Thin Files, Wider Spreads: The Unbundling Hangover in UK Small-Caps

Unbundling is usually treated as a procurement question: who pays for research, and how much? That framing is too narrow. In the UK small- and mid-cap market, the move away from bundled commissions has altered the economics of information production itself. The consequence is not a sudden blackout but a gradual thinning of the files on which investors, lenders and advisers depend. By 2026, that thinning is visible in wider spreads, patchier coverage and a more fragile price-discovery process.

A market that runs on attention

Small-cap equities are not merely large-caps with lower liquidity. Their investment case often rests on company-specific information: contract wins, management change, balance-sheet headroom and the credibility of a strategy that has limited public history. Sell-side analysts performed a useful function in gathering and testing that information, even when their conclusions were wrong. The revenue model mattered because it funded continuous coverage of companies that generated little trading commission.

MiFID II, implemented in the UK in 2018, forced asset managers to separate research payments from execution. The policy intent was sound: clients should not pay for research they did not consume, and conflicts should be exposed. The commercial effect, however, was a sharp reduction in the research budgets of many mid-tier managers. Research payment accounts proved administratively cumbersome and rarely scaled. Coverage of smaller companies was an early casualty.

What unbundling changed

The first-order effect was fewer analysts covering fewer names. The second-order effect was more important: coverage became concentrated in companies large enough to command investor attention or to sponsor their own research. For a FTSE SmallCap or AIM company outside the top tier, the gap between formal coverage and no coverage at all widened. Some retained one or two brokers; others relied on corporate access events and occasional initiation notes.

That matters because research is not simply a source of recommendations. It is a mechanism for standardising disclosure, testing management claims and creating a common language around valuation. When coverage thins, the burden shifts to buy-side analysts, many of whom run multi-sector mandates and cannot replicate the same depth. The market does not become uninformed, but it becomes less evenly informed.

Price discovery pays the price

Wider bid-ask spreads are the most visible symptom. Market makers price uncertainty, and uncertainty rises when there are fewer independent estimates of earnings, cash flow and asset value. A thin research file does not by itself cause a wide spread, but it compounds the reluctance of liquidity providers to commit capital. In stressed conditions, the effect can be self-reinforcing: wider spreads deter trading, less trading reduces the value of coverage, and weaker coverage widens spreads further.

The cost of capital follows. Investors demand a larger discount for information asymmetry, particularly in secondary fundraisings and initial public offerings. Founders often interpret a low valuation as a market judgment on the business. Sometimes it is. But part of the discount may be a liquidity and information premium that has little to do with operational quality. That distinction is easily lost in boardroom discussions.

The independent research response

The gap has not gone unfilled. Independent research providers, specialist brokers, credit research houses and data platforms have expanded their offer. Some operate subscription models; others provide issuer-sponsored research with clear disclosure. The result is a more fragmented market for information, with greater variety but less consistency. Quality ranges from rigorous fundamental work to marketing dressed as analysis.

This fragmentation creates a new governance task for investors. They must assess not only the conclusion but the commercial relationship behind it. Issuer-sponsored research can be valuable, particularly when it follows a transparent template and is distributed widely. It cannot, however, replace the adversarial scrutiny that a competitive analyst community once provided. The answer is not to ban sponsorship but to make its terms visible.

Regulatory direction has also shifted. The UK's Investment Research Review, published in 2023, recognised that the post-unbundling settlement had imposed costs on smaller companies and recommended a more flexible approach. The FCA has since consulted on changes designed to reduce friction while preserving investor protection. Reform is welcome, but it would be unrealistic to expect rule changes alone to recreate a revenue model that the market has already abandoned.

A coverage agenda for 2026

A credible response has three parts. First, disclosure should be standardised and machine-readable, so that basic financial and governance information is cheap to process. Research is more valuable when it builds on a reliable public base. Second, issuer-sponsored research should be governed by clear conflict-management rules and wide distribution, not confined to a favoured circle of investors. Third, investors should treat coverage as a portfolio risk factor, not a convenience. A small-cap holding without independent scrutiny deserves a larger margin of safety.

None of this is a plea for a return to bundled commissions. The old model had real conflicts and was poor at demonstrating value. But unbundling has exposed a collective-action problem: information about small companies benefits the market as a whole, while the cost of producing it falls on a shrinking number of payers. Until that problem is addressed, the UK small-cap gap will not close simply because valuations look attractive. Thin files make for wider spreads, and wider spreads make for a higher cost of capital. That is the quiet price of the research deficit.