A recap on the disruptive impact of Mifid II
Mifid first came into our capital market lives 10 years ago. Since November 2007, it has been a primary reference point and the driving force of the EU’s regulation of the financial markets.
Ten years on and with the worst economic downturn behind us, Mifid’s next generation – Mifid II – is about to disrupt our working practices once again as it comes into force in January 2018. It is aimed, among other things, at unbundling broker commissions and this time it is far-reaching, more stringent, certainly means business and has significant cost implications.
It touches many aspects of the securities market, but there are two main areas of concern for IR teams. Equity research teams are expected to charge fund managers for each piece of research. If a fund manager can’t justify such a purchase, he/she is expected to pay out of his/her personal funds.
As a practical implication, the pressure on banks to have revenue-generating, efficient research teams that justify their existence independently has already resulted in significant restructuring, shrinking and – in some cases – termination of research teams. It is a tricky balance to reach: price your research too high and investors will find an alternative, too low and the quality will suffer.
Those who survive will increasingly come under tremendous pressure to monetize their time, which in turn will translate into very selective stock picking for continuous coverage, as liquidity and potential for a return are likely to be the key selection criteria.
Consequently, many small and mid-cap stocks will be dropped and IROs will lose a good proportion of their allies and cheerleaders in the market. If you are lucky and your analyst coverage continues to be reasonably stable, it is worth bearing in mind that the time spent by an analyst on each stock would in future have to be reduced dramatically in order to deliver the required monetization. This is also likely to put the quality of the research at risk.
The same pressure is likely to lead to deteriorating quality of the publicly available consensus, as analysts would have little incentive to provide their research to third-party aggregators.
End of the global research model
To complicate things further, Mifid II is on a collision course with existing US regulation. Under current guidelines, European fund managers may be unable to buy research from US research teams unless banks create ‘fiduciary duty’. This would be operationally complex and financially costly, according to a number of legal advisers, as it requires a full spectrum of activities such as an internal reassessment of what ‘best execution’ means, externally communicating these criteria to the sell-side teams, and investing in technology to ensure effective monitoring. This means the current global research service model will no longer work.
Unbundling of the broker commission will result in transparent and clear corporate access pricing. This will hand over to fund managers the decision on who and when they would like to meet, and how much they are prepared to pay for it. It also implies that the traditionally complimentary corporate broking services to corporate clients would have to be charged for. Being taken on a roadshow by your broker will no longer be free of charge.
Commercializing corporate access
What are the latest developments? Talks between regulators, the sell side and fund managers continue, but all parties don’t have much time left to negotiate. According to the implementation timetable set by the European Securities and Markets Authority (Esma), on July 3 this year ‘Mifid II transposes into the national law of member states’.
In preparation, Esma published its updated Q&A paper providing further clarity on how this new regulation should be interpreted by the market players, especially in relation to corporate access. It is brutal and very clear in stating that:
– Corporate access cannot be justified as research
– Services provided by the broker that ‘are by their nature exclusive, such as individual meetings or field trips with an issuer, may involve the allocation of valuable resources by the provider and/or have a value to the recipient’ cannot be considered a minor non-monetary benefit
– Commercial levels for the pricing of corporate access services must be applied at all times and ‘not linked to or dependent on payments for research or execution services where the provider offers these other Mifid services’
– Arranging meetings with issuers directly ‘and/or paying for a third-party corporate access service provider that does not provide other Mifid investment services’ is referred to as new best practice as ‘this removes the primary potential conflict of interest or inducement risk.’
In addition, the UK’s Financial Conduct Authority is expected to make public all final Mifid II requirements in June and has already addressed in various statements the issue of accountability of senior managers and boards under the new Senior Managers and Certification Regime. We anticipate that other EU member states will follow soon.
Marina Zakharova de Calero is CEO at Conduit Communications