A provision in an upcoming securities regulation for the financial services sector could bring changes to the way banks and asset managers do business and interact with clients.
That transformation agent is the Marketing in Financial Instruments Directive II (MiFID II), which goes into effect Jan. 3, 2018, in the European Union. The law seeks to offer more investor protections and greater transparency on products sold and marketed by banks and asset managers.
Among the voluminous requirements within MiFID II is a provision called “unbundling,” which requires banks and brokers to separate investment research—traditionally a “complimentary” product—from execution services. And this little-known rule could potentially disrupt the whole industry.
Traditionally, asset managers pay banks and broker-dealers for execution services—the purchase, settlement, reconciliation, and eventual sale of investments that banks carry out on behalf of asset manager clients. As part of paying for such execution services, asset managers receive investment research from banks for no additional charge.
But European regulators want this dynamic to change. Investors who give asset managers money to manage generally pay for trade execution—it’s an added cost, in addition to management fees. MiFID II demands asset managers break out, or unbundle, the cost of research from the cost of execution. The rules require that banks and brokers break out the cost of research from execution to clarify to their clients—the asset managers—what exact services they are paying for.
The regulations aren’t limited to the EU. Any financial institution trading European securities is affected.
This may sound reasonable and easy to implement, but the reality is not so simple. Currently, banks generate and provide far more investment research—often beyond the scope of client needs—than necessary, mainly to drum up business and encourage more trading activity (more revenue for banks). And since this was all provided for free as part of execution activities, and the research division was never a profit center for the bank, little thought was given to the value of this service or how to sell it independently.
By converting research into a new product of its own, MiFID II could drastically change the dynamic and relationship between banks, asset managers, and end-user investors.
Advantage: Large Asset Managers
Asset managers have two main options under the new rules. MiFID II allows them to either budget and pay for investment research themselves, or to pass the cost of research on to their investors by charging an additional research fee on top of execution fees.Most of the world’s biggest asset managers chose the first option: bearing the cost on investors’ behalf.
AXA Investment Managers, the French investment giant with 735 billion euros ($878 billion) in assets under management (AUM), said earlier this month that it would “fully absorb the costs associated with the external research we utilize on our clients’ behalf,” according to CEO Andrea Rossi.
