The Financial Conduct Authority has acknowledged there may be "potential negative effects" on competition in the investment market as a result of the research unbundling rules introduced under Mifid II.
Mifid II was introduced in January 2018 and requires asset managers to pay for research separately from execution services, either charging clients transparently or paying for research themselves.
In a review of the new rules published yesterday (September 19) the regulator found "broadly positive changes" in the behaviour of firms in response to the unbundling reforms, but did find independent research providers had concerns over competition in the market as a result.
The watchdog spoke with five independent research providers between July 2018 and March 2019 and its research indicated levels of pricing in the market were potentially too low because large multi-service banks are internally cross-subsidising their research, making it hard for them to compete.
The FCA said: "In general, lower pricing can be positive. However, we are aware of the potential negative effects on competition in the medium term if some firm’s ‘loss leading’ prices drive out competitors, reducing choice."
The regulator said at least one broker it spoke with suggested to avoid their services being considered an inducement, which is prohibited under the rules, they set cost-recovery as a minimum threshold that underpins their pricing model.
The FCA added: "Low ‘entry level’ pricing for research accompanied by higher fees for more exclusive (‘high-touch’) interactions could be a reasonable pricing strategy overall. We have followed up on some providers’ models in more detail."
The regulator is expected to review how sell-side pricing models are developing in its further work in the area in 12-24 months’ time.
The issue is one which has prompted cause for concern in the industry since the implementation of Mifid II last year, with FTAdviser reporting in January that some believed the rules had already done permanent damage to investment markets.
Speaking at the time Daniel Schlaepfer, president and chief executive of trading company Select Vantage Inc, said unbundling research costs has significantly damaged the quality of research and market competition.
Mr Schlaepfer warned unbundling had forced fund managers to drastically cut spending on research, most of them opting for a few larger research providers at the expense of independent specialists and smaller research firms.
In its latest review of the unbundling rules the FCA said research pricing models on the sell-side remained "highly varied" and it was common for providers to charge a baseline fee for access to written research and price additional services separately.
The regulator said: "Firms’ models varied with some using tiered service pricing levels, others offering ‘pay as you go’, while others price per type of interaction or product consumed.
"Some firms suggested providers were sometimes reluctant to offer a price to buy-side firms and prefer to be price takers. We expect firms offering execution and research or other services to price services separately."