The US vs Mifid II: A regulation clash
A number of areas are set to cause contention as the upcoming pan-European regulation, Mifid II, comes into play. One major flashpoint is the treatment of corporate access, which has become more problematic as EU regulators are favoring the UK’s more stringent interpretations of the rules.
Corporate access under Mifid II
In its April Q&A relating to research inducements, the European Securities and Markets Authority (Esma) clarified its position on corporate access payments, largely in favor of the UK’s stricter view.
Esma believes vanilla corporate access – namely, arranging a meeting – does not meet its test of what qualifies as research and therefore cannot be paid through research payment accounts (RPAs) funded with client assets. This corresponds to the UK’s position, first implemented in 2014. Esma cites ‘field trips, conferences and individual meetings involving a corporate issuer and facilitated by an investment firm’, indicating that these activities fall under the umbrella of vanilla corporate access, even where the services are exclusive to a limited set of asset managers.
Esma also nixes the bundling of corporate access with standard analytic coverage of a stock, as originally floated by French regulators. Instead, Esma requires brokers to ensure their research pricing and research payments received from asset managers do not subsidize a charge for the corporate access (concierge) service.
The European regulator does, however, agree with French regulators that under certain conditions corporate access could be considered a minor non-monetary benefit (and received for free). One such example would be roadshows that are ‘freely and publicly open to analysts from investment firms and other investors’.
Esma is silent on the subject of corporate access that has been combined with analytic involvement but, given its research definitions, enhanced corporate access is likely to be acceptable for payment from RPAs when combined with a higher-value service, as outlined by French regulators in their consultation paper.
US treatment of corporate access
Under US regulation, corporate access is considered a legitimate research expense payable with client commissions. In its 2006 interpretive release on soft dollars, the SEC explicitly condoned corporate access as meeting the eligibility criteria for ‘research services’ as defined in Section 28(e) of the Securities Exchange Act of 1934, which allows the use of client commissions to pay for research. Specifically, the SEC wrote:
‘Meetings with corporate executives to obtain oral reports on the performance of a company are eligible because reasoning or knowledge will be imparted at the meeting (ie, reports) about the subject matter of Section 28(e) (ie, concerning issuers). Seminars or conferences may also be eligible under the safe harbor if they truly relate to research – that is, if they provide substantive content relating to the subject matter in the statute, such as issuers, industries and securities.’
For this reason, corporate access remains one of the most valuable research services in the US, ranked either first or second in surveys of buy-side commission spending.
The differing regulatory treatments of corporate access are not a new phenomenon because UK regulators banned the use of client commissions to pay for corporate access in 2014. Mifid II will broaden the problem from the UK to all of the EU, but does not change the essential issue.
As a result of the UK ban, more corporate access activity has gravitated to the US, and Mifid II will continue that trend. For global asset managers it is often easier to teleconference events from the US or rely on US staff for the interactions. Mifid II will accelerate a preference for US-based activity wherever possible.
In Europe, corporate access events will be more actively chaperoned by security analysts to provide ‘substantive’ value, in an effort to justify activity as meeting research criteria. Also, the increasing importance of interaction metrics in the buy-side calculation of research value will lend support to European corporate access activity. Even though vanilla corporate access interactions will not be a valid basis for research payments under the new regulations, many of the metrics are supplied by vendors specializing in aggregating corporate access calendars.
Brokers supplying corporate access events will be well represented in the metrics, even if they cannot be paid explicitly for vanilla access.
New corporate access platforms
The advent of Mifid II unbundling has spawned many new platforms seeking to benefit from regulatory change. There are at least a dozen corporate access platforms competing for the attention of investors and corporates. By our count, six firms seek to set up direct meetings between corporates and investors, disintermediating the role of investment banks: Paris-based MyDCA, Swiss Interaction Partners, US-based Meetyl, UK-based ingage, emerging markets-oriented Closir and the London Stock Exchange’s ELITE Connect.
The platforms serve a useful purpose for the under-served segments of corporate access, especially smaller publicly traded companies. For small-caps, the platforms are supplemented by issuer-paid research firms, which offer corporate access as well as paid-for research coverage. Such firms include Edison Group, LifeSci Advisors and Sidoti & Company.
For large and mid-sized public companies, however, investment banks are likely to continue to be major conduits for corporate access. Partly this reflects the ongoing ability to be paid by investors for corporate access outside of Europe, and partly flows from ongoing investment banking relationships.
The resilience of investment banks
Although we don’t expect the corporate access marketplace to be radically transformed by the new Mifid II research-unbundling rules, the increased restrictions on payments for vanilla corporate access will have consequences.
Reduced payments will shrink European corporate access infrastructure and European asset managers will be more likely to embrace do-it-yourself platforms. As investment banks rationalize their research services in the wake of reduced buy-side payments, corporate access teams will not be immune. But it would be a mistake to underestimate the creativity and resilience of the investment banks, or their commitment to corporate access.
Sanford Bragg is a principal at Integrity Research Associates