European small-cap coverage increases since Mifid II

Feb 10, 2021
Research shows biggest coverage cuts have been among mega-cap companies

European small-cap coverage has actually increased since the introduction of Mifid II in 2018, according to the latest research from IR Magazine.

The Global Investor Relations Practice Report 2020 shows that small-cap companies in Europe now have an average of 6.2 covering analysts, up from 5.7 in 2019. Interestingly, this is actually higher than the global average, where small caps have just five covering analysts, down from 5.4 in 2019.

Mifid II, which came into force across Europe in January 2018, was expected to have a big – and detrimental – impact on small-cap coverage. Instead, IR Magazine’s research shows that there has been something of a ‘rebalancing’, with European mega-cap companies shedding an average five covering analysts to a still respectable 22 in 2020, down from 27 in 2019.

Globally, all cap sizes have seen at least some reduction in analyst coverage between the 2019 and 2020 reports but, again, mega-caps lead on the cuts: down to an average 21.5 analysts from 25.5 in 2019.

Laura Hayter, CEO of the UK’s IR Society, says coverage numbers – and quality – have been an issue, at least anecdotally. ‘Over the period since Mifid II was introduced, we have heard from member IROs that the consistency and quality of research has become sporadic, with cost pressures and the changing market dynamics in some instances leading to a contraction in sell-side coverage,’ she tells IR Magazine.

She adds that the IR Society is currently working on its own study into how the wide-ranging regulation has impacted the IR role and the market for information.

Differing predictions

While anecdotally we have been hearing about a significant hit to small and mid-cap coverage across European firms post-Mifid II (and indeed as part of a wider trend that began long before the contentious regulation was enforced), some research indicates that the regulation has already had a positive effect on these smaller firms.

‘Contrary to industry concerns, the drop in analyst coverage has not come [to affect] small or mid-cap firms but rather is concentrated among large firms,’ wrote Yifeng Guo and Lira Mota, PhD candidates at Columbia Business School, in IR Magazine last year. The pair investigated the impact of unbundling on sell-side research, looking at analyst coverage of public firms in the US and the EU from 2014 to 2018. They found that while coverage of EU public firms decreased in general (by 7.67 percent relative to the average coverage of these firms prior to Mifid II), the coverage quality actually improved.

Forecast errors decreased, while ‘individual forecasts became more informative and capital markets responded more significantly to analyst forecast revisions.’

Guo and Mota conclude that ‘the unbundling requirement in Mifid II has enhanced analyst competition’. A finding they say ‘speaks directly to the competition story’ is the outsized – and unexpected – impact on large companies. ‘When looking at the size of the firm in particular, small and mid-cap firms’ coverage remains almost unchanged,’ they write. ‘By contrast, large firms’ coverage has dropped on average by 10.74 percent.’

Rolling back the years

The coming years might see a further boost to small-cap coverage after the European Commission (EC) proposed an exemption to unbundling rules for research on companies of less than €1 bn ($1.2 bn) in market cap in a bid to stimulate the market, wrote Tim Human in the winter 2020 issue of IR Magazine.

Announced in July last year, the EC’s proposals would free asset managers from unbundling rules where the research covers companies under €1 bn in market cap, calculated by looking at a 12-month average, explains Human. To make use of the exemption, investors would have to enter into an agreement with the research provider and inform the client. Fixed-income research will also be exempted from unbundling under the changes.

Human’s article notes a mix of responses to the proposed rollback, which was heartily welcomed by some. Others, including brokers, said its impact would be limited because it would essentially add another layer of complexity to an already complicated system – one that firms have spent significant amounts of time and money implementing.

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