Unbundling the Unbundling: The Impact of Re-bundling on Asset Managers
Regulators in both the UK and EU are taking steps to make it easier for asset managers to charge clients for research without their consent (which was required under MiFID II). While the re-bundling creates complexities, it brings huge opportunities for asset managers. Neil Scarth, Principal at Frost Consulting, addressed these changes at our TT Connect: Unlocking Profit with Data & Analytics event last September. We’ve since caught up with Scarth about what the changes mean for asset managers and how they can capitalize on the opportunities.
The additional requirements for using client money for research was one of the most controversial and complex of MiFID II’s myriad changes to European financial markets. As a result, asset managers subject to MiFID II have seen a reduction in both profitability and the budgets committed to research.
The reduction in profitability came primarily from a move by asset managers to allocate payments for research directly out of their profit and loss accounts, which quickly led to cuts in research spending as firms looked for ways to boost profitability – a trend that accelerated in the bear market of 2022.
An additional factor for asset managers to accommodate as they were cutting research budgets was the increased requirement for research driven by Environmental, Social and Governance (ESG) and responsible investing. This put further pressure on budgets and led to additional cuts to traditional research.
Scarth welcomes the upcoming changes in the UK, EU and U.S.: “The objectives of the MiFID II research rules were to increase asset owner transparency over research payments and to protect asset owner returns by making sure that asset managers didn’t over-spend on research. Neither of these objectives were achieved.”
The new rules in the UK came into effect on August 1 and will soon include UCITS funds. The final EU rules are expected to be published by ESMA in H1 2025 following the passing of the EU Listing Act in October. In a move that Scarth says is a rare and interesting example of the U.S. following European regulators, the U.S. Securities and Exchange Commission (SEC) has also announced a review into research rules and is expected to align with the UK and EU.
Scarth says that a major benefit for asset managers from the re-bundling will be an increase in profitability as firms are able to move the cost of research back to the asset owner. For the clients of asset managers, they will benefit from their money managers having greater access to research.
“The cuts to research budgets were up to 80% at some firms,” says Scarth. “If you were invested in one of these funds, the information that the portfolio manager had access to suddenly reduced dramatically and there was no requirement for firms to disclose this.”
The new UK rules remove the need for asset managers to gain explicit consent from their clients to use their money for research as well as eliminate the requirement to pay for research out of a dedicated research payment account.
However, there are some additional requirements for firms under the UK’s regulation, such as the requirement for asset managers to benchmark the costs that they are spending on research. Currently there are publicly available benchmarks that compare research spending by equity category (i.e., Emerging Markets or Global Growth).
Scarth says that the new frameworks for research payments will also see a return to the use of commission sharing arrangements (CSAs) to pay for research. While this will create an additional level of complexity for some firms, there are ways to mitigate this, such as using CSA aggregators and new CSA varieties to cover multiple asset classes.
“The bottom line for asset managers is that these new rules are going to make them a lot more profitable, reduce the market risk and make their investment processes more sustainable,” he says.
At the same time, he says that the impact on asset owners has been exaggerated, with estimated costs of only around 1.5 basis points of total funding costs—or equivalent to £7500 on a £50m mandate.
There will be some operational uplift and investment in processes required for asset managers to meet the new requirements. Asset managers will need to adopt currently available tools to manage not only how much they are paying to the banks for the research but also how much and how they are charging their clients, for example.
There will also inevitably be the emergence of new models of fee schedules and charging protocols for clients. Scarth compares this to the shift to profit and loss (P&L) accounting in the wake of MiFID II where no firm wanted to be seen to be the first to make the transition.
“Everyone wants to be a second mover,” he says. “We are working with numerous asset managers quietly building out the processes they will need to operate in the new environment, but nobody wants to be seen to be the first to announce the model they will adopt.” Most managers who have made the transition successfully have not made a grand announcement.
Time will tell how asset managers’ models and protocols will change as a result of this, but the re-bundling of research looks set to increase profitability in the short term, enabling firms to dedicate more budget to research in the medium term and beyond.