UK free-market think tank the Institute of Economic Affairs (IEA) has issued a report criticizing what it calls Mifid II’s ‘unintended consequences’.
The report, written by IEA senior economist Catherine McBride, states: ‘One year on, many practitioners’ initial fears about Mifid II appear to have been realized, especially with regard to unbundled research causing a reduction in the amount of research available on smaller companies.
‘While regulation of financial services is generally seen as necessary to protect investors from unscrupulous agents, it may in fact have the opposite effect… Excessive granular regulations increase the cost of doing business and so deter new firms from entering the market or force smaller firms to merge, thereby reducing consumer choice, increasing prices, entrenching established providers and eventually leading to the formation of oligopolies.
‘EU financial regulation has also tended to increase salary expenses and capital requirements, making UK investment firms less competitive than their international rivals as well as reducing investment in small and medium-sized [enterprises] (SMEs).’
The report asserts that in order for the financial sector in the UK to remain relevant as well as vibrant, competitive and innovative in the future, it is important that regulations ‘do not hinder new market entrants, innovators and scale-up companies’.
And yet it warns: ‘The most consistent problem raised with Mifid II, as with most EU regulations and directives, is that it disproportionately affects SME companies that must employ more compliance staff and increase their computing capacity just to cope with the regulatory requirements.
‘Mifid II has added an extra layer of regulation and has been described as ‘the greatest job creation mechanism in the world’. Certainly, it is responsible for much of the recent growth in employment in financial service providers. While increased employment may sound positive, if the regulation is not solving a problem, it is not. Compliance is purely a cost center and makes EU-based banks less competitive in international markets.’
In this way, Brexit offers the UK financial services industry an opportunity, notes the report: ‘While some regulation of financial markets may be necessary, there is an opportunity for the UK’s financial market authorities to review and amend current regulations when the UK leaves the EU.
‘In particular, it is important to consider the effect on competition in the marketplace when evaluating the economic impact of regulation, as well as whether the regulation is achieving its intended result. If regulation is left unchecked, the provision of financial services in the UK may eventually be controlled by large oligopolies, to the detriment of both consumers and market stability.’
Therefore, the report makes a number of observations and recommendations:
● UK firms that do not trade in the EU market should not be required to comply with EU regulation. In an international marketplace, Mifid II is disadvantageous to UK companies competing with non-EU firms, dealing in US dollar-denominated instruments and servicing non-EU people who do not need to comply with EU regulations
● Regulations should be proportionate to the size and age of the firm to actively encourage new market entrants
● Unbundling research payments from dealing fees has allowed multinational investment banks to devastate independent research providers. While this will be hard to reverse, allowing firms to give away research if they wish to should not be an offense and could help smaller firms remain on investment managers’ brokerage lists
● Unbundled research payments are reducing the amount of analyst coverage available on SME companies and thus reducing the amount of interest in Aim-listed and start-up companies
● Falling liquidity in both the bond and equity markets increases price volatility and investment risk. Returning to or introducing a new market-making system, a specialist system or encouraging arbitrage trading could improve liquidity for investors.