The Path to Rebundling is Going to be Messy

Reading some of the headlines this morning, I’m literally floored by recent announcements out of the UK from the FCA – so much so that I moved around my calendar just so I could get some thoughts out. Back in July of 2020, I wrote a thought piece called “The Great Rebundling Begins.” I shared my thoughts on how the ‘thrust to take MIFID global” had ended, and highlighted how the EU (and the FCA) was thinking about making exemptions to the unbundling rules, thus effectively rebundling research with execution.

Today, we got a lot more insight into what is happening there, but more importantly, a lot more insight into the thought process of the FCA in particular. It seems that the FCA is focused on another important topic: increasing coverage. The thinking is that by allowing the rebundling of research and trading for companies with a market cap of less than $250M, brokerages will increase their coverage of these names. The issue the FCA has highlighted is that insufficient coverage may not “provide a fully informed view for investors.” As a reminder, the EU already rolled back unbundling for companies with a market cap of less than $1B, so this is just the FCA playing catch up. So if it’s a UK company, the current exemption will be $250M. If it’s an EU company, the exemption will be $1B. Confused yet? How do they expect brokerages and clients to possibly manage the operational impacts behind this?

That being said, I agree with their assessment that companies need coverage to form opinions and drive price discovery. The more opinions that are in the market, the more information that is being shared, the more that discovery can happen. Thus, the larger the company, and the more complex it is, the more coverage it likely needs in order to be able to deeply understand the business. While we likely don’t need 60 analysts covering Apple, we probably need a lot more than 2. So, if the ‘adequate coverage’ needed for Apple is 30 analysts, why aren’t they exempted too?

The FCA also changed its stance on FICC research. Before, it was that as long as the research was “broadly available” (i.e. buried somewhere on your corporate site) you didn’t have to unbundle that side of the business. They are also walking that back, saying that because FICC is largely a ‘spread capture business’, you don’t have to unbundle at all (obviously the FCA has never heard of the spread capture in block trading on the equities side of the business, but I guess that’s another story…)

A “Research Pool”

One of the interesting FCA proposals was to create a “research pool.” The idea (as I can understand it) is that industry participants would contribute dollars to this pool, and then those dollars would be used to fund research on particular companies (whether that’s on an ad-hoc basis, on an ongoing basis is unclear). My view here is that it just sounds like an increased complication in an already complex market structure. So, to get research on SME’s (perhaps below some market cap threshold?), I have to contribute to a pool of research dollars (is this hard or soft dollars?), then allocate those dollars to a research provider to put out coverage on the company I want to understand? What stops funds from putting in dollars to drive coverage of companies they cover, thus ‘talking their book’? Isn’t this just soft dollar payments for research? (unless it’s hard dollars only, in which case, good luck)

Let the free market decide

Historically, the industry has taken care of ‘adequate’ research coverage using the free market. If there is business to be done in a specific sector or industry, brokerages have spun up research to monetize that opportunity. If there isn’t, brokerages withdraw. It might make sense to add to that structure (allowing corporate sponsored research seems fair to me, as long as it’s transparent), but it seems like the FCA is not only trying to stay half in on the existing MiFID II structure, while rolling back the other half, but also adding in other increasingly complex legislation.

The Great Unbundling is definitely continuing, and while the end state will likely be a return to ‘normal’, I feel bad for the regulatory and compliance teams who will have to navigate the transition period over the next few years.

Much like COVID, I guess we’ll find out what the “new normal” is once the MiFID II dust eventually settles.

Street Contxt

Hit The Street

Cut through the noise and avoid information overload.