Now they tell us…

The imminent prospect – January 2018 - of Mifid II, with the unbundling of research costs, was bad enough in terms of complexity and lower profitability for both the buy and sell sides...never mind disastrous for the analysts who are likely lose their jobs. Now the regulatory powers that be in London are ensuring that collective hatred of them is about to reach a new all-time high. The definition of “research” is to be expanded from the tsunami of analyst reports to the even bigger tsunami of email and Bloomberg messages swapped between sellside salesmen and sales traders and buyside portfolio managers and dealers. According to the FT.

The UK financial watchdog has alarmed some City brokers by saying new rules on payment for investment research could extend to wider sales and trading roles. From January - under European legislation known as Mifid II - asset managers will have to pay financial institutions directly for research instead of combining the cost with trading commissions. To date, the debate has focused on price negotiations for research between banks and asset managers, with the former offering packages that include written reports and direct access to analysts. But some brokers have been caught off guard after the Financial Conduct Authority (FCA) said that content produced by sales traders who take orders on trades and typically advise clients by highlighting trends and “market colour” — would also count as research.

 

“Whilst this is logically consistent with everything the FCA has said on (research) unbundling, it will still come as a bombshell,” said Richard Balarkas, director of Quendon Consulting and former chief executive of Instinet, an agency broker.

 

“Most firms will have hoped to sidestep the question of how to charge for all those client-facing employees whose role is neither research nor pure trading.”

With most firms acknowledging that they are less than fully prepared for Mifid II, it’s likely that the FCA’s latest “gem” has led to a widespread muttering of expletives in scores of offices, including in “execution only” firms who thought they had no explicit research relationship with their clients. However, presumably wise to regulatory incompetence, some firms had already assumed the widest possible assumption of “research”, where the key term is “substantive”. The FT continues.

An FCA official told an industry conference this month that if a sales trader provided an idea with “substantive” analysis or insight, that would need to be paid for by an asset manager to avoid being classed as an inducement, according to multiple sources who attended the event.

 

“Research departments give a structured output that you can price, but this will be extremely hard to monitor and police,” said the chief executive of one City broking house, who did not wish to be named.

 

The rules could make it more difficult for a broker to interact with an institution with which it traded but had no research deal, he added. Nevertheless, some larger banks and brokers said they had already interpreted the rules in this way and were taking precautions to ensure staff would not breach them. One said that in drawing up Mifid II agreements with asset managers, it was pricing “research and sales” as a combined package.

Some firms are pursuing an alternative solution…if saying something “substantive” is going to attract more regulatory scrutiny, don’t say anything “substantive”. What this means the FT doesn’t explain. Our suspicion is that saying nothing substantive means not giving a recommendation in terms of Buy, Sell or Hold. Having said that there is a hundred ways of getting across your view on a security without specifically characterising it in terms of a recommendation. However, the FCA is already trying to head this off.

By contrast, another bulge bracket bank said that it was reviewing its sales communication policies and had given training to traders to ensure they would not write or say anything that could be deemed “substantive”. Neil Robson, a regulatory law partner at Katten Muchin Rosenman in London, said the FCA had likely spoken out as a warning to any investment banks who planned to blanket label certain content as “non-substantive” or “not research material’ — where it might not always be the case.

 

“Simply because it’s coming out of the front office doesn’t mean it’s immediately out of scope,” he said. “Asset managers will have to look at everything in context, on a case-by-case basis, to determine if something is research covered by Mifid II rules or not.”

If the Mifid ii implementation has led to the “discovery” that formal research has, in many cases, little or no value, it’s amusing to speculate on the likely value of much of the gossip, hunches and “guestimates” peddled by salesmen and sales traders when they (frequently) diverge from marketing their firms published research. The FT speculates in catastrophic terms that it could signal the beginning of the end for salesmen and their service.

Others have raised concerns about what the changes might mean for the future of sales traders, whose numbers have already fallen with the move towards automated trading. “It makes the job of the salesman ever more redundant because he’s not allowed to have a view on anything,” said a senior executive at a London stockbroker.

 

Mr Balarkas said: “Brokers will either have to cease supplying some services, or price them on a discrete basis — or ensure that the service has little or no value, which rather defeats the point of supplying it.”