Unbundling’s Death Knell? TABB Research Shows 67% of European Buy-Side Traders Expect Research Payments to Decline with Proposed MiFID II Regulations

The traditional method of paying for research in Europe through client commissions is set to be redefined if regulators’ proposed rules hold sway. Some perceive the use of commissions has been open to abuse through obfuscation and lack of clarity on fees but according to annual benchmark research from TABB Group, the proposed radical overhaul of how research can be obtained and paid for throws the debate wide open as to how research will be consumed in the future.

European regulators believe the link between turnover and payment for research must be severed. Only through complete unbundling of dealing commissions will firms reduce any wastage in the research-purchasing process, uncover new cost-effective sources of independent research and deliver value for money.

The reality is payment for research is already undergoing a metamorphosis in Europe as a result of wider industry changes. But confusion reigns as to how MiFID II Level II text should be interpreted given differing stances by European regulators. As a result, says Rebecca Healey, a TABB Group Europe principal and senior equity analyst who wrote “The Changing Face of Equity Trading: Paying for Research,” the first in a trilogy of reports into European equity trading, two-thirds of the 50 global heads of trading interviewed in January 2015 fully anticipate their research payments to decline due to proposed regulations. These firms comprise 44 long-only asset management firms and seven hedge funds, managing €25.5 trillion in assets under management (AUM).

Geography and size matter. Nearly 80% believe smaller asset firms face a greater disadvantage. Although 35% UK firms see a flight to quality research, not an outright decline, 86% of the firms across Continental European see it differently, expecting a more severe decline.

With the unbundling process already underway in Europe as a result of previous regulation instigated by the Financial Conduct Authority (FCA), Healey says 58% of the firms interviewed now have a budgeted target for research payments and over 50% anticipate switching to execution-only commissions once the target’s been reached. Drawing from the study’s 30-plus highlights, she adds:

• 68% are talking with their brokers regarding the cost of research but 56% are dissatisfied with progress.
• Regulatory confusion between European National Competent authorities is now beginning to hamper progress, which is why 38% of UK firms and 30% of all firms are now sitting on the sidelines, unsure of what to do next.
• Over 90% of participants see mandated commission-sharing agreements (CSAs) as a potential solution to the regulatory deadlock; however, this includes 20% who recognise they are only part of the solution in increasing transparency over fees.
• Nearly 60% assume that firms will be unable to increase fees in the current competitive environment, while 46% see forced absorption of any increase in fees having a direct negative impact on their firm.
• While commoditised access to algorithms will continue to reduce low-touch rates, 44% believe execution fees will come under scrutiny as firms look to the provision of menu pricing for execution and research.

As European equities trading undergoes radical transformation, says Healey, the question that must now be answered is whether proposed regulation will represent positive change for the industry and end investor; or will the perceived subsequent decline of research payments and the outcome of this become another unintended consequence of European regulation. “With research and payment models now set to undergo a similar evolution across the asset classes, including fixed income, further innovation may well emerge that will benefit smaller players as well as those who traditionally have been able to dominate. Only time will tell.”

The 33-page, 30-exhibit study can be downloaded by TABB Group Research Alliance Equity clients and pre-qualified media at http://www.tabbgroup.com/Login.aspx. For the Executive Summary, more information or to purchase the report, write to info@tabbgroup.com.

About TABB Group

Based in New York and London, TABB Group is the research and consulting firm focused exclusively on capital markets, based on the interview-based, “first-person knowledge” research methodology developed by Larry Tabb.