New regulations, such as MiFID II, are dissolving the relationship between research and trading.

The old adage on Wall Street that research drives the trading bus is being turned on its head – as regulators move the industry away from the decades old model where research is paid out of trading commissions. The buy-side, and others, are looking for increased transparency on how their money is spent and want to pay for their information in different ways – not just via trades. And now there is research to back up this trend, which has affected European equity trading and is now, according to new research from market consultancy Greenwich Associates, seen coming to the US markets.

According to Greenwich’s latest report, “U.S. Equities: Regulations Loosen Bonds Between Research and Trading,” 61% of the $9.7 billion paid by institutional investors to brokers on trades of U.S. equities last year, or $6 billion dollars, went to providers of research and advisory services. Given that proportion, report author John Colon said, “it’s no surprise that brokers’ market share in institutional U.S. equity trading traditionally has been tightly correlated to their performance as a provider of research and advisory services.”

But now, that lofty amount of money is expected to shrink as new rules are taking effect and will create an “unbundling” of trading and research. Regulations are playing a major role in weakening the link between research and trading, and no rule has addressed the issue more head-on than Europe’s MiFID II. Although the latest MiFID rules appear to stop short of the outcome many feared most—an outright ban on the use of trading commissions to pay for research—institutions in Europe are increasingly responding to the new regulations by moving to a “fully unbundled” model.

MiFID II dictates that all brokerages are required to demonstrate best execution and provide full disclosure and transparency on the following items: price, transaction costs, speed of execution, likelihood of execution, trading venue selection, etc.

“Although there is still a relationship between broker’s market share and position in equity research/advisory and trading, those two things are no longer moving in lockstep,” Colon said.

While the leading brokers in U.S. equity trading remain closely grouped in trading share (the top four are separated by only 50 basis points), they are much more widely dispersed in share of the research/advisory vote, with a spread of nearly 400 bps separating the top four, according to Greenwich.

In addition, whereas the leading bulge-bracket brokers’ trading share historically exceeded their research/advisory share, the reverse is now true for three of the four leading brokerage firms.

The shifting relationship between research/advisory and trading partly reflects changing dynamics on both sides of the business. Bulge-bracket brokers are becoming less willing to cede research/advisory share to mid-sized/regional firms and independent research providers but are ceding share—particularly in electronic execution.

“While we have always provided unique research to our clients – something the bulge hasn’t been able or unwilling to do – they are stepping up their game and giving us more of a run for our money,” said one trader in New York. “They know that they can use their economies of scale and provide a certain level of service, such as corporate access. They just have deeper pockets and in some instances, simply outbid us to provide access.”

Another trader agreed, noting that shrinking trading volumes, thanks in part to increased usage of electronic trading systems, has hurt the research provision business.

“The bulge is looking to carve out a new profit center by going after the research and corporate access slice of the pie,” he said.

Meanwhile one trader agreed with Greenwich’s point of the bulge loosening its grip on e-trading. He said that firms being squeezed out of the research business are refocusing their energies on trading – particularly melding electronic execution with a human sales trader.

“You read and hear a lot about smaller shops melding human sales traders and their algorithms to provide best execution,” he said. “So while it is electronic trading, there is a certain human touch – which suits these smaller firms and the clients they are going after.”

Greenwich’s Colon also noted that these mid-sized, and in some cases smaller firms, have been free of the regulatory issues impacting several bulge-bracket firms’ dark pools in recent years.

Meanwhile, institutional investors, Greenwich uncovered, are making more use of “tack-on” payments in electronic trading and commission management programs to pay for research.

But will these changes in Europe affect the U.S. equity market? In Europe, unbundling could commissions in Europe could cost broker-dealers and other research providers 1.7 billion euros  in equity commissions annually.

“Absolutely. By Greenwich Associates estimates, roughly 30% of institutions drive 70% of the U.S. commission pool,” Colon wrote. “These institutions are more often than not global and intent on pursuing globally consistent practices.”

For its research, Greenwich Associates conducted in-person and telephone interviews regarding U.S. equity investing with 223 U.S. equity portfolio managers and 320 U.S. equity traders between November 2015 and February 2016. Respondents answered a series of qualitative and quantitative questions about the brokers they use and their businesses in the U.S. cash equity space.

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