Rhodri Preece writes that firms are under competitive pressures as the market for investment research takes shape.
The European financial services industry underwent its biggest regulatory overhaul in more than a decade with the introduction of the revised Markets in Financial Instruments Directive (MiFID II) in January 2018. The legislative package introduced significant changes to investment firms and financial markets, including enhanced ‘inducements’ rules governing the payment for investment research.
The changes to portfolio management inducements rules disrupted the provision of investment research. Under MiFID II, providers of research, such as investment banks and brokers, are required to set prices and charge for research separately from trading costs (commissions and spreads). Investment management firms – users of research – have had to determine whether to absorb the cost of research or to pass on those costs to clients. The changes broke the historical business model of investment firms bundling research with transaction costs, which are deducted from the client’s account.
Competitive tilt favour large firms as research budgets and profit margins come under pressure from client demands, increased competition, and business model disruption.
These competitive pressures are best illustrated by the findings that asset managers are overwhelmingly absorbing research costs against their profit and loss, and they are scaling back research budgets accordingly. In turn, sell-side firms are recalibrating analyst coverage. Overcapacity in the supply of research is being removed, but it is an open question as to whether an equilibrium has been reached that serves the best interests of end-investors.
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