This article first appeared in Capital, The Edge Malaysia Weekly on October 2, 2017 - October 8, 2017

NEW regulations imposed by the European Union (EU) to make its securities markets more transparent come Jan 3, 2018, are causing confusion in this part of the world.

According to the International Capital Market Association (ICMA), the Markets in Financial Instruments Directive (Mifid II) rules are only intended for EU investment firms and activities undertaken in the bloc. Mifid II introduces new rules related to “inducements” and prohibits EU Mifid authorised firms from receiving certain inducements, including free research.

“Therefore, EU firms are required to pay for research received, which, in the case of fixed income research, can be either from their own P&L (profit and loss) or through the establishment of a research payment account, which is funded by a direct charge to clients.

“While non-EU investment firms dealing with EU counterparties are not directly within the scope of Mifid II rules, they may be indirectly impacted in a number of different areas that they will need to be aware of,” ICMA said in a statement last Tuesday.

The rules, which will force fund managers in the bloc to pay directly for analysts’ research, are expected to disrupt research houses in Malaysia that are servicing international asset managers, analysts say. And they believe small research firms without deep pockets will be the first to go.

Chris Eng Poh Yoon, chief strategy officer at Etiqa Insurance & Takaful, says while the Mifid II rules only apply to asset owners and managers that do business in Europe, the bigger local fund managers could eventually adopt them as well.

That means smaller research houses may eventually see less business from international asset managers that have to comply with the rules as they will likely channel their business to a few bigger research houses.

“This is because the separate payment for research is deemed a cost to the asset managers’ profits rather than being part of the trading fees [as was the case] in the past,” he tells The Edge.

“However, we will only see the full impact on Malaysia in five to 10 years’ time,” Eng adds.

For Tan Ting Min, former director and head of Malaysia equity research at Credit Suisse Securities (Malaysia) Sdn Bhd, there will be short-term pain for analysts as they ponder how much their research will fetch. “Under Mifid II, fund managers in the EU can no longer bundle research costs with trading services, but must pay from their own costs. The problem is no one really knows how much the investment research reports are worth.

“Every research firm is still trying to work out what everyone else is doing. It (pricing structure) is not clear yet because no one has announced (how much they are charging for research). And no one wants to be the first to announce,” says the 40-something, who retired in July after 25 years in the investment research industry.

Tan says asset managers may choose to pay investment banks a lump sum for a wider coverage or choose tailored coverage based on markets or stocks.

This, in turn, could see research houses offering a variety of packages based on the different needs of their clients, with one recent news report estimating an entry price of US$10,000 for basic yearly access to as high as US$450,000 per year for an all-inclusive premium package.

Last month, the world’s second-largest fund manager, Vanguard, was reported as saying that it expects to spend around US$5 million annually on research from banks and brokerages globally under the new European rules.

Further complicating the situation is the stance of research firms and fund management houses that are not obliged to comply with Mifid II, which could then set the stage for the co-existence of two separate channels of services to be provided by the sell-side to the buy-side players.

“I think asset managers may only choose to pay for the top three or five research firms with international coverage like Malaysia, Thailand, Hong Kong, and so on, and drop the rest,” says Tan.

“While the ultimate aim (of Mifid II) is transparency, [the road] leading towards it may not be a good thing. I think the big, established and independent research firms may do better, but the smaller ones that are not bank-backed or those without wide regional coverage will find it tough,” she adds.

Tan is concerned that smaller research firms will resort to lowering their fees to artificial levels as they compete for investors’ research budgets. “Some firms will have less business and start undercutting.”

“I reckon this whole exercise will be ‘pain first’, with the weaker players weeded out, leaving the remaining ones stronger. The pain could be (for) one, two or three years ... I don’t know,” she says.

Tan also believes Mifid II will put new analysts at a disadvantage because when clients are paying for research, they will not want research produced by juniors. “If I am a fund manager who buys on a per-report basis, I will not buy a new analyst’s research report. So, how will a new analyst break into the industry?”

As asset managers — accustomed to free research from investment banks in exchange for placing trades with them — will be required by the new rules to pay for research, Tan also sees an increased administrative burden.

Vincent Khoo, head of research of UOB Kay Hian Malaysia, is of the view that Mifid II will lower transaction commission costs in Europe at the expense of research and the investment banking industry.

“With a rising work load and potentially lower rewards, Mifid II could make it harder to retain or attract talent in the industry,” he says.

Aberdeen Asset Management Sdn Bhd managing director Daniel Choong says the company is planning to absorb the cost of research after the new rules come into force.

“We have been saying publicly that we will pay for all the research ourselves. The majority of the industry is now moving in this direction,” he tells The Edge.

“We will still be buying research, but we aim to bring down the number of core providers to a more focused list globally, although in any given market, there may be specialists who, for example, give us insights into less-accessible areas of the market (like small caps), or unaffiliated research houses with more independent views,” he explains.

Choong says non-EU companies will have no choice but to comply with the rules if they want to sell their services in the EU. “Where Malaysian firms may be affected already is when global groups that fall under Mifid II, like Aberdeen, take a blanket approach to research and choose to pay for it themselves wherever they operate in the world. That will make investment managers choosier about what they buy and with whom they trade.”

Moving forward, investment managers will have to think hard about what is actually useful to them, he says.“They may decide that they can do without a lot of the research, particularly if they do their own. The burden will then be on the sell-side firms to improve their product or risk losing business.”

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