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Decades ago, when I visited my firm’s fund management clients as a sell-side analyst in the City of London, I regularly asked them a simple question: What did they want in research?

The answer back then was: every conceivable option. Fund managers’ desks were often crowded with stacks of unread research and their phones were besieged by brokers full of ideas. But investors wanted even more. Why? Because the direct costs for them were low. Everything was paid for largely through trading commissions. These, in turn, were paid out of the pockets of the fund managers’ clients – pension funds and the like.

Ultimately, regulators didn’t think this was such a good idea and in 2018 introduced the much-vaunted European Markets in Financial Instruments Directive II – or Mifid II – making costs explicit.

Now, however, regulators are implementing what is known in my current profession as “reverse ferret.” Under pressure from the UK Treasury, which wants to use its post-Brexit freedom from setting EU rules, regulators at the Financial Conduct Authority have begun to rethink this unbundling of research and trading costs. The European Securities and Markets Authority is implementing a similar measure.

The main reason for this extraordinary turnaround is the recognition of the unintended consequences that Mifid II has brought with it. The directive undoubtedly brought more transparency. But there have also been complaints that the changes have damaged the financial ecosystem and reduced the availability of stock research, particularly for smaller companies.

Originally, Mifid II unbundling promised a way to promote higher quality analysis and reduce redundant reporting. But it also began a period of sharp price cuts in analysis by the largest brokerage firms.

While small, independent research houses watched in horror, the prices for their services plummeted. Asset managers, realizing that they had to pay more explicitly for research costs, were happy to take advantage of any opportunity for discounts. Bulge bracket brokers faced competition from independents with all-inclusive research packages at very low prices.

And even for large investment banks, Mifid II had disadvantages. Layers of management have been added to help win the research battle. Regardless of possible subsidies from other parts of the investment banks, research costs became even larger costs than before.

“I think many research leaders will be happy about the abolition of the current system,” says Steve Kelly, consultant to the European Association of Independent Research Providers.

Research remains big business. According to Kelly’s analysis of Integrity Research data, the cost of analyzing cash stocks worldwide was estimated to be about $11 billion a year last year. About $6 billion comes from the United States, with Europe and the United Kingdom providing about $3 billion. But research customers in the USA have also become more cautious with their budgets. “As you move from the all-you-can-eat model to the à la carte model, you think more carefully about what you consume,” says an executive at a major U.S. fund manager.

In the United States, the investment community has long bundled research costs with trading commissions. Under the US Investment Act of 1940, professional investors cannot pay directly for research. Local concerns that US brokerage firms would have to set up dedicated investment advisors to accept direct payments under Mifid II were recently allayed. A workaround would result in all British and European research funds paid in this region being confiscated.

In Europe, things will not return to the days before Mifid II. Even in the UK, a government-commissioned review by financial services lawyer Rachel Kent did not recommend a mandatory return to the commission-sharing arrangements (on trading) of the past. However, Kent suggested that more payment flexibility is needed. And even independent research groups don’t expect business to suddenly improve radically. “I expect our global sales to increase by perhaps 5 to 6 percent,” says Iain Johnston, chairman of New Street Research.

With the government backing down on Mifid II for research purposes, many investment managers will want to postpone discussion of costs until the changes are confirmed. These discussions will undoubtedly be difficult. If their clients expect detailed analysis from their asset managers, shouldn’t these costs be shared?

As part of the trading costs, the costs may only be a few hundredths of a percent. Not so fast, asset owners might say. Substantive Research’s Mike Carrodus jokes that pension fund bosses are asking, “If it’s so little, why aren’t you paying for it?” The real question is who is spending on research, not just how much.

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