Price formation of FICC research following MiFID II unbundling rules
| Pages | 97-113 |
| DOI | https://doi.org/10.1108/JFRC-02-2019-0018 |
| Published date | 28 August 2019 |
| Date | 28 August 2019 |
| Author | Fidelio Tata |
| Subject Matter | Financial risk/company failure,Financial compliance/regulation,Accounting & Finance |
Price formation of FICC
research following MiFID II
unbundling rules
Fidelio Tata
Department of Business and Economics, Berlin School of Economics and Law,
Berlin, Germany
Abstract
Purpose –Traditionally, full-servicebroker/dealers catering to institutional investors have bundled trade
execution withinvestment research. Since 2018, new market regulation has forced broker/dealersto unbundle
and to sell research separately. The purpose of this paper is to shed some light on the expected pricing of
research.
Design/methodology/approach –A stylized model is presented in this study in which a monopolist
fixed income, currenciesand commodities (FICC) research provider faces a linear demand function and picks
an appropriateprice schedule.
Findings –It is shown that it is important to initiate the pricediscovery process using a low price and that
some broker/dealers willnot be able to identify a regulatory compliant price/quantitysolution because their
research-productionfixed cost is very high comparedto the research demand function they face.
Practical implications –There are three main findings from our model: pricing researchat cost is not
always possible; if thereis a unique solution, an iterative approach only works when startingoff with a low-
enough initial price; and if there are two solutions,only the low-cost/high-volume solution can be discovered
in an iterativeprocess.
Originality/value –The results presented are important to broker/dealers about to discover the market
demandfor their FICC research publicationson the back of the implementationof MiFID II. Havingdistributed
FICC research for free in the past, they have no knowledge about the demand function (other than what is
demanded at a priceof zero). Because research publicationsare highly differentiated products,observing the
pricing of competitors is insufficient. Iteratively gaining knowledge about the demand function using price
adjustmentsand customer questionnairesbecomes the most likely mean for discoveringthe demand function.
It is importantto initiate the price discovery processwith a low price. Some broker/dealerswill not be able to
identifya regulatory compliant price/quantitysolution becausetheir research-productionfixed cost is too high
compared to the researchdemand function they face. Finally, it is shown thatthese broker/dealers with two
possible equilibriums face difficulty in identifying the high-price/low-volume researchequilibrium because of
the non-convergingnature of the iterativeprocess.
Keywords Pricing, Regulation, Investment strategy, Information markets, Unbundling, Monopoly,
Investment research, FICC, MiFID II
Paper type Research paper
1. Introduction
Traditionally, full-service broker/dealers catering to institutional investors[1] have bundled
trade execution with investment research. Starting January 2018, new market regulation
forces broker/dealers to unbundle and to sell research separately. This initiates an
industrywide discovery process of market demand for fixed income, currencies and
JEL classification –D42, L86, G28
Price
formation of
FICC research
97
Received16 February 2019
Revised20 June 2019
Accepted21 June 2019
Journalof Financial Regulation
andCompliance
Vol.28 No. 1, 2020
pp. 97-113
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-02-2019-0018
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
commodities (FICC) researchpublications. Having distributed their FICC researchfor free in
the past, broker/dealers have no knowledge about the demand function for research (other
than what is demanded at a price of zero). Further complicating the price-setting dynamics
is coming from two constraints: First, regulatory rules prevent pricing below cost; second,
the broker/dealer’s sales and trading departments would like to see customers granted
access to research at the lowest possibleprice.
The rest of this paper is organized as follows. Section 2 describesthe regulatory change
that took effect on January 3, 2018, with respect to research unbundling requirements.
Section 3 discusses the specifics of the FICC markets.Section 4 provides an overview of the
literature. Section 5 presents a simple framework for the market dynamics and pricing of
FICC research before and after research unbundling. Section 6 proposes the outcome that
should be expected for research providers facing different individual cost and demand
functions underthe new regulatory regime. Section 7 provides the conclusionof this study.
2. Regulatory contexts
In this section, we provide a briefoverview of the relevant regulatory environment. First, we
summarize the main rules of MiFIDII with respect to investment research that have become
effective on January 3, 2018. Then, we list the specific aspects that impact the future
unbundling of research and trading cost. They are the reason why (certain) research needs
to be separately priced going forward.
2.1 MiFID II rules with respect to investment research
In 2007, the first major EU regulation of financial markets came into effect with MiFID
(“Markets in Financial Instruments Directive,”Directive 2004/39/EC).The provisions of the
directive of the European Parliamentand the Council of April 21, 2004, were transposed into
EU national law by November 2007. MiFID aimed at creating more competition between
banks, investment firms, traditional stock exchanges and alternative trading venues, thus
bringing more choiceand lower prices for investors.
In 2014, based on the experiences from the financial crisis of 2008 ledto the belief that a
further strengthening of investorprotection is needed and, as a consequence, the European
(“Markets in Financial Instruments,”Directive 2014/65/EU, going forward referred to as
“Directive”), supplementedby the European Commission Delegated Directive (C(2016) 2031
final, going forward referred to as “Delegated Directive”). MiFID II was supposed to come
into effect on January 3, 2017; however, the deadline was extended to January 3, 2018. The
strengthening of transparency requirements; limiting of speculation on commodities;
adapting regulatory rules to new technologies such as high-frequency trading and
reinforcing investorprotection.
An important part of MiFID II regulation concerns the production and dissemination of
investment research. According to Article 24 (7) and (8) of the Directive, investment firms
providing both trade execution and research services have to price and supply them
separately. Thisis referredto as “unbundling”of research and execution.
concerning one or several financial instrumentsor other assets, the issuer or potential issuer
of financial instruments, or something closely related to a specific industry or financial
market. More specifically, these are explicit or implicit recommendations and investment
strategies, providing substantiated opinions on financial instrument prices or contain
analysis and originalvalue-adding insights[2].
JFRC
28,1
98
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