Mifid II fallout over fund research fees predicted

The chief investment officer of Seven Investment Management (7IM) said Mifid II could create a depolarisation of investment research and the demise of some independent firms. 

He claimed the large investment banks will be able to package up their research costs with other services, while independent research houses will struggle.

Mr Darbyshire said: "We expect significant fallout from Mifid II, possibly leading to material reductions in pricing, the demise of industry players - including personnel, departments and possibly entire firms - and the eventual restructuring of the research industry around a new business model."

He explained that Mifid II, which is coming into force in January 2018, will put great pressure on firms to be clear about how they pay for research and whether they pass this onto clients.

As a result, he said: "For the first time, banks will be forced to charge explicitly for their research.

"Overnight, their business model will move from one where research is integrated with execution of trades to one which competes directly with the far-smaller independent research industry.

"Few fund management houses will want to bear the whole cost of research themselves, but they may also not be willing to charge it explicitly to their funds.

"There is a distinct risk that research budgets shrink, and research departments with them."

The new Mifid II regulations increase the level of transparency around the cost of research services, and we feel under these regulations the direct payment of this cost is in the best interests of our clients. Ken Lambden

But Mr Darbyshire added: "Our customers won’t see any impact on fund costs as these are already absorbed directly by 7IM; we must ensure that these changes do not reduce the quality of our internal research or the decision-making that it drives."

He said: "Being larger and offering more company-specific services, investment banks may be able to package up their single-stock coverage with their top-down research services.

"This will threaten the top-down independent research houses, who will be forced to rely on their clients’ existing contractual obligations and their greater expertise in a narrower range of disciplines."

He said the "coming battle" reminded him of the entry of Premier League and Championship teams into the third round of the FA Cup. "The bulge-bracket investment banks provide research on thousands of companies worldwide, plus hundreds of national economies, industries, currencies and commodities.

"A bulge-bracket investment bank might employ close to a thousand people in research, whereas even the staff of large independent research houses are numbered in the tens. It will be behemoths versus minnows."

7IM has never charged research costs to its funds, either explicitly or implicitly through execution costs and, according to Mr Darbyshire, has always paid investment banks for their execution abilities rather than for their research.

"Now that the investment banks are to become quasi-“independent” providers, we’ll compare their research offering with our existing providers", he added.

Over the past few weeks, many fund management houses have announced they will absorb any external research costs. 

JO Hambro Capital Management (JOHCM) was the latest to say it would pay for external research used by its fund management teams, when the Mifid II reforms come into force. 

Ken Lambden, chief executive of JOHCM Group, said: "The new Mifid II regulations increase the level of transparency around the cost of research services, and we feel under these regulations the direct payment of this cost is in the best interests of our clients."

According to Mr Lambden, the funding of JOHCM's external research is expected to be approximately £5m a year.

Also in August, US-listed T Rowe Price Group announced it would be paying for the third-party investment research used by its UK-based investment manager, T Rowe Price International.

Earlier this year, sister paper Investment Adviser reported that a quarter of fund managers were expected to absorb research costs, including Hermes and Woodford Investment Management.

Jackie Beard, director of manager research services for Morningstar, said: "From a financial adviser's point of view, one of the considerations for them to focus on is which houses are passing on the research costs to investors, and which are not." 

simoney.kyriakou@ft.com