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MiFID II: the research enigma

MiFID II's new fee regime has revamped the research market and ushered in new approaches to corporate access

Since the implementation of the second Markets in Financial Instruments Directive (MiFID II) in January 2018, the investment research industry remains in flux as sell-side firms and asset managers adjust to the new regime of unbundled fees, and new business models take shape. Amid the growing disintermediation of banks and brokers as 'corporate access' channels, companies are boosting their investor relations functions to deal with fund managers directly while technology providers are emerging to match investors with smaller firms that might have challenges in marketing their business widely.

Key insights:

  • New fees regime under MiFID II has put additional pressure on broker commissions
  • Asset managers are more reluctant to use brokers to arrange corporate access, prompting companies to conduct their own outreach through investor relations units
  • Impacts of reforms have attracted regulator scrutiny amid concerns that cheap research may be employed as as an inducement to trade

Putting a new price on research

As part of the investor protection framework under MiFID II, investment firms are now required to pay for research rather than receive it free or bundled with trading commissions to minimize actual and perceived conflicts of interest. The reforms also compel banks and brokers to charge for corporate access, including face-to-face meetings with company management.The impact of the reforms has been swift and dramatic, with evidence of an exodus of sell-side analysts and significant reductions in research fees.1 Amid concerns of a decline in analyst coverage of smaller companies the Financial Conduct Authority (FCA), the United Kingdom's regulator, has launched a probe into the effects of MiFID II on the research industry.

Broker commissions under pressure

The price of research has dramatically declined, with some larger banks offering their entire portfolio of published research for as little as USD 10,000 per annum.This is significantly less than the six-figure costs that were mooted a year ago.2 The discounting has been accompanied by reports of analyst redundancies which has triggered concerns about the quality of intelligence that may be produced by stripped- back research units.3

Broker commissions have also come under pressure following the implementation of MiFID II. Commissions paid by asset managers to UK banks and brokers have dropped by nearly a third since MiFID II's reforms were implemented in January 2018, according to financial technology company ITG.4 The downward pressure on commissions has also been noted in other EU jurisdictions. Commissions had been expected to decrease as more fund managers switch to algorithmic trading but not at such a rapid pace.

Andre Nogueria, ITG director of trading analytics noted that, “A fall in execution rates was always likely, but not to this extent." 5

Companies beef up investor relations units

MiFID II's requirements for banks and brokers to charge for corporate access have prompted asset managers to seek alternative ways of acquiring investment intelligence, not only to reduce fees paid to intermediaries, but also to avoid the potential risk of non- compliance.In a recent survey by Capital Access Group, more than half of asset managers said that under MiFID II they would be unlikely to pay a broker to set up a company meeting, while 68 percent said they would not pay a broker to set up a meeting with a company in which they did not own shares.6 

The impact of the reforms has been swift and dramatic, with evidence of an exodus of sell-side analysts and significant reductions in research fees

Conferences organized by banks and brokers to bring investors and companies together have also been affected, with many asset managers unwilling to pay attendance fees.The decline in broker-organized events, however, has been offset to some extent by an increase in events organized by companies' investor relations teams. A survey by investment data firm Ipreo found investors have become more accepting of attending such events, even without the attendance of the companies' senior managers. “We expect IROs to increasingly be the sole representative of their companies at marketing events," Ipreo said in its 2018 Corporate Access Survey.7

Technology providers who match investors and companies are also finding a niche in the post-MiFID II world, particularly in serving small and mid-cap firms that may not have the resources to organize proprietary road-shows or arrange other direct marketing efforts. Some large European stock exchanges have also offered to market small-cap companies' research at discounted rates, including Paris-based Euronext, which publishes research for more than 400 of its listed firms for free in collaboration with Morningstar.8

MiFID II impacts attract regulator scrutiny

Technology providers who match investors and companies are also finding a niche in the post-MiFID II world

The fall in the price of research has raised concerns about the quality of the information produced and the sustainability of the industry overall. The FCA announced in June 2018 that it would investigate the impact of the MiFID II reforms on the investment management industry, including the research market.9 Banks that offer their suite of research to clients at favourable rates may still be seen to be offering inducements for clients to trade, which could be considered a breach of the rules. While the market is still assessing the appropriate price for research, the FCA is likely to have two aims, according to Andrew Glessing, head of regulation at asset management consultancy Alpha FMC.

“Firstly, in a changing investment research market, is the new model delivering the inducement-free outcomes it seeks? And secondly, can firms demonstrate that they have embedded the right governance and controls needed? Time will tell."10

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Sources

  1. Financial Times (June 23, 2018) MiFID II leads to exodus of sell-side analysts
  2. Financial Times (June 18, 2018) FCA to launch asset management MiFID probe
  3. Australian Financial Review (July 8, 2018) Investment banks face more research pain
  4. Citywire (June 5, 2018) UK broker commissions tumble as MiFID II bites
  5. Ibid.
  6. Financial Times (April 21, 2018) Corporate access: death of the go-between?
  7. Ipreo (July 2018) Corporate access survey 2018
  8. Financial Times (January 29, 2018) Mifid II pushes exchanges to lend helping hand to small companies
  9. Reuters (June 19, 2018) FCA to investigate impact of EU asset management rules after criticism
  10. Ibid.