Earlier this month stakeholders from all facets of the investment research industry met at the Unbundling Uncovered event, hosted by Substantive Research. The discussion and debate on the future for research threw up lots of talking points with a suggestion that investment research, and particularly how it is paid for, may change yet again.
Since the introduction of research rules under MiFID II in 2018 the investment community has been forced to unbundle in the UK (and to some extent Europe) with knock-on effects in the US. Now, almost 6 years down the road, we could potentially see changes taking us back to the way things were before MiFID II.
The Investment Research Review – established by the UK Government in March 2023 to consider levels of financial services investment research and its contribution to UK capital markets competitiveness – published its findings and recommendations in July 2023. These included the idea of “optionality” for the buy-side where a potential softening of existing FCA rules on unbundling would allow the possibility to revert back to using underlying client commissions to pay for research. The recommendations are now being lobbied to the FCA with the aim for optionality becoming part of the FCA’s potential rule changes. We expect to see an FCA consultation paper sometime in the first half of 2024.
What’s interesting is the reaction and commentary from the buy-side. Initially the idea of moving away from funding the research budget with anything other than their own P&L was resolutely dismissed; now, just 4 months later, the sentiment has shifted, and some asset managers are exploring such possibilities and having conversations with their clients.
So, will we move back to asset managers using a CSA mechanism to pay for their research, with the underlying clients funding the research pot? Maybe. The devil is always, of course, in the detail. There is momentum. The market is driving it this time (unlike MiFID II), and you could argue that comments made by the UK Chancellor Jeremy Hunt during his Mansion House speech – that he would welcome sell-side firms producing more research in respect of medium and small-sized UK companies – suggests government would be supportive of the move. Firms are looking at this seriously to see if it can be done.
It’s not without its complications, though. Will the underlying funds pay for the research, or will a CSA rebate function win out? Will this move to optionality suit all participants? It must be remembered that research budgeting and transparency is here to stay, regardless; with asset managers having overhauled their processes for funding and paying for research to meet MiFID II requirements just a few years ago, it would perhaps be costly and time-consuming to update their set-ups, structures, and regional approaches all over again. Further, for it to work well the industry will need the UK government to support small and mid-cap companies in order to generate demand for research on those companies. This would certainly make it easier for the buy-side to persuade their investors of the value in paying for research. This in turn would mean a greater chance of buy-side firms using a CSA mechanism, especially if the FCA disclosure rules are relaxed from the MiFID II extreme we operate under today.
What is clear is that the conversation is still very much alive. While we might not be going back to how things were before MiFID II, we will likely see a shift towards greater optionality when it comes to paying for research, coupled with continued transparency. Although many market participants will hold off making major changes until they see how the new rules are laid out by the FCA, it’s fair to say that in the coming months brokers will be reviewing their approach to managing their clients’ research commissions and payments.
As these critically important rules and interpretations evolve, Meritsoft continues to provide market-leading solutions to facilitate MiFID II compliance and CSA management oversight.
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