With less than a year to go before the implementation of MiFID II, institutional investors and brokers are racing to create ways to determine the true value of sell-side research.
A new report from Greenwich Associates, MiFID II Causing a Research Evaluation Headache, examines the challenges the industry faces in adapting to the radical changes that will be imposed by the new regulations, and assesses the progress made by the buy side and sell side in crafting solutions.
The implementation of MiFID II on January 3, 2018 will upend the process used by investors to obtain and pay for research from brokers and other providers. In equities, this process has long been governed by an informal “broker vote,” in which buy-side portfolio managers and analysts “vote” for the brokers and providers who have supplied them with valuable research. Buy-side trading desks use the results of this process to allocate trading business to providers in accordance with vote results.
At the moment, only slightly more than half of European institutions participating in a recent Greenwich Associates study track the number of analyst calls and research reports they receive, and only 20% rate the quality of analyst service, corporate access and written research. “Rather than tracking these items on a granular basis, most firms just rely on the judgement of their portfolio managers and analysts—as expressed through the broker vote—about how much value each research provider contributes to the investment process,” says William Llamas, Associate Director at Greenwich Associates and author of the new report .
MiFID will require investors to discard the broker vote in favor of a more rigorous and transparent valuation methodology. The only catch: Neither the buy side nor the sell side know exactly what that methodology will look like. “The basic challenge facing the industry is that a single piece of research might hold a different value to any number of investment managers, and even within the same firm, to different funds,” says William Llamas. “Value is therefore subjective.”
New Pricing Models
The industry is currently experimenting with a variety of new approaches and pricing models. The simplest is the “a la carte” model, pricing each interaction type individually. Many independent, non-broker research providers institute this model, since their product offering isn’t very diverse. Full-service brokers used to the current coverage-type model will likely opt for a “threshold of service/consumption” pricing model, in which research providers can then define a range of services they can offer and negotiate a price with their buy-side consumers. This negotiation will likely specify which analysts, sectors and regions clients will continue to value and want covered. “Through such negotiations, the equity research delivery and consumption process could become more efficient, which is one of the regulators’ primary goals,” says William Llamas.
The vast majority of institutional investors still use in-house proprietary systems to track and value research. (Excel spreadsheets are still commonly used for the task.) About a third of investors are using a third-party vendor such as Eze Software, Markit, A-2 Access, or Commcise—a share Greenwich Associates expects to increase significantly as MiFID II implementation proceeds. “Once vendors are able to solve for the shortfalls in current systems and provide an economical solution, the buy side will begin to gravitate toward their software solutions,” says William Llamas.
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