their research too high for fears of disappearing off the radar.
An analyst wants plenty of people receiving his or her work, and to see that research is driving lots of investment decisions. But, there is no such thing as a single, objective price for a piece of research. By that I mean that there is no rule under MiFID II that says a research house must charge its smaller clients the same price for a piece of research as they would one of their blue-chip clients. I’m not sure the marketplace has fully grasped this point. There is plenty of scope to be creative and for research desks to develop innovative structures whereby they price research flexibly, perhaps on a sliding scale, based on the size of their client.
It is unlikely that this price discovery dance will be completed by January. In my view, there will be initial, feeling-out arrangements whereby many sell-side firms try to remain hooked in to the buy-side by not pricing themselves out of the market. Buy-side firms will be happy to receive useful, value-for-money research but not priced so cheaply that they risk falling foul of the inducement rules. A research provider will need to be clear that whilst they can offer their research at Price X in Year 1, there’s no guarantee it will be the same price in Year 2.
I have got ahead of myself – many buy-side firms still don’t fully understand what research they currently receive and what they value and don’t value, it will likely take 12 to 24 months before the real economics of this are known. What does seem certain is that there is going to be a shake-out in the investment research industry – a Darwinian process of natural selection, in which only the strong survive.
One question that is still out there is how much this change is going to help the independent research houses and whether new ways of accessing research will develop. Using research from providers that are completely unconnected to the order flow is exactly what the policy-makers want to happen.
Will it be a good idea to assign a proportion of your research budget to access research from a platform, without necessarily knowing what research it will be and who exactly it’s coming from? I am not sure I know the answer to that but when I see the uptick in investment in start-up platforms that will help “brokerages, independent research providers, and asset managers distribute, manage, unbundle and value research” then it sounds like things are probably going to change. For now, the price discovery dance makes for fascinating viewing.