Forefront Communications

IR Magazine: The Bill for the Buffet: Mifid II in the US

Tourmaline

Amanda Perrucci

Amanda Perrucci

A year on from the implementation of Mifid II in Europe, IROs in the US are seeing how the regulation is changing the EU’s investment management landscape – and are watching for ripple effects. That’s because two areas IROs typically manage – research coverage and corporate access – are starting to be impacted.

It’s important for IROs in the US to understand how their interactions with analysts and investors could change due to the mammoth regulation so they can develop effective strategies to mitigate potentially negative developments.

Change coming to the IRO realm

The main driver behind changes to research-related relationships is the set of Mifid II requirements stipulating that buy-side firms conducting business in the EU may no longer pay for sell-side services on what regulators consider to be a vague or arbitrary basis.

Instead, buy-side firms are now required to have a robust mechanism for determining the value of the research services they consume and must pay for those services independent of their trading volumes. Because of this greater scrutiny on research spend, investors are spending less on research and being more conservative in how they spend their remaining budget.

How good was the soup?

Consider this analogy for the old research pricing model. In the pre-Mifid II days, sell-side services were like a multi-station dinner buffet the buy side went to every night. The first night, the buy-side diner visited the soup station, had a little salad from the salad bar and then grilled salmon from the seafood section. The next night, it was soup again, shrimp cocktail and a steak from the carving station. This continued with the buy-side customer eating different quantities of the same, or different, food every night for three months, but never receiving a bill.

At the end of the quarter, it was time for the buy-side diner to pay up, but the sell side still didn’t present a bill per se. Instead, the cost for each station was largely left to the buy-sider’s discretion, which went something like: Hmm, I seem to remember that the soup and salad was OK and the seafood was great, but I didn’t care for the steak. I’ll divvy up the money I have (read equity commission flow) between the different stations (the brokers providing research).

If volatility was low and the investor wasn’t transacting much, there wasn’t much commission to split. If the buy-side firm happened to trade more the next quarter and hence generate more commission to spread around, it would pay more, even if it consumed the same volume of services. In short, it was qualitative, anecdotal and – to a regulator’s eye – arbitrary pricing.

While not actually mandated by the legislation, under Mifid II, buy-side and sell-side firms have leaned toward a more à la carte arrangement. In order to have a rigorous process to connect value with price, investors are increasingly trying to count everything consumed at the buffet and attempt to set a price on each interaction they have with a research provider – analyst meetings, conferences, bespoke research, and so on – to reflect the specific value their investment professionals received. This requires an understanding of both the services that have been used and which research firms add the most value to the investment process, such as differentiated ideas, accurate forecasts or great insights.

Compared with the all-you-can-eat buffet model, this approach is more detailed and therefore more cumbersome and, regardless of how firms handle the change, the requirements of quantifying value and unbundling research and trading costs are putting an end to the buffet.

Scott Rosen is CEO of Visible Alpha, a provider of discovery, analysis and valuation tools.

To read the full article, click here.