Mifid IINov 9 2017

How your clients will benefit from unbundled research

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How your clients will benefit from unbundled research

On the face of it, this seems only to affect wealth managers or fund providers, and how they purchase and use third-party research.

However, until earlier this year, the majority of advisers and their clients had no idea how much fund managers were paying for third-party research, and therefore had no idea how much of this expense was being absorbed by the provider – or passed onto the client through higher fees.

Now, Mifid II requires the unbundling of research and greater transparency on costs, so that investment firms can show they are not being induced to trade. 

They will, from 3 January, have to put in place systems that can manage unbundled payments for execution and advisory service, and be able to show the research and pricing models for those services. 

Sell-side firms (those providing research, such as investment banks, stockbrokers and market makers) must also disclose all the associated costs and charges to buy-side firms (fund managers, asset allocators, retail and institutional investors) so the latter can demonstrate they are acting in the client’s best interests, and have not been induced to trade. 

In its 2016 paper on Mifid II’s requirements for research, PricewaterhouseCoopers outlines five core implications. These are: 

•    Sell-side firms must not induce clients to trade by bundling research within their execution services.
•    Sell-side firms are required to review and identify services provided that could be categorised as research, and therefore for which payment would be required. 
•    Sell-side firms need to provide clients with unbundled costs of trading, separately identifying and charging for execution, research and other advisory services.
•    Buy-side firms have to make explicit payments for research, and demonstrate that research contributes to better investment decisions, and is therefore not an inducement.
•    Investment firms must provide better reporting to facilitate payments being made for research, and to help demonstrate the value that research is providing.

Linda Gibson, director of regulatory change and compliance risk for BNY Mellon’s Pershing, claims Mifid II will “govern the way wealth managers purchase and use third-party research". 

“The increased transparency heralded by research unbundling not only changes the way advisory firms budget for research services, but also puts greater scrutiny on demonstrating the value of such services to investors.”

For advisers, wealth managers and discretionary managers, this means they need to develop more robust quality criteria, which will help them assess the value of any research they receive, and how it will contribute to better investment decisions.

According to Susann Altkemper, counsel for law firm CMS: “Advisers should benefit from more efficient price information, as research providers will increasingly look to differentiate themselves from other providers, and price their research competitively.”

Complexity

However, this is going to be complicated, and advisers and providers will have to work better together to make any cost transparency meaningful to the client.

This is the view of Jennine Watts, regulatory solutions manager for SEI Wealth Platform, who says: “The challenge in breaking out implicit costs for things such as research is complex, not just in practical terms but also in relationship terms.

“Some firms will see it as an unavoidable cost, and absorb it into their profit and loss, while others will pass it onto clients, with the result that the proposed fee varies significantly.”

There is an expectation that the quality of investment advice will improve, because it is no longer tainted by the kind of conflicts that may arise where research is received for free. Susann Altkemper

The main challenge, therefore, will be in how to break down the value chain to the client meaningfully.

Ms Watts says just breaking out implicit fees does not, in itself, provide ‘transparency’. She explains: “When you start seeing a cost of X amount for research on your statement as a client, that won’t mean much.

“What will happen in the short term is clients will make superficial comparisons across different service providers, based on a number.

“This will be the catalyst for lots of conversations as clients try to understand these new fees across the spectrum, not only for research.”

Costs to investors?

With the breaking down of research costs, and ascertaining whether any of the material and services they are producing and consuming, concerns were raised earlier this year this could lead to fund management groups finding they are paying for a lot more than previously. 

With the potential additional costs imposed on various commentary, trade ideas or ‘behind barriers’ research, or on research which the Financial Conduct Authority’s Conduct of Business sourcebook 11.6.5 might class as ‘substantive’, there were concerns these expenses could be passed onto the end consumer – the investor. 

This spurred great activity in July and August this year, as fund manager after fund manager issued statements to the press pledging to absorb any additional costs, rather than pass them onto the client. 

Not all fund managers have yet made this disclosure; some large US-owned investment houses are yet to declare whether or not they will absorb or pass on the costs. Some have said they will be passing costs onto investors.

However, the names of just some of the asset management groups who have announced they will be bearing the costs themselves are in the table below: 

Aberdeen Standard Investments
Artemis Investment Management
Axa Investment Managers
Baillie Gifford
BlackRock
Deutsche Asset Management
Fidelity has completely overhauled its fee structure to a variable management fee
First State Stewart Asia
Franklin Templeton Investments
Invesco
Janus Henderson (a u-turn decision)
JO Hambro Capital Management
JPMorgan Asset Management
Jupiter
Kempen Capital Management
Legal & General Investment Management
M&G Investments
RAM Active Investments
Royal London Asset Management
Schroders
Seven Investment Management (already absorbed the costs)
SVM Asset Management
T Rowe Price
Vanguard 

Chris Darbyshire, chief investment officer for Seven Investment Management (7IM), comments it is "business as usual" for 7IM as it has been able to avoid research costs either explicitly or implicitly through execution costs. 

However, Mr Darbyshire says greater unbundling is "hugely welcome". 

"Now the investment banks are to become quasi-independent providers, we'll compare their research offering with our existing providers. We'll take our time making any research-related decisions, we'll compare their research offering with our existing providers."

According to Sarah Lyons, head of marketing at Ascentric, the new rules on disclosing the costs on research unbundling are already driving change in the asset management sector.

She explains: “Some asset management companies are absorbing any external research costs incurred in the management of clients’ assets.

“This can only be a good thing for the investor, as the required transparency is already driving down costs and making it easier for advisers to select investment solutions that offer the best value for their clients.” 

Indeed, as Mr Darbyshire adds, 7IM will be "taking our time" making any research-related decisions, "as we expect significant fallout from Mifid, possibly leading to material reductions in pricing, the demise of industry players and the eventual restructuring of the research industry around a new business model".

Moreover, as Richard Janes, spokesman for Brewin Dolphin explains, this transparency will also reassure clients and their advisers there has been “no undue inducement in that regard by their investment manager to use one firm over another".

“They may still end up paying for the research if their firm employs research payment accounts, but it will be clear to them what the cost is and, if the firm pays for research centrally, it could end up in an overall reduction in cost for the client.”

Possible downsides

For SEI Wealth Platform’s Ms Watts, advisers will need to be able to articulate the standalone value that the research may have to the client, and to extrapolate any correlation between research and performance. This is not so easy to do.

She adds: “When a number of providers look the same from a bundled fee comparison, are some actually providing more value to the client by virtue of research quality? Does more, or better, research actually lead to better returns?”

A research document from Marten & Co also highlights the possible detrimental effect on smaller companies in particular.

The research note – Mifid II: less than 96 days – states: “We believe medium and smaller companies will be hit hardest, with coverage for many residing with the corporate broker only, if they continue to offer that service.”

The research also warns that quoted companies may have to commit significantly more resources to investor relations and events to get the message out there, as they may no longer get sell-side assistance with organising roadshows as things unbundle and costs become visible.

The FCA has made it clear that it expects firms to have conversations with clients to explain the changes. Jennine Watts

According to Marten & Co, this may mean fewer seminars and conferences for advisers. The research note states: “Investor conferences organised by the sell side are likely to reduce dramatically and will probably all but disappear in the medium term.”

Moreover, will providers try to make aggressive cost assumptions to make their costs look lower than another provider doing very similar business? 

According to Ms Watts, SEI asked the FCA about these practical challenges with calculating the figures for disclosures, and the fact clients could end up being “overloaded by information” and ultimately more confused.

Ms Watts says: “The FCA has made it clear that it expects firms to have conversations with clients to explain the changes.”

There could be another potential downside, as Hugues Gillibert, chief executive of Fitz Partners, points out. 

He says while investors will only end up paying for costs relating to their investments, and not to a share of all research bought by a firm, this could “limit the choice or breadth of research available”.

Only time will tell if the legislation does limit such research, and if this has a knock-on negative effect on people’s investments.

Better market 

Ms Gibson claims the additional transparency and scrutiny will benefit both advisers and the end investor. 

“For advisers and investors this means the emergence of a market where research costs are directly linked to the quality and quantity, and the investor value of research services,” Ms Gibson says. 

CMS’s Ms Altkemper agrees, suggesting that as costs come down and transparency makes the fee structure far clearer to clients, this could incentivise them and their advisers to shop around much more for the best possible fund recommendation.

Moreover, she says: “There is an expectation that the quality of investment advice will improve, because it is no longer tainted by the kind of conflicts that may arise where research is received for free.”

Many industry commentators broadly welcome regulation that works to provide better client outcomes.

Richard Romer-Lee, managing director of Square Mile Investment Consulting and Research, says such regulation will help create a financial services market that “functions effectively and efficiently”.

He says this is becoming ever-more important as the responsibility for saving, and the risk if one’s saving strategy does not work, falls increasingly at the feet of each investor.

“The consequences of a strategy not working is likely to impact many things: the person’s standard of living, how much they need to save, how long they will have to work, and the amount of risk they may need to take with their investments,” he says.

“Certainly in this country, the government and regulator are well aware of this and are continually working on creating an environment where the financial services industry will share some of the risk, to help deliver better outcomes.”

Mr Romer-Lee adds that all of the legislation and regulation is designed to support transparency, efficiency, competition and the delivery of better customer outcomes.

In her research note: Mifid II: It’s not just a regulatory issue, Jackie Beard, director of manager research services for Morningstar, comments: “We welcome the regulatory changes Mifid II will bring.

“It is far more than a compliance exercise. At the heart of the directive is the objective to make investors far more informed in a way that’s comparable, and to give them better quality advice that matches their suitability and needs.

“That should lead to a better investing experience, and when the investor wins, we all win.”

simoney.kyriakou@ft.com