Mifid II unbundling review flags cross-subsidisation concerns

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Sep 19, 2019

The FCA‘s discussions with independent research providers about separating research costs have pushed attention onto cross-subsidisation.

That is according to the regulator’s  findings from its multi-firm review of post-Mifid II research price “unbundling” rules.

Asset managers have been required to pay for research and execution services separately since January 2018 under Mifid II rules, rather than providing clients with a bundled cost fee.

The FCA says: “Our engagement with independent research providers indicated that levels of pricing in the market were potentially too low, because large multi-service banks are internally cross-subsidising their research, making it hard for them to compete.

“Lower pricing can be positive, however we are aware of the potential negative effects on competition in the medium term if some firm’s loss leading prices drive out competitors, reducing choice.”

The FCA reviewed 40 buy-side firms, and 10 firms across the buy-side and sell-side between July 2018 and March 2019; five independent research providers were also approached for the first findings review.

Despite the concerns flagged by independent research providers, the watchdog says asset managers’ accountability on costs has improved overall.

The FCA says: “A key principle is to ensure that portfolio managers act as good agents in the best interests of their clients and that their investment decisions are not unduly influences by third parties.

“At this relatively early stage, we have seen broadly positive changes in behaviours by firms in response to the reforms and found no evidence to suggest firms are unable to access the research they need.

“Nor does our analysis suggest that small and medium enterprise research coverage has materially diminished, contrary to some reports.”

Firms did not raise concerns over declining quality of research, but some said Mifid has harmed the number of analysts contributing to consensus forecasts and increased confusion over inducement rules.

The FCA says: “Some brokers have concerns that allowing their analysts to provide attributable forecasts to data platforms that are accessible to all market participants, rather than solely the broker’s clients, could breach Mifid rules.

“Brokers can contribute to these forecasts, and platforms can disclose their identity to all the platform’s clients, without this being a material benefit under the inducements rules. Robust and transparent consensus forecasts can be useful both for investors and corporate issuers. However, if an asset manager wants to speak directly to a broker’s analyst who provided a forecast or receive an underlying research report from them, the inducement rules would likely apply.”

Moving forward, the FCA confirmed it could continue its supervisory research for another 12 or 24 months.

“At this time we observe that price discovery is still evolving, alongside refinements to valuation and budgeting approaches on the buy-side. This may result in further changes to sell-side pricing models and competition in the research market.

“It is therefore likely that we will continue to work to assess the impact of these reforms in 2020/21.

The regulator estimates savings from the reform of research pricing could total £1bn over the next five years.

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