MiFID II Update: Reversion to the mean?
Following last summer’s proposed changes to the unbundling rules under MiFID II, the European Commission published its final amendments in February. These amendments enable investors to bundle payments for research and execution, where the research is on issuers with a market cap of less than €1 billion over 36 months.
There has been a mix of reactions within the buy side and research provider communities. Most commonly, there has been a general view that, while there was clear anticipation for rule changes, the scale of response by regulators was much lower than expected by market participants – and many buy side firms in particular feeling that the changes did not address the “unexpected consequences” of unbundling – particularly in the context of impeding smaller buy side managers and overly benefiting larger incumbents.
Over eight months on from the initial proposal, there is still considerable uncertainty around what the changes mean, how market participants are responding and the future for unbundling.
In this brief, I summarise insights gathered from a recent market survey to answer some of these questions.
Research budgets fell in the first two years after MiFID II was introduced and have since stabilised.
In the US, where research continues to be primarily paid for through CSAs, there has been a fall in budget allocations to traditional research providers over the past 12 months, as buy side firms look to “find a home” for alternative data and ESG services. I expect that trend to follow to Europe, as the demand for “alt data” rises.
In Europe, there is a general acceptance that the new status quo is fixed – and firms paying for research via P&L will not re-engage with asset owners to change this, yet there is curiosity around the implications of the carve out. In particular, French and German Investment Managers – where there are a disproportionately high number of Small/Mid Cap Equity funds – are keen to see if there were opportunities to expand research availability, or reduce costs through implementation of the provision. However, they were waiting to see national interpretation and ratification before acting on the changes, with a view to incorporating any operational or budgetary considerations in 2022.
UK buy side firms surveyed viewed the carve-out to be a European regulation not directly related to UK domiciled entities – the view was that the original principle and implementation of unbundling rules should be continued to be adhered to.
While there has been some evidence linking declines in small and mid-cap research coverage with unbundling, the rules to re-bundle such services have received a muted response thus far.
Buy side firms are focused on expanding the range of research services used to inform the investment process (such as alt data and ESG). Sell side firms are concentrating their efforts on better customer servicing, through segmentation of clients, the ability of sales and research professionals to benefit from the influx of new user behaviour data received as services went online during the pandemic and in planning for the post pandemic digital-first “new normal”.
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