Most asset managers are still undecided even as the D-day for MiFID II nears

The deadline for implementation of the Markets in Financial Instruments Directive (MiFID II) is just a few months away, but most asset managers (AMs) are still undecided on several key aspects of it.

Our recent survey and discussions with AMs indicate they are undecided over nearly all the key facets of the new regime, whether it be best execution, trade transparency and reporting, product control and governance, or research unbundling. They are yet to finalize the appropriate means to demonstrate best execution for non-equity products, deploy the right IT and data management systems to comply with trade and transaction reporting norms, and set up the appropriate research procurement and funding strategies.

We see five key shifts as the AMs go about research unbundling:  

• Smaller AMs or those with relatively small share of European or equity assets appear to be favoring absorbing the research costs; we expect most AMs to eventually absorb research costs
  
• AMs are likely to cut their external research budgets by 15-30%
  
• Internal research budgets are expected to grow by 10-15%
  
• Most AMs will engage with fewer than five bulge brackets for waterfront coverage and instead focus more on niche tie-up with more specialists or regional players that offer specialized research and flexible research pricing options, and,
  
• AMs would continue to strengthen their in-house fixed-income research teams.

Research subscription pricing is still in a flux and we expect negotiations to close only towards end-4Q17 or early 1Q18. We reiterate our expectation (refer to our report, Asset managers face profitability pressure, published in October 2016) that most AMs would eventually absorb research costs driven by investor and peer pressure and regulatory nudges. While many have indicated they would reduce external research budgets, we believe the benefits of that would be partly offset by the cost of augmenting in-house research teams. Net-net, we continue to foresee 14-27% cut in the operating profits of AMs absorbing research costs.

Most AMs are re-evaluating their operating models and looking to adopt a strategic approach towards MiFID II. Active AMs are understandably focused on reducing costs to minimize the impact of research unbundling. However, it is equally critical to focus on alpha generating opportunities as investors would eventually choose those that generate superior fee-adjusted returns irrespective of who absorbs the research costs.

We therefore believe AMs should focus on four things:  

• Marry operational compliance to best practices and ensure value of adherence to asset owners
  
• Finalize a balanced research sourcing mix that enhances value and minimizes costs
  
• Accelerate investments in data analytics and alternative data for differentiated insights, and
  
• Accelerate adoption of advanced technology to enable all-round efficiencies