How the big banks are making a mockery of a genuine attempt to reform financial services

The end result of MiFID II – legislation that forces asset managers to pay directly for financial research – will be one of damage to the investment industry

A rethink of the new rules is required before investors suffer (Getty)

Across the City, the talk is of bargains to be had, of deals to be done at mind-bogglingly low prices.

I’m not referring to the January sales in the shops but in the amounts fund managers will be paying in future for analysts’ research. Under the new MiFID II legislation that came into force on 3 January, asset managers must now pay directly for research rather than have it combined with trading commissions.

The funds have indicated they will pay the so-called “unbundled” research cost themselves, out of their profit and loss accounts, rather than pass it on to clients. The result has been a price war as the mighty investment banks have scrambled to sign up the funds.

Some extraordinary tales of negotiations and outcomes are being bandied around: the investment bank that used to charge north of $500,000 for its services to one fund, that priced its research at little more than $100,000 in an opening gambit, only to come down still further, to less than $10,000; the massive bank that said an hour with one of its analysts could be worth up to $20,000 (£14,759) but is now prepared to charge less than a tenth of that, and in arrears, which presumably means if the research turns out to be rubbish the fund manager can just refuse to pay.

This, though, is research that costs millions of dollars to produce. So why the unbank-like rush of generosity?

The answer, of course, is that the large banks are being far from charitable: they’re keen to build market share, to hog the market, to price out of the industry the smaller players that do not have their vast resources and cannot weather these discounted price levels.

There is irony, too, in the fact the banks have been able to behave in this fashion precisely because the fund managers have determined they will not spread charges for research to customers. Initially, they said they would expect their clients to cough up. Then they changed their minds and said they would pick up the tab. But by saying they will take on the costs themselves they’re keen to keep them down – not more than 3 per cent of pre-tax profit.

Capital Access Group, a firm that advises companies on how they should engage with investors, has said it expects the UK’s total fund management budget for research to fall from around £200m to £90m this year. Given the talk in the City that now seems optimistic.

Sensing an opportunity to grow their business, and sniffing blood, the giant banks have moved, slashing their prices to shore up the relationships with the funds and the owning groups, something that can yield all sorts of spin-offs across the investment banking spectrum of activities, and at the same time to drive the competition out of the market.

But this raises an awkward legal question. Offering anything that might be considered an inducement to trade with a particular bank or broker is contrary to the rules. Given the scale of the discounts on offer and the fact they’re heavily subsidised, with little attempt by the bank to even come close to covering its costs, it must be hard to argue this is not a rule-breaking incentive.

Also, it goes against the overall spirit and guiding light of MiFID II, which is all about cleaning up the system, making it less opaque and introducing clear transparency of charges. The price for the research may be declared, but that disclosure is meaningless if it comes on the back of a massive, hidden subsidy and bears no semblance to reality.

So far the response of the regulators has been non-committal. They called in the banks and told them they thought their actions were anti-competitive. Otherwise, though, they are sticking to a line that the investment managers must ensure the strictures on inducements are not being broken, and welcoming the positive consumer outcome that the cost of research is coming down, and how that can only be good news for the end-user, the client.

Well, up to a point. How the rules are not being breached when the price is so low, and so far removed from the amount the research is actually costing the bank to produce, is difficult to fathom.

The end result will be one of damage to the investment industry. The effect, inevitably, of the giant banks’ aggressive stance will be to cut back on some of the quality and breadth of research they supply. Stocks will not be analysed or if they are, the scrutiny will be done badly. Plus, their fierce price-lowering approach is bound to damage revenues at the smaller firms – the second tier banks, small-cap stockbrokers and independent research houses. That can only result in a reduction to their services or their disappearance completely. That means loss of analysts’ jobs and less coverage of stocks – something that will only harm the investor.

Presumably that was never the intention of those behind MiFID II. The banks are making a mockery of a genuine, enlightened attempt to reform and to improve an industry that was open to all manner of abuses. A rethink is required before investors suffer.

Chris Blackhurst is a former editor of The Independent, and executive director of C|T|F Partners, a campaigns and strategic communications advisory firm