A new law in the European Union is in the early stages of being implemented that will require, as Margot Patrick and Juliet Samuel write in their Wall Street Journal article, New Rules Reshape Research Sector, “investment managers, such as those at hedge funds, to pay specifically for any analyst research or services they receive.” Some people are claiming that this law will be good by fixing an old outdated system where as Matt Levine writes in his article, Valuing Analysts and Hedging Death, “High finance operates on basically a gift economy, in which many goods and services — sports tickets, strategic advice, jobs for relatives, investment banking research — are given away to create goodwill in the recipient. The recipient is then supposed to reward the donor with lucrative merger mandates or trading commissions, but not in a straightforward transactional way. That would be crass. This is about relationships, not a mechanical balancing of accounts.” While I agree that this system is outdated, I am going to argue that this new law is going to lead to less regulated markets in two distinct unintended ways that create a system worse off than before.
The first unintended consequence of this law will be that some people and organizations will get information before others. Whoever pays the most will have first access to research and therefore be able to act on this research before others. This will create an even greater imbalance in the stock market towards large institutional investors (such as hedge funds) over individuals. The large hedge funds will be able to pay the most for this research and act upon it before others may even receive this research. This will lead to a market where firms pay extra to have these research reports before their competitors. You could have already purchased a report, but not received it because your competitor paid twice as much to receive it before you. This will create an imbalance and a largely unregulated market of firms having access to more resources and research than their competitors, not leveling the playing field in the slightest.
The second consequence of this law will be that it “could be most damaging for small brokers, particularly those specializing in less-traded stocks from smaller companies. Those brokers could end up out of business, if money managers use less research and fewer providers, industry officials said.” This will not only be devastating for smaller brokers, but will create a relatively large sector of smaller companies whose stocks don’t trade as frequently largely unregulated. This will leave certain companies without any research done on them, which could potentially leave companies susceptible to being part of a bubble because of lack of research on them. At the very least this lack of research will reduce the amount of transparency in this part of the market, the opposite effect of this new law.