New rules now under discussion in Europe governing asset managers’ use of trade commissions to pay for research could cause investors to cut ties with some brokers, decrease the availability of sell-side research in certain areas, and place small asset management companies at a competitive disadvantage.

A May 2015 Greenwich Associates study, A Brave New World for Asset Managers—and the Brokers Who Serve Them, of 118 U.S. institutional asset management companies found that investors believe proposed regulations in Europe would have a significant impact on the industry in both Europe and the United States—even if the new rules stop short of full “unbundling” of commissions and research.

44% of study participants think it is “somewhat” or “very” likely that global markets will be fully unbundled in the next five years. That share jumps to 60% among large U.S. institutional investors— most of which have operations falling under the jurisdiction of European regulators pushing for the change.

European regulators contend that the purchase of research and advisory services with client brokerage commission payments creates inducements, or at least opportunities, for asset managers to be less than careful spenders. 

Proposed rules are at the very least expected to increase transparency into how asset managers spend client funds, how exactly they determine the value of research and advisory services, how they pay for those services, and what value they receive in return.

“The study results show some of the very biggest U.S. asset managers are already planning to extend new rules out of Europe to their U.S. operations as part of a new global best practice,” says Greenwich Associates consultant John Colon. 

The Hidden Costs of Unbundling
Implementing the changes required to set more precise valuations on individual sell-side research products and services will impose real financial and administrative costs on the buy side. 

Participants in Roundtable Discussions hosted by Greenwich Associates in New York and Boston in June described the difficulty they face in assigning a set value to specific research products and services. The same piece of research or meeting will have different values for different investment strategies, portfolio compositions, and even for the same people and functions at different times in the investment cycle. 

“Even if you set a standard price on a type of research, that price probably does not reflect the actual value,” says John Colon. “Some pieces of research might be discarded as irrelevant, even as others trigger important decisions to trade or not to trade.” 

Not only will asset managers have to invest in the IT and personnel required to administer the increasingly complicated procedures needed to assign specific value to research products, firms will also have to demand more detailed feedback from portfolio managers and analysts who will be forced to divert time from their portfolios. 

Unintended Consequences
37% of the investors in the study say they expect the actions of European regulators to cause them to reduce the total number of brokers they use for research and advisory services within the next year, and 36% expect rule changes to prompt cuts to the number of brokers they use for trading. The reason: New regulations—even if they stop short of full unbundling—would increase the costs of supporting sell-side relationships in terms of time, administrative burden and money.

These shifts would have real impacts on the research industry and, potentially, on asset managers’ ability to deliver investment performance for their clients. For example, a full 25% of the study participants think the availability of small-cap equity research will decline in the next 12 months as a result of the regulatory changes.

Several research participants said a move to unbundling or a shift to hard-dollar payments would place smaller buy-side firms at a disadvantage. “The potential influence on access to critical research services and products for smaller firms, and the disparity it would create within the industry, would be extraordinary,” said a representative of a small U.S. asset manager.