Will MiFID II bring Evolution or Revolution to investment research?

There has been significant discussion, and indeed some confusion, around the impact of MiFID II on investment research. Some investment firms, including M&G recently, have made announcements that they will no longer charge the cost of broker’s research to the investor’s funds, but will pay them out of their own resources – a potentially revolutionary change. Others are saying that they will continue to operate in much the same way as today with only minor changes to their processes – adding up to, at most, evolution. So which is likely to be the dominant trend, how much will the world of investment research change, and how much is being mandated by regulation and how much is simply a change in market practice.

It has been commonly accepted that access to good and cost effective research is important for efficient asset management. Over the years investment firms, research providers and brokers have made extensive use of commission sharing agreements (CSA) to manage this process and to allow them to keep track of the research costs. However, the EU regulators and some in the market argue that this does not provide sufficient transparency of the costs to the investment firm’s client. Hence enter the changes being driven by the new MiFID II regulations, including the introduction of research payment accounts (RPA) and additional transparency requirements.

There are a number of different scenarios that are allowed under the new regulations, some apparently revolutionary and some more a kind of evolution.

At the revolution end of the spectrum is the hard cash only option. Under this alternative, an investment firm will not charge its customers for research and will only buy research as a direct cost. The impact will be a lower cost of investing for the customer and likely strong downward pressure on research charges from brokers and research providers, as well as a move to more use of independent research providers. However, if the downward cost pressure reduces the quality of the research provided, then the customer may lose investment return which could more than offset the reduction in research costs. Also not all firms will have the additional available cash to pay for this, or indeed their board/CFO may not view it as the best use of funds. They may argue that the hard cash option is a customer proposition alternative, rather than a mandated regulatory change.

In the evolution camp, the existing established CSA process will continue but at a minimum must be modified to satisfy the new RPA and allied transparency requirements, including agreeing the research cost element with the end customer.

Between these two extremes are a number of compromise positions. For example, where the customer is not charged for research, but the investment firm still uses its existing CSA process to monitor and manage the research costs.

So what is certain is that there will be change in the coming months. New processes and likely new systems will be required either for “revolutionary” cost management and control or for “evolutionary” valuation, management and transparency. Under either scenario there will be a sharper, more focussed assessment of whether the research consumed is worth its cost.