How Regulation Could Damage Investment Research
By Timothy P. O'Halloran
By Timothy P. O'Halloran
NEW YORK, Jan. 29, 2016 /PRNewswire/ -- In December, The European Commission leaked a draft of their proposed policy recommendations for MiFID II regarding inducements, research and the use of commissions (CSAs). After a long wait, we now know that dealing commissions will continue to be the currency of exchange for research in Europe, albeit with a handful of additional requirements around budgeting and the disclosure of costs. Yet, the question this raises about the use of research is an existential, game-changing one that demands our industry's attention.
When was the last time that a pension plan hired an underperforming manager because they spent less on research than their peers? Or, conversely, when was an outperforming investment manager fired because they overspent on research? You see the point.
Along with new requirements for budgeting and disclosure, European regulators have outlined a narrower definition of research than what investment managers adhere to in the United States.1 One should also note that this comes on the heels of regulators referring to research as an 'expense' and an 'inducement.' The concern of many is that the subliminal message from regulators is that too much research may be a bad thing. This should be a matter of great concern to the investment community. If this is in fact the case, we are heading down a dangerous road that will lead to a marketplace with less information, fewer jobs and ultimately less human interaction in the investment process.
Quality investment research is the foundation on which capital markets operate. The more research there is, and the better that research is, the better the capital allocation process works. It is not unreasonable to think that well-intended policy designed to protect investors could actually destroy a vibrant research marketplace and lead to transformative change in the way all money is managed.
The pool of research which an investment manager can obtain via the use of commissions must be broad enough to recognize the changing research landscape and the manner in which research is conducted. And, as most global investment managers would agree, it would be prudent to have all regulators on the same page with regard to how this pool is defined.
European regulators would be wise to take a page out of the SEC's playbook and recognize that as both the nature of research and the manner in which research is used by the investment community is constantly evolving, a more flexible definition of research is required.2
When we think about how research is consumed and valued we ask the simple question "Is there such a thing as too much research?" Or perhaps more to the point – "While budgeting and cost controls make good business sense, are we enacting policy that incents investment managers to use less research? Are regulators conditioning asset owners to worry about how much research their investment managers are using?"
A research budget is necessary for sure, but we need to remember that any single piece of research is part of a broader mosaic that an investment manager uses to develop an investment thesis. A single research input may not seem important in and of itself, but in the context of all a manager's research information, it can take on new meaning. You simply can't know. And perhaps that's why many people believe that there is no such thing as too much research, too much homework or too much reading. We have a lot of company here…
"I have said that in my whole life, I've known no wise person over a broad subject matter area who didn't read all the time—none, zero. Now I know all kinds of shrewd people who by staying within a narrow area can do very well without reading. But investment is a broad area. So if you think you're going to be good at it and not read all the time, you have a different idea than I do…You'd be amazed at how much Warren reads. You'd be amazed at how much I read."
Charlie Munger, Vice-Chairman of Berkshire Hathaway
Research is changing, not only in our industry but in all walks of life. Can you name any university, industry or company which conducts research in the same manner in which it did even a decade ago? Technology has allowed for new research paradigms and for good information and ideas to originate from virtually anywhere.
As we have said before, research is more a 'process' that is owned by investment managers than a 'product' supplied by the sell-side. Investment managers want and need the discretion to decide which inputs are valuable and what should be included in their process.3
Any policy regarding the use of commissions should not have the unintended consequence of limiting the production of or the use of research. And, any policy should be broad enough and flexible enough to accommodate a dynamic and growing research landscape.
While we may not know where the next great idea will come from, we do know that we need to keep the doors open to make sure it gets here. Good regulation will insure that this happens.
To learn more about this topic or to subscribe to Westminster This Week, Westminster Research's weekly update on independent research companies and resources, please reach out to us directly.
Mr. O'Halloran is copresident of Westminster Research Associates LLC, a Convergex Group company.
Westminster Research Associates LLC, a Convergex Group company, is a brokerdealer and FINRA member founded in 1993 and headquartered in New York. Westminster Research Associates specializes in the provision of investment research and commission management solutions to the institutional investment community. Convergex Group is a leading provider of global brokerage and trading related services for institutional investors and financial intermediaries.
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1 The United States Securities and Exchange Commission's guidelines regarding the provision of investment research have been developed over many years, originally via the 1975 safe harbor statute (Section 28(e) of the Securities Exchange Act of 1934, as amended) and subsequent interpretive guidance.
2 Our March 2, 2015 Comment Letter to the European Commission (here) reiterates the need for a more flexible approach in defining research.
3 In Westminster's May 2015 CSA and Research Usage Survey 88% of respondents believed that investment managers and their staff are best suited to decide how their research is sourced and paid for. See the survey here.
CONTACT
United States
Timothy P. O'Halloran
212.448.6050
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Europe
Francis Land
+44. 207. 964. 7489
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