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Research Unbundling A ‘Win-Win’ For Best Execution

Rebecca Healey, global head of market structure at institutional liquidity pool Liquidnet, said research unbundling in the European Union has led to a changing role for execution as part of the investment process.

In a report, Unbundling: What’s the Verdict?, Healey said that fund mangers paying for research from their revenues has allowed them to select the best providers for research and execution services respectively.

Rebecca Healey, Liquidnet

“It is also leading to a changing role for execution as part of the investment process as greater in-depth pre-trade data can be fed into the investment process to enhance timing of an execution or uncover hidden liquidity through analysing previous executions to select the most appropriate venues and minimise unnecessary information leakage,” she added.

Healey continued that executions will improve as research evolves to include richer and bespoke datasets and help increase alpha.

The EU’s MiFID II regulation required the unbundling of research payments from the beginning of last year, and most asset managers have chosen to pay for research out of their own revenues. Before MiFID II research costs were often ‘bundled’ into transaction commissions and paid by investors, with many buy-side firms not monitoring how much of their clients’ money was being used to pay for research.

The Financial Conduct Authority reviewed changes in the research market since MiFID II came into effect at the start of last year. The UK regulator said in report last month that investor savings from unbundling could reach nearly £1bn ($1.25bn) over five years.

A US asset manager told Liquidnet in the report: “Historically the broker who did not have research would never have made it onto the list. It’s a different freedom, we can send our flow where we should.”

The FCA added that unbundling has allowed asset managers to select brokers purely on their ability to provide best execution and that the number of counterparties used for execution-only services has increased.

“Several firms said that fully separating execution from research has allowed them to reassess their use of high-cost versus low-cost execution channels, e.g. electronic and algorithmic trading,” said the FCA. “This has resulted in them making more use of lower cost channels, and further client cost savings.”

New data

The regulator continued that the majority of asset managers can still get all the research they need and are not experiencing a reduction in coverage on smaller companies.

Healy said in the Liquidnet report that the focus should not just be on the coverage of small and medium enterprises but on the new requirements for research – including the requirement for both structured and unstructured data; and the rise of environmental, social and governance and sustainable investing.

“The ability to access, analyse, interpret and act upon the information now available in a global 24/7 economy will be how active managers can deliver better fund performance for end-investors,” Healey added. “Automating the investment process will be what differentiates the active managers who survive versus those that will not.”

Buy-side firms are likely to spend $1.7bn on alternative data in 2020, a sevenfold increase since 2016, according to the report.

Liquidnet found that 64% of asset managers now use both structured and unstructured datasets. The majority, 51%, also expect the greatest disruption to the industry to come from increased use in third party data and for technology providers to provide greater access, portability and modelling of data rather than the traditional bulge bracket brokers.

Healey gave the example of a multi-billion dollar discretionary fund which used systematic analysis to review all research reports, emails, instant messages and trader notes to extract data signals and create a shadow portfolio. Over a three-year period the strategy outperformed the fund’s own P&L.

She said: “It will not only be necessary to absorb an increased quantity of data from a continuing variety of sources but to also have the ability to efficiently aggregate and analyse this data in order to extract actionable insight.”

International standard

Liquidnet continued that research unbundling is becoming an unofficial international standard.

There were reports in the summer that the US Securities and Exchange Commission is looking to extend the exemption that allows US brokers to provide unbundled research to EU fund managers. SEC regulations prohibit fund managers from directly charging for research unless they register as investment advisers.

“Interestingly a recent report by the Tabb shows that only 33% of large US asset managers are still operating a bundled model; although this figure increases to 45% of mid-sized and 67% of smaller funds,” added Healey.


The FCA survey said the quality of asset managers’ research valuation models varies and the UK regulator re-iterated that it expects buy-side firms to refine their models to ensure they are acting in the best interests of their clients. The report also said there are a wide range of sell-side research pricing levels.

“We will monitor for potential competition concerns in this market and will act if necessary,” added the FCA. “Firms are continuing to develop their arrangements and a market for separately priced research is still emerging. Therefore, we intend to undertake further work in 12 to 24 months’ time.”

Healey said research pricing models varied with some using tiered service pricing levels, others offering ’pay as you go’, while others price per type of interaction or product consumed.

“However, if what the buy-side receives is so cheap as to call into question whether it is genuinely divorced from trading or wider relationships with a broker, the FCA indicate that they are planning to monitor this for potential competition concerns and will act if necessary,” she added.

Independent research providers also expressed concerns to the FCA that pricing is too low because large multi-service banks are internally cross-subsidising their research, making it hard for them to compete.

The FCA said: “We are aware of the potential negative effects on competition in the medium term if some firm’s loss leading prices drive out competitors, reducing choice.”

Healey continued that while there are clearly anti-competitive issues which need to be addressed; in some sense this is a question of “stable-horse-bolted.”

“Conversations with asset managers who contributed to Canary in a Coalmine indicated that high touch services such as analyst access, conference attendance are increasingly being internalised or sourced from more cost-effective sources,” she said.