Mifid II: How IROs should react to the changes ahead
With asset managers and investment banks in the spotlight for Mifid II, it would be easy to think they are the only ones affected. The reality, however, is very different. Mifid II aims to inaugurate a new era of transparency in institutional investment, to the benefit of the end-investor.
For companies, particularly those with lower levels of liquidity and market capitalization, its impact on asset managers and investment banks has a knock-on effect set to bring significant challenges. IROs are caught in the middle and must adapt to dwindling research coverage, while taking greater control over the strategy, targeting and communication of their IR programs.
Mifid II is a catalyst for the contraction of the traditional buy-side and sell-side models. At the heart is the unbundling of research, a core prescription that ends the model of funding through dealing commissions. On the buy side, a number of funds may follow Woodford Investment Management in shifting the costs of research to their P&L, placing the onus on portfolio managers to justify the use of externally produced research. Whether other investment managers emulate this or instead pass on their research spend to asset owners via research payment accounts, the net consequence will be increased pressure to reduce the reliance on sell-side reports.
A consequence of the crackdown on research expenditure and commissions – a recurring theme of the post-crisis years that saw global equity-related commissions declining by 43 percent between 2007 and 2012 – has been a concerted shift toward more liquid, typically large-cap stocks. A secondary implication is that corporate access offerings are coming under pressure.
Alongside rising regulatory scrutiny, weaker incentives to promote small and mid-caps mean roadshows and other marketing activities tend to be reserved for deal-related campaigns rather than steady outreach. Anchoring roadshows around deal flow makes for an inconsistent approach to IR for less frequently traded companies that want to build steady momentum during early phases of growth.
So how should small and mid-cap IROs respond? An immediate conclusion is that they must take the lead in clearly communicating the investment case. Paucity of research makes it likely a company will be overlooked by portfolio managers, so IROs should have the key aim of improving coverage, whether by developing relationships with sector-specific and generalist sell-side analysts, or by working with independent research providers.
The simultaneous contraction of the buy-side and sell-side models also forces companies toward a reduced group of larger funds, limiting options when it comes to developing a strong and more diversified register. It also completely ignores the large pools of private wealth assets that have been steadily increasing since 2008.
IROs must therefore lead in the strategic targeting of new investors, as well as in the prequalification of roadshow meetings, to ensure an adequate return on senior management time. Nurturing feedback mechanisms with the market is also paramount. The best IR embraces both the good and the bad as a means to develop its strategy; shedding light on investor concerns through open communication channels is an integral part of this.
In summary, Mifid II, by unbundling research and contributing to the contraction of the traditional buy-side and sell-side models, adds to the burden on IROs, especially in the mid-market. These changes come at a cost, now borne by companies as the sell side withdraws from funding corporate access and research out of commissions. That said, an unintended consequence of the evolution of institutional investment may be a move toward a new standard of IR, concentrating greater expertise in-house and taking a smarter, fundamental approach which promises to create longer-term shareholder value.
Rachel Carroll is global head of investor access at Edison Group