Lynn Strongin Dodds looks at why independent research providers (IRP) have not gained the foothold expected after MiFID II.

Although MiFID II was supposed to usher in a new era of research, the bulge bracket banks continue to dominate the investment scene and the independents are still struggling to get a foothold. The picture is not expected to change as the pie is getting even smaller with asset managers tightening their belts even further due to the current economic turbulence.

“Independent research firms have made little progress since MiFID II came into force in 2017,” says Tim Parker of Messels Ltd, which opened its doors in 2000. “The regulation led to the unforeseen response that fund managers decided to pay for research themselves from their P&L. There is a structural flaw because in a bear market, when the buyside needs greater insights, there will be less money to pay for it.”

Steve Kelly, special adviser at Euro IRP, the European Association of Independent Research Providers, which represents the interests of independent firms, agrees, adding that one of the fundamental aims of regulators in developing the MiFID II rulebook was that it would pave the way for a more level playing field in the investment research market. By separating provision of research services from trading/execution services, then the thinking was research would stand or fall on its own merits, and be priced accordingly.

“Quality, diversity and independent thinking would be highly prized, and the flood of sub-standard, ‘me-too’ research would reduce to a trickle,” he adds. ‘All this would create a far broader research ecosystem, and one that best served both institutional investors, and their ultimate clients.

Kelly notes it wasn’t just the regulators that had this view but also the research platforms who set up ready to welcome the new incumbents. “However, there is less research than before MiFID II, and several providers have either exited the market, or significantly scaled back operations, but the overall market share mix is very much as before,” he adds. “Indeed, whilst asset managers usually take research from fewer bulge bracket houses than before, the bulge bracket share of the research wallet has grown, especially over the last year.”

The numbers speak for themselves. A recent buy-side study on investment research by Substantive Research, a research curation, comparison and valuation provider, shows that in fact the market is much less competitive, and specialist, while differentiated research has become less available in times of heightened volatility. Surveying 40 asset managers across Europe and the US with AUM of between $2bn and $800bn, it revealed that regulation has not altered the landscape and provision is still concentrated.

The report showed that in 2019, 52% of research budgets went to the top 10 providers, compared with 51.6% in 2020, only to increase to 53.1% in 2021. This means that the incumbents are actually getting more powerful and that competition has decreased due to MiFID II.

Squeezed wallets

Research budgets also decreased once again year on year – with US wallets dropping by the same 11 percentage points as their European counterparts for the first time. The drivers are different, according to the report. European fund managers having to dig deeper into their pockets are feeling the heat while in the US buy side firms are looking for more efficient, mutually valued relationships with a core list that is still longer and better rewarded than the European counterparts.

“The commercial dynamics makes it difficult to be a niche provider,” says Mike Carrodus founder of Substantive Research, “IRPs were taking slightly more than a tenth of research budgets on average and that figure had remained largely static up to now.”

One reason is that it is difficult to be competitive with the bulge brackets who have the deep pockets and resources to generate a greater depth and breadth of research. As Kelly notes, the large investment banks, and sell side brokers also offering execution and/or corporate finance services, have provided core access to their research at very aggressive prices.