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Mifid II set to change the way buyside firms access and pay for research

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The nature of how research is disseminated and accessed within the funds industry is changing. In some respects, sellside institutions are adopting a Good Cop Bad Cop stance. On the one hand, they are starting to scale back the value of the research they send out to smaller clients. On the other hand, they are committed to providing best execution prices to those same clients. 

One of the primary drivers behind this scaling back, which is known as ‘ghosting’, is that under Mifid II, sellside institutions will be required to disentangle research from trade commissions and as such place greater focus on the value of research being produced. Buyside institutions will need to set research budgets and separate research from trading activities; something that has long been in place, with sellside research teams flooding the market with daily reports in a bid to encourage clients to trade.

Speaking to Hedgeweek, one source familiar with the situation who asked not to be identified said that whilst high value clients are still receiving substantial research reports, lower value clients are starting to only receive 1- and 2-page reports as the tap gets steadily turned off.

“The idea behind doing this is that buyside clients often tell banks they don’t read their research. By ghosting, the banks are waiting to see who calls,” says the source. 

Something else the banks are in the process of doing is locking down their research. Research was faxed back in the day, then it was emailed and added to Bloomberg terminals. More recently it has started to be track-linked so that the sellside can see who has opened it. Citibank in the summer were the first to lock down their content by taking it off PDF and onto HTML5, bringing it back onto their own portal. This is to stop people forwarding it. 

“If they’re going to get pricing power the sellside community has to lock down their content. I was expecting a couple of other banks to have followed Citibank before Xmas but I’m now hearing they’ve delayed it until early New Year. What the banks are doing are stepping back from taking research off general distribution and hosting on their own secure research portals,” adds the source.

The upshot to this is that research is moving into an exchange-like environment where buyside analysts can rate the research they pay for and start to build greater control over how they allocate their research budgets. 

One such platform, which launched at the end of the summer, is London-based Research Exchange – RSRCHXchange. Established by former CQS executive Jeremy Davies and Vicky Sanders, a commodity broker who also worked in equity sales at Goldman Sachs and Bank of America Merrill Lynch, the platform is a marketplace to help buyside firms access the most appropriate research. 

Although the requirements are not yet set in stone under Mifid II, by setting separate research budgets that are less tied to the commissions of their executing counterparties, large firms will have the opportunity to access smaller research providers. Equally, as smaller firms have constrained budgets, the pressure to access research from a wider range of providers will grow, going forward.  

In effect, RSRCHXchange sets out to overcome some of the challenges that Davies faced whilst working on the buyside. 

“The first was finding the right research. Secondly, once I found a good research provider the compliance process could take up to three months. Thirdly, the payment process; this often involved a reluctance to set up new counterparties or to pay for individual small reports. So accessing research was never a straightforward process. 

“With RSRCHXchange, we’ve built a search algorithm that allows the user to find the right provider based on keyword searches; the algorithm ranks results in order of relevance just as with Google. We compliance check and do due diligence on every single research provider on the platform and we pass that information on to the client’s compliance department so that when an analyst or portfolio manager comes to buy a piece of research, the compliance team has the all the information they need. 

“Finally, with respect to the payment process, we become a central payment counterparty, meaning the user only has to transact with a single payment counterparty to access research from hundreds of people instead of having to pay every research provider individually,” explains Davies.

By having all of one’s research in one place to consume, a buyside COO can see exactly what the analysts have read and what they thought of the research. Based on the feedback and ranking – much like Morningstar will rank funds – buyside firms will be able to refine their research budgets, paying more to certain research providers and less to others. 

“It should be possible for managers to do cost value analysis on research and tailor their research consumption based on where they are deriving the greatest value,” adds Davies.

One firm that is taking a slightly different approach to the opportunity being created by Mifid II is Feedstock. 

The central premise here is that rather than become a repository for research, which buyside firms are able to search for in a marketplace arrangement such as RSRCHXchange, Feedstock acts as a productivity tool. By integrating with a buyside’s email system, Feedstock filters through the hundreds of research reports that are sent on a daily basis and presents only the most relevant research to the user; which is typically only 5 to 10 per cent of the total research sent.

“Under Mifid II, firms will have to be able to devise an internal system to assess the value of a sell-side institution’s research and attribute that value to a dollar amount that we believe will have to be set at the start of the year, not retrospectively. 

“With Feedstock, we’ve created a tool that allows managers to categorise and filter information, using behavioural algorithms, to deliver information in a more coherent and actionable manner. Where the Mifid II element comes in is that the platform allows the user to generate an audit trail without having to build a compliance system that interferes with existing workflows,” explains Feedstock co-founder, Lucas Wurfbain.

Every piece of research that is read, and every meeting and phone call that arises on the back of that research, is tracked on the platform. When it comes to the payment term (i.e. end of quarter or end of year) the user can go back and see that they’ve had, for example, 16 meetings with Goldman Sachs, they’ve downloaded 300 of their reports, and they’ve delivered a measurable value to the firm. 

“It gives the user both a volume metric and a quality metric of the research they’ve consumed. A manager can say, ‘We believe that Goldman Sachs’ research is worth X per cent of our research budget’, so that if and when the regulator or an investor asks the manager why they paid the sell-side firm a certain amount, they’ll be able to fall back on a fully defendable audit trail,” adds Charlie Henderson, the second co-founder of Feedstock.

In Wurfbain’s opinion, the flow of research is dictated by the buy-side. As such, Feedstock is completely agnostic as to where the research comes from, as it is entirely dependent on each individual client. And whereas it will help improve the way that buy-side firms evaluate research, going forward, the platform will also benefit the sell-side community. 

“Until now, they’ve not cared as much. It’s been a complimentary service to their clients. What we create through Feedstock’s rating system is a feedback loop that gives the sell-side more insight into what the buy-side actually appreciates and values; and that’s something that doesn’t currently exist,” states Wurfbain.

When clients of RSRCHXchange join the platform they can continue with existing subscriptions to research providers. In addition, any research providers that the client uses that are not on the platform will be approached, as well as highly specific providers that hedge funds, for example, might ask for. Davies notes that given the recent market volatility, Chinese macro research has been a very big focus. 

Every report that a client buys or subscribes to sits within the platform. They cannot be downloaded and if printed, will be watermarked. Davies explains the payment process as follows:

“Let’s say a client trades with Morgan Stanley and pays 15 basis points. Five basis points is for execution, 10 basis points is for research. Morgan Stanley puts aside that 10 basis points in its commission sharing pool and the money can be used to pay for research. Once a client selects a report to purchase, we would then bill Morgan Stanley at which point the money comes out of the Commission Sharing Agreement.”

Feedstock is not due to go live until March 2016 but the initial feedback has already been encouraging. 

“On average, fund managers can spend up to two hours a day just going through emails. We can reduce that to a much more manageable timeframe. On the compliance side, it is also receiving a lot of good feedback because it improves transparency for Mifid II. They don’t have to change what they do as Feedstock provides an automatic audit trail just by using it,” confirms Henderson.

Whilst the larger fund management groups have started to manage their research budgets there are plenty that haven’t. Setting the budget and managing it more efficiently is set to become a key requirement once Mifid II is officially brought into force. As such, having access to the best research, be it on exchanges on buy using productivity tools, will take on greater significance. 

“Our ambition is to try to create a form of global waterfront coverage on our platform. That will require having hundreds of research providers. We currently have approximately 120 research providers. To achieve global waterfront coverage will take 300 or so research providers,” concludes Davies

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