Corbin Insights: MiFID II
MiFID II – the Markets in Financial Instruments Directive – will take effect on Jan. 3, 2018. The regulation broadly affects the equity, derivatives and fixed income markets. More specifically, it attempts to resolve historic potential conflicts of interest when trading commissions are used to compensate the sell-side for research or corporate access. Banks and broker-dealers that offer trade execution, research and corporate access will be required to unbundle and separately price each of these services.
We expect the larger global investment firms to move fully into MiFID II compliance worldwide to avoid operating under two sets of regulations. Smaller firms will likely follow, even though the SEC has issued three “no-action” letters to temporarily exempt US broker-dealers from various MiFID II requirements (more on that in a minute). Some asset managers will absorb the unbundled third-party research costs, while others will pass them on to clients. According to our research, 96% of surveyed investors utilize the sell side to some extent though the vast majority report “respecting” just three to four analysts on average. They point to company/industry knowledge, differentiated research, a balanced view and long-term perspective as top qualities and analysts exemplifying these characteristics will bode well as MiFID II is implemented.
The most significant potential implications of MiFID II for your company:
- Less Investment Research: One asset manager we surveyed commented, “We are scratching our heads over what to pay and whether the research is really worth what the sell-side wants. Ultimately, having to pay for research will be a good way to clean [out] our inboxes and receive less email we never read.” Instead, the sell-side will focus on in-demand companies and sectors where it can most easily monetize research – likely resulting in smaller coverage universes and analyst staffs. Apple and Amazon need not fear, but small- and mid-cap companies are likely to lose analyst coverage, limiting their ability to attract new investors. On the buy-side, many firms will reduce their sell-side relationships and bring more research in-house. As these changes flow through the system, we also expect greater demand for independent research and increased transparency/disclosure from companies. Your IR department may need to react accordingly.
- The Haves versus Have-nots: Smaller public companies will be disadvantaged when the sell-side is no longer absorbing the cost of corporate access. There is the potential for fewer sell-side sponsored non-deal roadshows, potentially driving demand for management meetings at investor conferences. This will increase the importance of companies proactively marketing to the buy side. We believe employing a two-pronged approach – engaging the buy-side through the sell-side and directly – should be part of the IR strategy as many investors we interview today do not utilize the sell-side for management access.
- Ongoing Price Negotiations: Initial sell-side pricing and offerings range widely. According to early surveys conducted by Reuters, one sell-side firm’s platinum package – speaking directly to analysts, conference attendance and corporate access to companies and policymakers – is priced at $80,000 per user per year. Another firm is asking $25,000 per year for basic research and some analyst time. The high is $450,000 and the low ~$10,000. The question to be answered is what the buy-side market will bear.
- Continued Regulatory Uncertainty: The SEC and EU rules conflict in some areas so selling research to European clients under MiFID II was initially perceived to require America-based broker-dealers to register as investment advisers, increasing costs and regulatory oversight. In October, the SEC granted a 30-month delay in the implementation of MiFID II’s research rules by US firms while it monitors the situation. This will allow investment banks to accept payments for research in hard dollars or “bundled” soft-dollar trading commissions so long as the research component is determined in advance. Also, asset managers may continue to pay commissions that bundle research and trading costs if the cost of each service is agreed upon in advance.