# Investment research under MiFID II –a more meaningful approach to evaluation
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2017-10-27
Category: INVESTING
Category URL: https://financedigest.com/category/investing
Meta Title: MiFID II Deadline: Pricing and Evaluating Research -
Meta Description: Discover how MiFID II is reshaping the investment research market and how firms are evaluating and pricing research to comply with regulations.
URL: https://financedigest.com/investment-research-under-mifid-ii-a-more-meaningful-approach-to-evaluationhtml

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By **Ian Spittlehouse,** Alphametry

![Ian Spittlehouse](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/fd271017-16-300x225-1736843339502-compressed.png)

Ian Spittlehouse

The impending MiFID II deadline has sparked fierce debate around how investment research should be priced and paid for. We’ve seen a range of pricing options from the sell side, along with industry speculation on how boutique and mid-tier providers will fare against larger [investment banks](https://www.financedigest.com/pragma-investments.html "Pragma Investments on Wealth Management versus Private Banking"). On the buy side, most asset managers have said they will not be passing on the cost of research to clients. Notably, BlackRock revealed it would be footing the [bill for research](https://www.financedigest.com/brexit-has-added-6-to-britains-food-bills-researchers-say.html "Brexit has added 6% to Britain’s food bills, researchers say"), an announcement which quickly saw a number of firm backtracking on earlier decisions to pass these costs onto investors including Schroders, Janus Henderson Investors, Union Investment and Invesco. So what’s missing from this picture?

So far very little has been said about how [firms are or will be evaluating research to inform pricing](https://www.financedigest.com/oil-prices-stay-firm-on-fuel-demand-despite-covid-19-surge.html "Oil prices stay firm on fuel demand despite COVID-19 surge") and budgeting decisions. Similarly, the buy side [needs to establish whether the research that they purchase is substantive or risk](https://www.financedigest.com/21690.html "BRIGHTON, England (Reuters) – Britain needs to be more “clear-eyed” about the risks") breaching MiFID II regulation. This new requirement for robust evaluation should be welcomed, after all,the investment [research market has been crying out for innovation](https://www.financedigest.com/stretch-marks-treatment-market-insights-new-innovations-research-and-growth-factor-till-2025.html "Stretch Marks Treatment Market Insights, New Innovations, Research and Growth Factor till 2025") for some time. MiFID II will mean that research becomes a commodity in its own right;it will be bought and sold just like any other [commercial product](https://www.financedigest.com/why-are-commercial-food-products-manufacturers-adopting-insect-growth-regulators.html "Why are Commercial Food Products Manufacturers Adopting Insect Growth Regulators") and should therefore be subject to rigorous assessment. The problems firms face is not just how to evaluate, but what to evaluate and how to use the resulting data.

**Why evaluate?**

MiFID II stipulates that all firms must have a clear methodology around how they pay for research before they receive and [consume services](https://www.financedigest.com/keeping-up-with-heightened-consumer-expectations-in-financial-services.html "Keeping up with heightened consumer expectations in financial services"), including the setting of measurable, ex-ante criteria on how they will value the types, level and quality of service.Additionally, firms should have agreements with [research providers in place prior to receiving substantive services, with pricing being a natural part of these negotiations – any ex-post variation in payments made to the research firm](https://www.financedigest.com/lyme-disease-treatment-market-forecast-to-2031-made-available-by-top-research-firm.html "Lyme Disease Treatment Market Forecast to 2031 Made Available by Top Research Firm") based on actual services received should be made in a proportionate and predictable manner based on measureable criteria. MiFID II also specifies that firms must evaluate services using qualitative and quantitative frameworks consistently across providers, and that regular assessments of research consumption should be conducted to evaluate [future procurement decisions and research payment](https://www.financedigest.com/what-does-the-future-hold-for-corporate-payments.html "What Does the Future Hold for Corporate Payments?") levels.

In the past, regulators have granted unofficial grace periods to firms facing new regulation and this is likely to happen when MiFID II takes effect in January 2018. However, Buy-side firms have to show they have documented procedures and proper records from the outset.

**Evaluation process**

Research evaluation should take place at several points. Prior to purchase, users’ requirements need to be gathered and used to [develop a product](https://www.financedigest.com/tire-recycling-downstream-products-market-to-observe-strong-development-by-2019-2027.html "Tire Recycling Downstream Products Market to Observe Strong Development by 2019-2027") specification. Providers have historically been selected for their execution [services rather than research](https://www.financedigest.com/talent-acquisition-staffing-technology-and-services-market-to-reach-usd-196-1-bn-by-2028-comprehensive-research-report-by-fmi.html "Talent Acquisition & Staffing Technology and Services Market to reach USD 196.1 Bn by 2028 – Comprehensive Research Report by FMI"), causing providers which did not offer execution to beside-lined. Unbundling will enable the buy-side to consider research from a much wider range of suppliers and should help them match products to their requirements more accurately. This primary evaluation should be revisited on a regular basis to ensure that there is no specification creep, especially in terms of regulatory obligations.

The purchased research should then be reviewed on a regular basis. This evaluation should be multifaceted, not only grading quality in terms of user satisfaction and adherence to the product specification, but also for the comparison of similar [products in the market](https://www.financedigest.com/dry-molasses-products-market-overview-in-depth-analysis-of-market-size-growth-industry-overview-2022-2029-2.html "Dry Molasses Products Market Overview In-depth Analysis of Market Size, Growth, Industry Overview 2022-2029") place. This can only be achieved if evaluation [data is shared](https://www.financedigest.com/how-data-sharing-can-give-brands-confidence.html "How data sharing can give brands confidence"). Today’s post-purchase appraisal can then become part of tomorrow’s pre-purchase discovery.

**How to evaluate**

A new method of evaluating investment is needed. The much denigrated Broker Vote system’s limitations are well documented, including a lack of granularity, bias against new or niche providers, favouring of large institutions, the list goes on. MiFID II signals the end of a system which dictates that [ratings set price](https://www.financedigest.com/home-prices-are-setting-records-while-mortgage-rates-plunge-is-it-time-to-refinance.html "Home Prices Are Setting Records While Mortgage Rates Plunge – Is It Time To Refinance?") after consumption. The new legislation requires [prices to be set](https://www.financedigest.com/oil-prices-set-for-weekly-fall-on-stockpile-releases.html "Oil prices set for weekly fall on stockpile releases") beforehand, forcing the separation of evaluation from cost. Any new evaluation [methodology will therefore need to focus solely on rating the quality of research](https://www.financedigest.com/title-gallium-68-market-research-methodology-business-opportunities-and-analysis-report-by-2031.html "Gallium-68 Market Research Methodology, Business Opportunities and Analysis Report by 2031") products.

The new system of evaluation must be flexible, transparent, objective and easily adopted in order to be successful. [Flexibility is a pre-requisite as the evaluation model](https://www.financedigest.com/the-future-of-payments-flexibility-regulation-and-bespoke-models.html "The Future of Payments: Flexibility, Regulation, and Bespoke Models") will have to cope with research in a range of different formats. Whilst the [majority will be written reports](https://www.financedigest.com/bone-grafts-and-substitutes-market-overview-highlighting-major-drivers-growth-and-demand-report-2018-2026.html "Bone Grafts and Substitutes Market Overview Highlighting Major Drivers, Growth and Demand Report 2018 – 2026"), other formats such as meetings, phone conversations and video could be significant enough to require evaluation. Adopting a standard methodology will be beneficial to all research stakeholders – consumers will use ratings as a guide for purchase decisions, and producers will adapt their offerings according to the feedback received.

Transparency will also be necessary to fulfil regulatory requirements and to give credibility. It is, however, difficult to achieve if an overall, at-a-glance grade is the first visible score. To solve this problem, primary and secondary grades should be layered so that users can drill-down through the primary [grade to the component labels and ratings](https://www.financedigest.com/food-grade-phosphates-market-regional-industry-segmentation-analysis-by-production-consumption-revenue-and-growth-rate-by-2027.html "Food Grade Phosphates Market Regional Industry Segmentation, Analysis by Production, Consumption, Revenue and Growth Rate by 2027"). The number of ratings should be clearly visible, as should the categorisation of the product.

Objectivity is essential but will only be achieved once there is sufficient evaluation data to ensure that outlying scores do not cause distortion. This is only possible if the [rating data is shared](https://www.financedigest.com/global-shares-slide-dollar-gains-as-rates-rise-on-strong-data.html "Global shares slide, dollar gains as rates rise on strong data") and consolidated.

Finally, ease of adoption should be considered. Several major firms have rating models that are more complex than a simple five- star system, yet have [become widely used by diverse groups](https://www.financedigest.com/euronext-italian-arm-to-become-group-wide-clearer-from-end-2023.html "Euronext Italian arm to become group-wide clearer from end 2023") of customers. That said, an evaluation should not take more than a couple of minutes, and the rating system should be simple, clear and easy-to-use.

**Benchmarking**

To find the perfect evaluation model, the financial [services industry](https://www.financedigest.com/three-blockchain-application-scenarios-for-the-financial-services-industry.html "Three blockchain application scenarios for the financial services industry") may have to look outside of itself for inspiration. [Global companies](https://www.financedigest.com/surgical-imaging-market-2021-global-leading-companies-analysis-revenue-trends-and-forecasts-2027.html "Surgical Imaging Market 2021 Global Leading Companies Analysis, Revenue, Trends and Forecasts 2027") like eBay, Uber and Airbnb are successful because of their rating systems. In general, their complexity is proportional to the cost of the product. Uber uses a rudimentary five-star grading with optional labels, whereas eBay and Airbnb are more sophisticated. A simple system such as Uber’s is adequate given the [low price](https://www.financedigest.com/oil-prices-ease-to-trade-near-2-month-lows-on-china-demand-fears-dollar-strength.html "Oil prices ease to trade near 2-month lows on China demand fears, dollar strength") of the service in absolute terms. eBay and Airbnb use more complex systems combining a primary, overall rating with secondary ratings on specific aspects of the services or goods provided.

Full-service [global coverage from a bulge-bracket bank](https://www.financedigest.com/be-simple-in-bank-capital-bank-of-england-tells-global-regulators.html "Be simple in bank capital, Bank of England tells global regulators") may cost up to $10,000 per user, per year. Given the significant cost, it is clear that a one-dimensional grading model is not suitable for research. A derivative of the model used by eBay and Airbnb could form a sound [basis for rating](https://www.financedigest.com/fed-officials-still-leaning-to-75-basis-point-rate-hike-in-july.html "Fed officials still leaning to 75-basis-point rate hike in July") research, as the multiple layers will enable consumers to grade the various criteria that will form part of such an evaluation method, including a ‘substantivity’ test as implicitly required under MiFID II.

The problem with many grading systems is that they eventually become profligate – [drivers with Uber](https://www.financedigest.com/french-uber-drivers-to-earn-more-than-8-per-ride-after-union-deal.html "French Uber drivers to earn more than per ride after union deal") ratings below 4.6, and private sellers on eBay with ratings below 98.4 struggle to do business. As there is no [vetting prior to admission – anyone can offer their services or products – the rating system](https://www.financedigest.com/portugal-approves-new-vetting-system-after-string-of-hiring-scandals.html "Portugal approves new vetting system after string of hiring scandals") itself filters out less performant offerors over time. This is inefficient because the range of scores becomes so narrow that it is impossible to distinguish between the great and the good. This may not matter when choosing a taxi as the prices from different drivers will be the same, however, it becomes very important when two offerings for a similar product. European Equity Research for example, may well have a large price difference.

Ideally, [consumers will be able to purchase research from a trusted](https://www.financedigest.com/trusting-in-trust-marks-enhancing-consumer-trust-in-your-ecommerce-business.html "Trusting in trust marks: enhancing consumer trust in your ecommerce business ") marketplace where all the offerings have met certain standards prior to their inclusion. This will both save time and ensure that the scores are graduated enough to identify differences. When combined with price and precise coverage information, research buyers will have real choices based on a large number of objective ratings – participation in most commercial grading models is optional, not so for research.

**What to evaluate**

Another issue is deciding what should be evaluated. Some discussions have concluded that evaluations should only be made at the analyst or even firm level. This is a mistake, as such an approach will have little granularity and will not cope with the [huge changes to the industry that are likely to follow](https://www.financedigest.com/uk-watchdog-contacts-banks-following-huge-withdrawal-of-mortgage-deals-ft.html "UK watchdog contacts banks following huge withdrawal of mortgage deals -FT") MiFID II. As research becomes a significant cost, [consumers will demand](https://www.financedigest.com/global-emi-shielding-market-significantly-hit-by-lack-of-consumer-demand-scenario-post-covid-19-crisis-likely-to-remain-gloom.html "Global EMI Shielding Market Significantly Hit By Lack Of Consumer Demand; Scenario Post Covid-19 Crisis Likely To Remain Gloom") more choice. For example, socially-conscious or green [funds will only want to buy research on equities](https://www.financedigest.com/global-equity-funds-attract-inflows-for-second-week-in-a-row.html "Global equity funds attract inflows for second week in a row") that match their eligibility criteria. Other factors such as geography, sector and size may not be relevant. Unless individual [research reports](https://www.financedigest.com/odor-detection-equipment-market-research-report-overview-with-geographical-segmentation-by-revenue-with-forecast-2028.html "Odor Detection Equipment Market Research Report: Overview With Geographical Segmentation By Revenue With Forecast 2028") have been evaluated, it will be nigh-on impossible for the green fund managers to select the appropriate research using measurable and objective criteria.

Analyst- and firm- ratings can be extrapolated from the ratings given to individual units of research, providing that firms performing evaluation using a standardized methodology and agree to [share results](https://www.financedigest.com/rouble-steadies-near-60-vs-dollar-tcs-m-video-shares-down-after-results.html "Rouble steadies near 60 vs dollar; TCS, M.Video shares down after results") – doing so on a strictly anonymous basis make the most sense.

The four tests for ‘substantivity’ set out in the FCA handbook are eminently sensible and should be at the heart of any evaluation method. They include adding value to investment decisions via new insights; representing original thought and not repeating what has been said before, having intellectual rigor and not stating the obvious and having meaningful conclusions based on analysis.

The easiest way to incorporate them is to use a model that combines labels and ratings. Labels work by enabling the evaluator to rapidly provide feedback that is richer than a grade on a linear scale. Such labels are grouped together as responses to a question. Ratings, on the other hand, [provide criteria of common interest to most potential](https://www.financedigest.com/french-cloud-provider-ovh-lines-up-diesel-generators-to-offset-potential-power-cuts.html "French cloud provider OVH lines up diesel generators to offset potential power cuts") assessors that are graded on a linear scale (typically 1-5 stars).

**Meaningful evaluation**

The [research industry](https://www.financedigest.com/water-soluble-vitamins-market-industry-research-segmentation-key-players-analysis-and-forecast-to-2029.html "Water Soluble Vitamins Market Industry Research, Segmentation, Key Players Analysis and Forecast to 2029") is going through radical change and this will accelerate post-MIFID II. A new evaluation methodology is needed and will have a variety of applications. Initially ratings will be made post-purchase, primarily for regulatory reasons. As the amount of data grows, and providing results are shared, it will become an important tool in pre-purchase decision making. It will also be used to measure performance internally, and help solve the old problem of to make or to buy, as many buy-side firms expand the own research departments to reduce costs.


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