What does the future hold for Mifid II's unbundling rules?

Dec 03, 2020
Tim Human analyzes the European Commission’s proposal to soften payment rules for small and mid-cap company research

It didn’t take long for Europe to roll back some of the strict rules surrounding research payments contained in Mifid II. As part of a Covid-19 relief package, the European Commission (EC) has proposed an exemption to unbundling rules for research on companies of less than €1 bn ($1.2 bn) in market cap. The aim is to stimulate more research on smaller issuers, which have witnessed declining analyst coverage for a number of years.

The tough unbundling rules contained in Mifid II, which force investors to pay for research either out of their own pocket or via a research payment account, were promoted by the UK’s regulator but opposed by authorities in France and Germany. With the UK now out of the EU, the field is clear to unpick some of the more contentious elements of the legislation.

Research rethink

Announced in July, 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. 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.

‘The exceptional circumstances resulting from the coronavirus pandemic have instilled a sense of urgency into the debate on investment analysts’ research,’ says the EC. ‘Increasing the visibility of European companies, in particular [small to medium-sized enterprises (SMEs)], to investors will promote more investment for the economic recovery.’

One advocate for such a change is DIRK, the German IR association. ‘Mifid II is, as expected, having a huge impact on research on small companies: it’s dead,’ says general manager Kay Bommer. ‘My hope was always that we would have more paid-for research but that hasn’t materialized yet.’

Critics have been quick to highlight perceived flaws in the plan, however. Some argue a return to bundled commissions for SMEs will be unworkable, given that asset managers will be unwilling to operate two separate systems for payments.

‘I would consider [the impact of the Mifid II rollback] as limited,’ says Cyril Gérard, head of corporate brokerage at Paris-based Kepler Cheuvreux. ‘The trend of less research on smaller companies is not going to be slowed. The main pushback I have seen on this evolution is that it is already very complicated for asset managers to evaluate the service of a broker. They are not going to add an extra layer.’

‘I don’t expect this to make a meaningful difference,’ agrees Clive Murray, head of equities at Investec. ‘It’s going to be very difficult for the fund managers. You’ve got Mifid systems that took a lot of effort to set up, which you would now have to undo in order to ‘rebundle’ research and trading. It’s another layer of complexity that I imagine they will not adopt.’

For the changes to have a chance of success, the EC would need to broaden the exemption beyond €1 bn, Murray says. He suggests €5 bn as a ‘more meaningful number’ that would allow firms to grow significantly without hitting the threshold and triggering changes in the way research is funded.

This is an extract of a feature from the Winter 2020 issue of IR Magazine. Click here to read the full article.

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