- Research Unbundling
- Best Execution Reporting
As a quick reminder, MIFID 2 demands that asset managers must pay banks and brokerages for investment research wholly separately from their trading fees, in what is generally referred to as “Research Unbundling.” This separation of the cost of research from trading commissions was imposed to reduce inducements and conflicts of interest between asset managers and brokers. Critics of unbundling suggest that it has reduced the availability and quality of available research, particularly for smaller capitalization stocks and the result is that smaller firms have subsequently struggled to attract investors and reduced market liquidity in such stocks. SMEs particularly need a good level of investment research to give them enough visibility to attract new investors, since they are often not well-known brand names. It has been suggested that asset managers’ research spending has reduced by up to 30 percent, spurring a price war between banks and independent research providers to sell research (an intended consequence), however, this also resulted in a big decline in research coverage of small-cap companies (an unintended consequence).
The other common cited criticism of unbundling is that it does not work for bond trading where the cost of trading is covered by spreads rather than commissions. Interestingly, this unbundling issue was already subject to an ongoing MIFID consultation where industry had strongly advocated for permanent removal of the unbundling rules.
Under the European Commission proposals, firms would be allowed to “re-bundle” research and trading costs for all fixed income trading (allowing all rates, credit, and loan research to be bundled) and for equities for all companies with a market capitalization of less than €1 billion (c.$1.15 billion).
MIFID 2 best-execution reports require that each trading and execution venue for other financial instruments publicly disclose data on the quality of transaction execution periodically. The detailed reports include details about trade price, costs, speed, and likelihood of execution for each trade. It’s a significant data aggregation and reporting burden, and industry believe that despite the huge volume of data disclosed, the reports are rarely read by investors, a point empirically proven by the very low numbers of downloads from the website where the reports can be found. Further, the Commission notes that 70% of respondents to the recent ESMA MIFID 2 review consultation indicated that the best execution reports are not useful.
Asset managers simply don’t rely on these regulatory reports either as they directly engage with their trading counterparts on best execution standards. ESMA had previously deprioritized the publication of these reports anyway to alleviate some burdens on asset managers in the context of the pandemic. This proposal just looks to extend this suspension and with the full review of MIFID 2 planned in 2021 anyway, we could see a permanent removal of these reports in due course.
Isn’t it ironic, don’t you think?
As usual, the Commissions’ proposal requires further approval by the parliament and Council but is likely to become effective in early 2021. These rollbacks are very intriguing targeted relief to assist the European capital markets. They also contain a large degree of irony. The looser ruleset will become effective early in 2021, after the United Kingdom has left the EU due to Brexit. The logic of Brexit was to remove certain unnecessary regulatory and operational burdens to allow business flourish, however, UK asset managers may be left with both unbundling and the reporting regimes under FCA rules and will not be able to directly avail of the EU relaxations. US managers have long urged the EU to solve for the unbundling anomaly, and while they will be pleased to see this proposal, they will also likely be uttering the occasional, “I told you so!”