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Unbundling research payments has hurt transparency, report finds

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The widespread move for asset managers to pay for investment research from their balance sheets could deprive investors of the ability to assess the robustness of managers’ investment process, it has been argued.

In Europe, most asset managers plan to absorb the cost of investment research onto their balance sheets rather than charging it directly to clients to meet new EU rules to separate research costs from execution.

However, a report from German ratings firm Scope Analysis and research procurement specialist Frost Consulting has warned this move could reduce the transparency on research spending that European regulators aimed to achieve.

“For investors, this introduces uncertainty at best; significant performance risk at worst,” the firms said, noting that managers paying for research themselves – rather than charging investors directly – did not have a regulatory obligation to disclose their total research spending.

“There has been well-documented downward pressure on virtually all research budgets,” added the report, “but this seems particularly pronounced at P&L managers where the delta of the change is unknown externally.”

Also, investment banks’ research budgets had been declining since the 2007-08 financial crisis, meaning European “P&L managers are competing for finite external research resources against other large managers that continue, primarily or entirely, to fund research budgets using client money”.

Overall, this meant the research operating environment had changed significantly, and “fund investors have no easy means to understand what the implications are for the investment/research process for their current or prospective investments”.

Last year, a poll of pension funds carried out by IPE indicated that most thought asset managers should pay for the cost of independent investment research under MiFID II rules. 

According to Scope and Frost Consulting, asset managers needed to understand that, under MiFID II, it was down to them to prove that the investment process agreed with the asset owner was still intact – particularly if they had decided to absorb the cost of research themselves rather than passing it on to their clients.

By preventing asset managers from receiving investment research where there was no contractual relationship with the provider, MiFID II had brought about an abrupt change to a long-established research procurement regime, they said.

This in turn introduced “an unprecedented series of information asymmetries”, and made it impossible to assess a manager’s ability to successfully adapt to the new environment, Scope and Frost argued.

Managers should commit to research transparency, such as through independent verification, as those who were “unable or unwilling to explain how their research processes have adapted to the MiFID II environment represent an unquantifiable risk for investors,” they said.

The two firms are collaborating on a new service intended to verify that asset managers’ research processes have successfully adapted to the MiFID II rules.

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