Price formation of FICC research following MiFID II unbundling rules

Abstract

Purpose

Traditionally, full-service broker/dealers catering to institutional investors have bundled trade execution with investment research. Since 2018, new market regulation has forced broker/dealers to 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, currencies and commodities (FICC) research provider faces a linear demand function and picks an appropriate price schedule.

Findings

It is shown that it is important to initiate the price discovery process using a low price and that some broker/dealers will not be able to identify a regulatory compliant price/quantity solution because their research-production fixed cost is very high compared to the research demand function they face.

Practical implications

There are three main findings from our model: pricing research at cost is not always possible; if there is a unique solution, an iterative approach only works when starting off with a low-enough initial price; and if there are two solutions, only the low-cost/high-volume solution can be discovered in an iterative process.

Originality/value

The results presented are important to broker/dealers about to discover the market demand for their FICC research publications on the back of the implementation of MiFID II. Having distributed FICC research for free in the past, they have no knowledge about the demand function (other than what is demanded at a price of zero). Because research publications are highly differentiated products, observing the pricing of competitors is insufficient. Iteratively gaining knowledge about the demand function using price adjustments and customer questionnaires becomes the most likely mean for discovering the demand function. It is important to initiate the price discovery process with a low price. Some broker/dealers will not be able to identify a regulatory compliant price/quantity solution because their research-production fixed cost is too high compared to the research demand function they face. Finally, it is shown that these broker/dealers with two possible equilibriums face difficulty in identifying the high-price/low-volume research equilibrium because of the non-converging nature of the iterative process.

Citation

Tata, F. (2020), "Price formation of FICC research following MiFID II unbundling rules", Journal of Financial Regulation and Compliance, Vol. 28 No. 1, pp. 97-113. https://doi.org/10.1108/JFRC-02-2019-0018