MiFID II: Preparing for uncharted territory
London, 26 May 2017, Across Europe, the investment industry is preparing itself for the introduction of a revised Markets in Financial Instruments Directive (Mifid II) in early 2018. There is little doubt that these new rules will bring far-reaching changes that will have a profound effect on operations right across the financial services sector and will inevitably impact how companies in the healthcare sector communicate with investors.
Perhaps the most widely publicised change under the new regime will be the requirement for fund management companies to explain clearly to their investors how much of their money is spent on research, significantly impacting the way financial research will be produced, distributed and consumed. Traditionally, research conducted by sell-side analysts has been sent to fund managers for free in return for the business asset managers provided to banks and brokerages through placed trades. The cost of the research was then “bundled” into the price of trading along with other related services, such as direct access to the analyst or corporate client through the bank. In addition to the unbundling of written research, ESMA, the European body charged with enforcing the rules has made it clear that it sees services such as the provision of corporate access, often regarded as one of the major value adds for the buy-side, as a source of potential conflict of interest and therefore a service that cannot be paid for from research payment accounts.
It would seem that the priorities for fund managers and investment bankers are clear. For buy-side investors the challenge will be getting the most bang for their buck; obtaining the best quality research efficiently and at a reasonable cost whilst maximizing the use and effectiveness of in-house research. From the sell-side perspective the challenge is finding the best way to monetise their research offering whilst ensuring that it is visible to existing and prospective clients.
The question facing both sides is not only how to value unbundled research, but who will ultimately pay for it? Will the cost of paying for external research be absorbed by the funds themselves, or will managers pass the cost on to their investors through higher fees. Some funds have already drawn a line in the sand, stating that they will foot the bill, but despite the looming deadline, research carried out by RSRCHXchange in the Autumn of last year found that more than half of 220 surveyed asset managers still did not know how they will pay for research when the rules come into force. Similarly, a survey carried out by Westminster Research Associates revealed that industry insiders believe they will be cutting it fine to implement the directive – with 10% of those surveyed believing they will be MiFID II compliant by December this year, just one month before the implementation date.
So what are the available options?
One possibility is that institutions will pick a limited panel of investment banks from which to obtain their research. In such a scenario it is possible there would be consolidation amongst research teams and the banks which are highly-rated across a range of sectors will be positioned for success. However, consolidation, or investors taking research from fewer of the already established houses could mean less diversity in opinion being present in the market.
Another possibility is that investment banks may choose to specialise in either research or trade execution. While some buy-siders believe this would improve the quality of execution service they receive, others warn that this could drive up the price of research, putting smaller investment managers at a disadvantage, squeezed out by the inevitably rising costs of research only affordable to the bigger players.
Companies looking to get noticed could also face a paucity of analysts covering a growing number of stocks – especially in crowded spaces like healthcare. Bigger companies with a strong institutional shareholder base will have little to fear, but smaller entities, perhaps covered by a single in-house broker may struggle to attract the attention of independent research analysts.
If independent research becomes more scarce, not only for investors but also small and mid-sized companies looking to publicise their stock, some predict that sponsored research by an established provider or as a service provided by an investment bank, could become an increasingly attractive option. Naturally, however, some investors fear that paid-for coverage can never be truly objective.
Clearly many aspects of the post-Mifid II landscape will remain uncertain up to and possibly beyond the January 2018 start date. At present it seems like there is potential for a range of models and only time will tell which of these will ultimately prove to be successful. For listed companies, navigating the new environment may require changes in tactics but we remain convinced that the case for a clear, compelling equity story and active engagement with the research community will remain as strong as ever.
