New EU regulation wields disruptive impact
For months, the asset management industry has been told to prepare for tougher regulations in Europe.
But even forewarning hasn't softened the impact of the European Union's revision of the Markets in Financial Instruments Directive, known as MiFID II.
One aspect of the rule will force managers to separately pay for research and trading services they get from banks. The intent is that managers will act in the best interests of clients, rather than select institutions offering free analysis.
Even though the rule doesn't go into effect until Jan. 3, a number of executives have complained they still don't understand the regulation or that their firms haven't enough time to comply with it.
Compliance concerns have also prompted asset managers both large and small to defray research costs. MiFID II sets out three options of how external investment research can be accounted for. These range from paying for it from a company's own P&L to continuing to charge clients directly through a research payment account.
Setting the bar for much of the fund industry, Vanguard announced it will absorb the costs for research it receives from banks rather than passing them onto investors in its European funds.
"Those research costs will be paid out of the management fees and therefore absorbed in Vanguard's P&L," Caroline Hancock, Vanguard's head of European public relations, told Bloomberg News. She estimated those costs will be less than $5 million annually.
Five European asset managers have said they would pass on research costs to clients: Amundi, Carmignac, Man Group, Schroders and Union Investment. Additionally, Invesco said it would be passing on research costs to fund clients.
Swiss investment manager Unigestion, which oversees $24 billion, joined Vanguard in absorbing research costs rather than passing those costs to its clients.
Practitioners say the rules conceal problems that regulators never fully considered.August 21
Software from Liquidnet is designed to avoid curbs on dark pools in Europe.August 15
The regulation encourages more transparency around fees for products that weren’t previously required to reveal such information.August 10
"Our clients are at the heart of everything that we do and the reasons behind our decision to pay for all research ourselves go beyond regulation," stated Unigestion CEO Fiona Frick.
"It is quite simply the right thing to do to ensure that we continue to give our clients the clearest picture of how and why they are being charged for our products, alongside safeguarding them from any potential conflicts of interest in providing best execution."
Though well-intended, the rule will result in less access to capital markets. less research and less liquidity, especially for small and mid-cap firms, said Steven Fine, chief executive at London-based Peel Hunt.
"One of the biggest worries for me are the unintended consequences of regulatory change," Fine stated.
Institutional firms are "obessessing" about the new rule, he noted.
"There will be less research they pay for, there will be less research that they consume, and there will be less reliance on people from the sell side," he said. "The corporates [who rely on brokers] unfortunately will be the last to learn about these changes."
Indeed, a number of financial executives are still asking for more clarity about the new rules, which touch everything from business conduct - logging all communications, assessing the advice provided to clients - to systems, controls and trading.
"The regulators are going to have to provide" more detail on the requirement that research is paid for separately from trading commissions, Michael Roberge, co-CEO of MFS Investment, said on an Aug. 10 earnings call for parent company Sun Life Financial.
While he didn't expect the rule to be "materially detrimental to the industry," he acknowledged that "as we sit here today," it's "not clear exactly what, how the research costs will actually get paid."
Another executive concern is that the regulatory change is happening all at once with no time for adjustment.
"Any time you have a change of this magnitude, where you just sort of flip a switch, we would expect the potential for disruption to be pretty high," Jonathan Pruzan, New York-based CFO of Morgan Stanley, said on his firm's July 19 call. "I'll tell you, it's going to be very hard to estimate what the impact of this is."
Some managers say they are prepared, since they have been providing the methodology book and rules for their indexes to regulators already.
"All index providers are required to provide more transparency in their construction," said, Raman Aylur Subramanian, head of equity applied research for Americas at MSCI. "The self-indexers are going to be impacted the most, because you are creating an index and managing money against that, and regulators see an issue there. They are worried about front-running and index, or an indexer hiding the facts."
There's a simple explanation as to why so many North American managers are still struggling to understand and prepare for MiFID II: many thought the rules had nothing to do with their business.
In the U.S., only 43% of of asset managers expected MiFID II to have a direct impact on them, according to a survey by New York-based Investment Technology Group.
The survey also found only 8% of firms have a plan to set up a research payment account to charge clients before the MiFID II start date. In Europe, 85% of fund groups won't be compliant by Q4 this year.
"MiFID II is going to have a significant impact well beyond the shores of Europe, as institutional investors require asset managers to change the way they budget, fund, price and pay for research," said Jack Pollina, ITG's head of global commission management.
Buy-side clients with global investment teams evaluating the un-bundling requirements of MiFID II will reconsider how they source and pay for the research they use in the U.S., according to Morningstar’s Marc DeMoss, head of research licensing and distribution.
“Most have told us that they’re still in evaluation mode, although this is a more pressing issue for firms who find it difficult to ring-fence the operations of their U.S.-based investment teams from their European-based teams,” said Marc DeMoss, head of research licensing and distribution at Morningstar. “On balance, though, we have not seen the same sense of urgency coming from our U.S. client base as what we’re seeing from our European clients – at least not yet.”
A number of tech providers suggest firms invest in a data analytics platform to maintain transparency in fund documentation and transaction data.
"With the increased need for trade automation and transaction reporting under MiFID II, US investment firms will need to hire technological talent and expertise in order to not only increase efficiency, but also to simply meet compliance," according to Kurtosys.