One Day in Paris: Taking the Temperature of Investment Research Evaluation
Visiting Paris from London last week with my colleague David Cook, Head of Regulatory Affairs at IHS Markit, never has the expression "Elephant in the Room" seemed so appropriate.
For now at least, we do not know what effect, if any, Brexit will have on MiFID II in particular, or on future European financial regulations in general.
Thirteen months in from MiFID II, we met with the French financial services industry regulator, Autorité des marchés financiers (AMF), and the European Securities Markets Association (ESMA).
David and I wanted to hear their thoughts on how the new regulations on research payments are going. Additionally, we shared our experience in other regions (Asia-Pacific, US) and explained how clients use IHS Markit products for compliance and to improve their research procurement processes.
During the period when MiFID II regulations were under construction, there was arguably no greater dichotomy of opinion on the future shape of the investment research industry, and how research is paid for, than between the Financial Conduct Authority (FCA) in London and the AMF in France.
Ten or so years before, during the CP-176 process, the Financial Services Authority (the FCA's previous incarnation) was a driving force behind increased transparency in trading commission payments and the use of commission sharing arrangements (CSAs) as an approved means for asset managers to secure best results for themselves and their customers in trading performance and research procurement. Subsequent periodic reviews by the UK regulator suggested a general satisfaction with the increased transparency and use of CSAs. CSAs became an increasingly common way to pay for research in Europe with regulators, including the AMF in France, which successfully adopted its own CSA regulations in the area.
Fast forward to the MiFID II negotiations, and as previously mentioned, it was the FCA that argued for an outright ban on commissions paying for investment research, while the AMF took the opposite approach, believing the existing model was fundamentally sound, but could benefit from some enhancements.
So why did the FCA see the world so differently?
One could spend a lot of time on that question, but I would highlight a combination of: the enormous impact of the 2008 financial crisis and the implementation of far reaching controls of other perceived conflicts of interest (inducements in particular) - linked to a particular concern on the FCA's behalf to be seen to be protecting the interests of the "main in the street", the retail investor.
The AMF on the other hand took the opposite stance, arguing that commissions and CSAs were an efficient way of paying for research and should continue to be an option.
Today, while commissions continue to be a pre-eminent method to pay for research across the entirety of asset managers across Europe, most of the largest firms have decided to pay for research services themselves for reasons of operation simplicity and a perception of competitive pressure. The AMF won the initial argument in that asset management firms were given the opportunity to continue to use commissions, however given many of the very largest firms across Europe have since then decided to pay for research themselves (which the FCA had argued for), the FCA's position was at least partially vindicated. That said, we still see many firms across Europe continuing to use commissions to pay for research.
In light of this, here are key points from our discussion with the AMF and ESMA
It's still early days
Both bodies agreed that, just over a year into changes in an industry that has been operating in a different way for many decades, we need to go through a few more payment cycles before making definitive conclusions about positive and negative impacts in areas such as research pricing.
Asset Managers: get your systems in place, but don't expect a knock at the door just yet
We don't anticipate that the regulators will be conducting detailed reviews of individual firm's specific implementation in the near future. However, the expectation is that firms should be taking the rules seriously and by now be operating at a minimum a short-term research evaluation process and be planning for proper long-term solutions to provide quality data and analytical outputs.
Beware side effects
Both bodies are concerned about the long-term unintended consequences of the new regulations, especially the future health of independent research providers and the provision of research coverage in small and mid-cap companies. They will monitor the implementation and impact of the regulations in the context of those two issues.
European Commission impact assessment
The European Commission has retained the services of a consulting firm has been appointed to conduct an impact assessment. We understand that the market can expect the initial findings to be issued by end of 2019 or early next year. Clearly, whether or not there is any evidence of potential side effects of MiFID II implementation, as previously outlined, will be prominent in the impact assessment.
As we learned last summer, the FCA is conducting its own review and has been interviewing market participants over the last 6-9 months. The results of the FCA's review are expected to be released during first half of 2019, and we will continue to monitor this space for developments.
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
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