Yesterday marked the first anniversary of new rules requiring ‘buy-side’ firms - such as pension funds, hedge funds and private equity - to purchase research as an 'unbundled' product, detached from an execution fee.

This change, mandated in the second Markets in Financial Instruments Directive (MiFID II), created a huge shift requiring ‘sell-side’ investment banks to price and sell their research into equities, currency and other financial investments – rather than provide it free to clients.

The updated regulation also proved to be a boon for RegTech providers, which offered affected financial services firms new solutions to ensure compliance.

Red Deer, a FinTech aimed at helping active investment managers, launched its Research Management solution, and now serves a client base of hedge funds, asset managers, wealth managers and pension funds.

The firm’s chief executive Henry Price explained that in terms of research, buy-side firms now have a much fuller understanding of the nuance and complexity of the regulation.

“Where firms have implemented legacy or non-compliant systems, or attempted to solve a problem manually, there is now a significant push to use technology to solve these problems in a more efficient manner,” he stated.

“We’ve seen greater understanding develop as the year progressed, and a changing of course in those who underestimated the complexity or overhead of the requirements initially. The change in focus has been accelerated by the FCA [Financial Conduct Authority] thematic review currently underway.

As for what’s going to change this year, Price said he’s expecting an increasing focus on business intelligence and reporting, and more specifically the insight firms can gain from having a data set for front, middle and back office teams.

“We’ve already started to see clients and prospects looking to make changes to their global processes as a result of their learnings from their MIFID implementation, including better valuation and voting, better data capture and the resulting improvements in the quality and value of management reporting and their relationships with providers.”

In July last year, a TeleWare survey found that 60 per cent of employees in financial services firms have suitable processes and technology in place to capture, record and consequently retrieve real-time business communications – meaning 40 per cent are risking non-compliance with Article 16 of MiFID II.

Firms that don’t comply with MiFID II risk fines of up to €5 million, or 10 per cent of annual turnover.

Gianluca Corradi, head of UK banking at pricing strategists Simon-Kucher, warned that large investment banks are currently pricing research low in order to push smaller research providers out of the market, in expectation of industry consolidation.

“Investment banks are trying to differentiate their value proposition from their competitors, both by providing research through different channels and also by making their content more innovative, the provision of raw data has consequently become almost as important as traditional written content.

“Many commentators believe the high fixed costs sustained by mid-sized research players will ultimately drive them out of the business, or at least retreat from any global ambitions, leaving only a handful of truly global players,” stated Corradi.

“This will be a problem if we see larger banks absorbing research costs over the long-term, as opposed to passing on charges to customers, because they see providing research as a crucial function for other business areas of the bank as a whole, such as primary market activities.”

He added that if larger banks are inclined to keep their research business barely profitable in order not to lose the revenue streams from the other business area, this would spell trouble for smaller banks, which cannot afford to dip into their own pockets to cross-subsidise providing research.

Chris Turnbull, co-founder at the Electronic Research Interchange, noted that in the year since the rule changes, asset managers were expected to become more transparent and reveal both their research costs and how they are paying for them.

“But many pre-MiFID II behaviours, such as deciding on the value of research after consuming it, have not changed,” he commented.

“It is easy to see this as a disappointment and ultimately a signal of MiFID II’s struggles, but things are starting to move in the right direction – a mitigating factor has been that the FCA has not been active enough in enforcing penalties and facilitating the transition.”

Turnbull said that the overwhelming majority of firms were unprepared for the changes last January, and a state of confusion continued throughout the year.

“We must now accept that achieving an effective research market will be a slow process, as we are very much in the infancy stage at this point – it could take five years for the regulation and implications of MiFID II to finally bed down across the industry, so we have a long way to go.”

Christian Voigt, senior regulatory adviser at Fidessa, concluded that if MiFID II has taught the industry anything it is that such large regulations should not exist in the first place.

“Instead of consulting and negotiating for ten years on texts exceeding 1.7 million paragraphs, how about lawmakers work on a steady stream of smaller changes?” he asked. “Faster time to market, better impact assessment, lower implementation costs, reduced risks, the benefits for everyone could be tremendous.”

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