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Dealing With Unbundling

Jason McAleer, Head of Dealing, Jupiter Asset Management, examines ongoing change in commission management and its impact across the buy-side and sell-side.
Jason McAleerAsset managers are now being a lot more explicit about how they spend and what they get for their money. This is being done through clear voting, identifying clear research needs, and generally, with asset managers appreciating that the money they spend on research is effectively their own. With greater care and due diligence about the research spend, the buy-side can make a big difference to how unbundled they are.
Drivers towards greater unbundling seems to come increasingly from the regulators rather than from the clients. We, of course, act in the best interest of our clients, but with the push from the regulators, we are having to engage much more in the process of thinking about what we receive for our cash. In a pure unbundled world we would be allocating individual brokers specific amounts for defined permitted services; bespoke analyst meetings, research, execution. Once we’ve established what we are paying for, we can start to look at budgets and managing that expenditure. We are better able to break out what we are paying, which makes us more accountable to our clients, and more transparent to the regulator.
Sell-side impact
It is a very different matter when it comes to the sell-side. For some firms this drive towards full unbundling is undoubtedly a good thing. But for others it could cause their models to struggle, and that is definitely something we should be aware of when making changes to how the market functions. The smaller independent research firms are highly valued and managers do seek them out. Our ongoing and well developed use of CSAs is very helpful in breaking out payments to the smaller firms to get specialist research. But as we have seen, there could be changes to how CSAs function (or indeed exist), which would have consequences here.
It is not only the direction of change towards unbundling that is important, but how that change manifests and what tools we can use to allocate our spend. There are vast differences between different buy-side firms. Dependent on the budget, the style of the house, you can break out your spending by fund, by individual manager etc, and there needs to be clarity as to how we pay. There also needs to be a better two way conversation with brokers offering their services through more of a menu – this allows us to access their services in a way that both parties are happier with. We need to know the true cost of research and the true value that it provides us, just as much as the sell-side needs to start giving value to these metrics. Mid to small sized brokers whose model was to capture flow to pay for research could suffer as these changes manifest, and we could see mergers off the back of this.
One consequence is that more and more analysts are leaving the sell-side research houses, either to go independent or to move into the buy-side. This is an ongoing trend, and one that needs more time to develop, but buy-side firms are starting to look at the potential benefits of building out bigger in-house research teams.
Buy-side management
At Jupiter we are currently building out our commissions management policy – taking key aspects of how we pay for research and pay for execution, and putting that into a formal policy. This allows us to better formulate research budgets across strategic groups – rather than have a budget that can run away this allows us to be much more focused on consumption and to properly value research that’s voted for. We are getting there slowly: as mentioned, it is a difficult conversation to get the brokers themselves to value research separately and to put a firm price on their offerings, and we need to work closely with our own fund managers . We are starting to work with a commission aggregation firm that allows us to organise and manage much of this operationally.
There is an angle to this which both benefits internal transparency and external transparency. By being more specific in information from our fund managers when they are voting we are much better able to put a specific dollar value on a given piece of research. That level of detail is very helpful for us. It is still very much more art than science – until brokers come up with tariffs – the same research will be worth different amounts to different people.
One slightly worrying consequence of this drive towards more specific pricing of research would be if the investment banks set that price targeted at the largest asset managers. We could see many small and mid tier buy-sides simply being priced out of being able to afford the research they need. So with smaller sell-sides suffering if they can’t use natural flow, and with buy-sides being priced out of the market, there is a very real threat to the nature of the industry in the UK if this is not properly managed.
Global
There is an ongoing discussion as to how this feeds into a global conversation. The UK and Europe have been developing unbundling for a long time – pre MiFID I and into MiFID II. The US predominantly pay for research via soft dollar arrangements. In Asia global firms are starting to become more unbundled, but in less developed markets it is still very difficult. On the sell-side they can often see our money coming to them as being from us as a whole client. The specific split for research and commission doesn’t always happen resulting in a bundled view of the revenue. And I think that needs to change, as again that would give them a view as to their revenue flows, which allows them to cost back to us a lot more clearly. There is a debate as to whether Europe and the UK going alone on this opens us up to an arbitrage – why would an asset manager work in these environments that are more regulated than in the US or elsewhere?
We do need much greater transparency from the regulators as to what they are likely to implement and need to make sure that the CSA systems we are building out will be useful beyond January 2017. At the moment we don’t have that clarity and it is causing us difficulties.
To summarise, we need to become a lot more precise in how we are putting a value on research and commissions, and the sell-side need to become a lot better at putting a value on their products. Once we have our budgets and they have a price list, we can see how to work our needs and budget to that. It will be tough, but with CSAs and systems in place we can make the industry more transparent, and hopefully not disenfranchise too many of the smaller firms along the way.

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