Equity research reforms will slash fund managers' profits

Neil Woodford is among the high-profile fund managers to have decided to shoulder the cost of research

The reforms are part of a package of measures under the post-crisis revision of the EU’s main market infrastructure rulebook – the Markets in Financial Instruments Directive, or Mifid II – that are due to come into force in January 2018.

They will call for fund managers to cease paying banks and other sellside analysts for their work out of clients’ general funds. Instead, the managers must either pay the costs themselves, or set up a new “research payment account” under which client money may be used, but only if budgeted for and clearly delineated for the purpose, with regular reporting and auditing.

Crisil Global Research and Analytics, an arm of S&P Global, said on October 17 that most large European fund firms will simply opt to pay research costs themselves, rather than going through the time and trouble necessary to set up a research account. Fund managers including Baillie Gifford, M&G Investments and Neil Woodford have decided to do so.

V Srinivasan, president of Crisil, said in a statement on October 17: “Based on a proforma financial analysis of large active asset managers in Europe, we believe operating profits of European asset managers could decline 17% to 29% because of research unbundling,”

Crisil’s researchers also imply bad news for banks’ analyst teams: “The research cost for asset managers will fall as they budget their requirement better.”

The extent of fund managers’ margin pain will depend on the detailed rules being drawn up by national financial regulators around Europe, who have to oversee Mifid II’s implementation in their home markets.

Unfortunately for fund managers in the City, there are indications the UK’s Financial Conduct Authority is taking a tough line on the issue – and that could have worldwide implications.

Dan Waters, chief executive of the fund-management lobby group ICI Global, said: “The FCA recently released its consultation on implementing Mifid II, including on how to operate the research payment account.

“The AMF [Autorité des Marchés Financiers, the French market regulator] also published something in September, and theirs was more flexible. A more rigorous form of commission-sharing agreement is maybe where we will end up in France. But it’s tough to see how we will get there in the UK.”

Waters added: “We have responded to the FCA, explaining that if you seek to ban any link between the funding of research and dealing commissions, you will immediately create a problem in the US, where brokers don’t have the necessary permissions to receive a specific payment for research.”

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