A new report from New York-based brokerage firm International Technology Group Inc. (ITG) aims to demystify forthcoming European rules that will require the asset-management industry and brokers to unbundle trading commissions and investment research.
Specifically, the report notes that measures to unbundle payments for research from trading commissions are a key part of the European Union’s (EU) regulatory reforms, known as MiFID II.
“By forcing brokers to price and charge for services separately, the aim is to enhance transparency and accountability, and achieve both best execution and best research,” the ITG report says. “European investment managers will be required to implement the changes on a global basis when they take effect in January 2017.”
Asset managers that are based in North America, Asia and elsewhere will have to comply with the EU rules when trading with a European trading desk and/or European investors, the report notes. For these firms, “the onus is on clearly disclosing to clients how you intend to pay for services and how you will use their commission dollars.”
The report sets out ITG’s view on how asset managers will pay for research under the proposed rules; how this is likely to affect sell-side pricing; and advises asset managers on how to prepare for the changes.
“Under the proposed rules, buy-side firms will have to justify their choice of research services and demonstrate the value it provides. As a result, the price and underlying value of the research will be subject to much closer scrutiny,” the ITG report says. “This means providers will have to quote a hard price for their research and make their pricing structures transparent.”
The ITG report points out that the sell-side will face a “major challenge” in how to value its research: “The value a customer derives depends on multiple, often user-specific factors, making it difficult to measure and price objectively.”
The report suggests that the impact of unbundling will differ based on the size of the firm and the markets in which it operates. For example, big firms “will need to focus on differentiating their research offerings, mid-tier brokers could benefit from opportunities to provide high-quality research and execution services, for example on small or mid-sized companies if bulge bracket competitors withdraw from such areas.”
The report also points out that small brokers “are likely to struggle unless they are/become high-quality sector specialists or bespoke research providers. On the execution side, opportunities to add value may lie in offering very local block liquidity or finding liquidity for small-/micro-cap and illiquid names. Such niche players could prosper.”
For the buy-side, ITG recommends that firms start unbundling their broker relationships to gain transparency between execution and research; that they examine past research budgets and assess their consumption of research; among other things.