The FCA has recently announced that it will begin a review of how firms have implemented the unbundling rules “within weeks”.

By Beatrice Lo and Jonathan Ritson-Candler

At its recent asset management conference, the FCA announced that it will imminently launch a review of how asset managers have implemented the new MiFID II obligation to pay for the research they receive from sell-side firms separately from execution costs (the so-called “unbundling rules”). This is the first FCA-initiated MiFID II review, and comes only six months after the implementation of MiFID II. This is indicative of the regulator’s focus in this area.

The unbundling rules, as part of MiFID II, came into effect on 3 January 2018. The rules represent one of the most significant implementation challenges for the industry given that previously, research had not been separately priced and the new rules are silent on how sell-side firms should negotiate and price their research services (and what buy-side firms could accept). This meant that firms were still developing their pricing models and were still engaged in negotiations post the 3 January 2018 deadline. In recognition of this, towards the end of 2017, the FCA and ESMA permitted “trial periods”. During these periods, sell-side firms can provide, and buy-side firms can receive, free research for a maximum of three months (within any 12 month period). The regulator is keen not only to ensure that firms are compliant with the new rules, but also to understand the broader impact of the unbundling rules on the market.

The industry awaits the FCA’s findings with interest, as they will be a useful tool with which both sell-side and buy-side firms can review their MiFID II implementation decisions in this area.

Market Developments

Much was written, in the run up to MiFID II, of the added competitive pressure the unbundling rules will have on research providers, and how this will lead to consolidation in the market, potentially meaning some issuers will have difficulty obtaining research coverage. Whilst the full extent of MiFID II’s impact in the sector will take time to emerge, increased activity is already evident, including:

  • An increase in M&A activity: Research providers are looking to their competitors to see if deals can be done to help expand sector coverage, enter new markets, acquire star analysts, and/or increase scale. Asset managers are also considering potential transactions to build in-house capability and drive cost efficiencies.
  • The development of new research products or functionality: Research providers are, for example, considering offering corporate sponsored research for the first time, in order to capitalise on increased demand for research coverage from issuers. Equally, some research houses are looking to deepen their expertise in coverage of certain sectors in order to stand out in the market. This too is driving prospective M&A activity.
  • Using technology to maximise existing research platforms: Research providers are adding functionality, data analytics tools, etc., in order to differentiate their offering and embed themselves with existing clients.

For any buy-side and sell-side firms considering deal activity, early engagement with advisers, regulators, and other key stakeholders, and careful navigation of the corporate, tax, finance, governance, and regulatory implications, amongst others, will be key to achieving desired outcomes for a successful transaction.

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