Unbundling requirements in the European Union have led to fund managers choosing more boutique brokers and research providers increasing coverage of small and mid-caps according to research from Liquidnet, the institutional investor block trading network.

MiFID II came into force in the EU at the beginning of last year and requires fund managers to either pay for research themselves or set up a research payment account, where the budget has been agreed with the client.

Liquidnet found in a survey, MiFID II Unbundling Research – Canary in the Coalmine II, that 55% of respondents are taking research from more than fifty brokers globally, the same as last year, but that the mix of brokers is changing.

Six months on from the first report, we revisit how leading asset managers are adjusting to the challenge of unbundling research, not only in Europe but across the globe. Attending #TradeTech Europe this week? Pick up your hard copy at Stand 39: https://t.co/XvSMwa3bDC pic.twitter.com/eTgH5Ms38B

— Liquidnet (@Liquidnet) April 24, 2019

Last year 69% of buy-side firms chose bulge bracket brokers for research but they are now differentiating between those who provide  basic waterfront coverage and those where they want to engage with an individual analyst.

Rebecca Healey, head of EMEA market structure and strategy at Liquidnet, said in the report: “There is an increased interest in smaller brokers’ offerings or specialist research provision as a way to differentiate themselves and add value to their investment process.”

She added that as the sell side develops a better understanding of where it can add value and what it can charge, there may eventually be an increase in some pricing models.

The survey found that since MiFID II came into force overall research spend has decreased for 39% of respondents and  remained constant for nearly half, 48%, of asset managers. In addition 13% of buy-side are choosing to increase their research spend.

“Increasingly, the focus for buy-side firms is not on how many providers to engage with but whether the brokers on the list deliver the quality and value-add that is expected to help with the investment process,” said Healey. “By honing in on quality and alternatives, the opportunity for growth in research provision could be an opportunity for providers globally, not just in Europe.”

For example, 80% of research providers are now increasing their coverage of small and mid-caps in a bid to diversify their product offering.

Healey continued that new third-party providers offering differentiated research will continue to emerge.

“The ability to combine traditional fundamental ideas with quantitative data analysis will help asset managers generate alpha over a more diverse portfolio construction,” she added. “Identifying what research services firms are paying for and the price for those services will be the first step, whether this is via better identification of bundled commissions or paying choosing to pay for research direct from P&L.”

Global implementation

Liquidnet said MiFID II unbundling has become an unofficial international standard as the majority, 58%, of respondents have chosen to implement unbundling globally. In addition, a further 11% expect to adopt a global MiFID II approach in the next five years.

“In Europe the change may be driven by regulation, but in the US it is being led by some asset owners are requiring greater transparency over what they are paying for research and the services they are receiving for that payment,” added Healey.

However, Liquidnet noted there are regulatory challenges in the  US for asset managers looking to unbundle as brokers are not allowed to receive cash payments for research. Although the US Securities and Exchange Commission has granted temporary relief to allow US firms to meet MiFID II requirements, the regulator looks reluctant to grant long-term relief.

“The current industry view is that the SEC will let the no-action letter expire, ultimately forcing broker-dealers to register as financial advisors to accept separate payments for research and execution services,” Healey added.

Sandy Bragg, principal at consultancy Integrity Research, told Markets Media this week that there is more unbundling in the US as a result of MiFID II, but it is occurring in the context of research costs funded with client commissions.

Bragg agreed that although MiFID II has increased research unbundling in the US, it is still an open question whether American asset managers will follow their European counterparts in absorbing research costs. He added that a handful of US fund managers have adopted the policy but the US Securities and Exchange Commission has signaled that it will no longer harmonize US regulations.

“This has put a damper on buy-side enthusiasm to absorb costs (which require cash payments),” he added. “It may still happen, but will require peer pressure because US asset owners seem largely indifferent and the US regulator is hostile to MiFID II.”

Integrity Research’s fourth benchmark study of research pricing found that average European research payments were $25,000 in Europe and $31,000 in the UK. These are both lower than the average Asian payment of $35,000 and $42,500 in North America according to the study. Bragg added that, irrespective of whether research costs are absorbed, global asset managers have been using more granular interactions data to tighten the fees paid to brokers.