MiFID II rollback – opportunities in the new regulatory landscape
Social Bonds : A significant financing opportunity amid the pandemic
Introduction
The UK Financial Conduct Authority (FCA) released a consultation paper on 10 April 2024 regarding its proposal to liberalise Markets in Financial Instruments Directive (MiFID) II rules to reintroduce the option for asset managers to make bundled payments to brokers
However, a number of public statements by major asset managers show that buy‑side firms are not too keen to go back to the old system
We believe that the UK government will need to step in, via direct and indirect measures, to get large asset managers on board with the plan to achieve the desired objectives
The reform
In 2007, the European Union (EU) introduced regulations to improve transparency, standardise disclosure norms for financial firms and improve investor protection. A year later, the global financial crisis brought to light the shortcomings of this regulation. To address these shortcomings and restore market confidence, the EU implemented MiFID II regulations in 2018. MiFID II widened the scope to include over-the-counter and dark-pool trades, fixed-income instruments, derivatives and currencies, and covered dealings with firms outside the EU.
Followed by some reconsideration
In 2020, the pandemic forced the sell side to transition to purely virtual interactions with the buy side; this impacted the perceived value of sell-side research further. Considering the effect on the reduced viability of sell-side businesses and falling sell-side research coverage of small caps, the EU and the UK sought to relax MiFID II rules. Both introduced “quick fixes”, with the UK allowing bundled research on listed firms with market cap of up to GBP200m and the EU allowing it for firms with market cap of up to EUR1bn. However, these measures were insufficient to correct the situation. Further motivation came from the end of the US Securities and Exchange Commission’s (SEC’s) waiver in July 2023, which used to allow US broker-dealers to receive “hard-dollar” payments for research from European buy-side firms without registering as investment advisers, effectively bypassing MiFID II unbundling rules.
The eventual retreat
On 10 April 2024, the UK’s FCA released a consultation paper titled “Payment Optionality for Investment Research”, detailing its proposal to liberalise certain MiFID II rules. It noted that despite most buy-side survey respondents saying that MiFID II had a neutral impact on the adequacy of investment research coverage, other findings from the FCA’s analysis suggested that there was a negative impact.
1. Research depth, measured by the number of analysts covering a stock, reduced to 3.7 in 2023 from 4.4 in 2011, with the sharpest decline in smaller companies.
2. Research breadth, measured by the share of companies with analyst coverage, decreased. The share of the smallest companies (GBP0-50m) with no coverage increased to 78% in 2023 from 61% in 2011
Will asset managers go back to bundled payments?
Although the FCA’s MiFID II liberalisation has the right idea, we believe that the rule change in itself is unlikely to achieve all the expected results. Fund investors hold the key to research payments, and many buy-side firms are not enthusiastic about passing on research costs to their investors.
Mike Carrodus, CEO of Substantive Research, said that “changing the business rules would make little difference. However keen asset managers are, end investors would simply refuse to go back to the old system and pay more”. Schroders CEO Peter Harrison also said that “there is ‘no way’ Schroders can reverse its stance on investment research costs, having absorbed them for more than five years”.
Conclusion
The latest FCA proposal aims to correct certain unintended consequences of the MiFID II regulation, while retaining the improvements it brought. The new proposal is expected to give UK asset managers the flexibility to choose the best option for themselves and to facilitate access to research from foreign sell-side firms. Additionally, it is expected to help small managers access research, levelling the playing field and promoting more competition in the sector.
Against this backdrop, although the rollback is an opportunity for sell-side firms, the odds are stacked against a major shift in how research is paid for, at least in the near term. We would need to consider whether buy-side firms see value in contributing to the expansion of research coverage. Furthermore, the government’s role would be crucial, as the additional steps it takes to support this switch would decide the extent to which the objectives are achieved.
How Acuity Knowledge Partners can help
Amid the evolving regulatory landscape, Acuity Knowledge Partners, with its team of seasoned equity and credit analysts and Research Publishing and Research Operations teams in India, Sri Lanka, China and Costa Rica, functions as a dedicated partner to investment banks and independent research firms, expediting sell-side coverage.
By leveraging our deep industry knowledge and analytical expertise, fund managers, traders and analysts benefit from a streamlined approach to realtime monitoring, ensuring that their time is better invested in generating trade ideas, client discussions and business-development activities.
Our team is committed to delivering excellence to our clients, providing them with tailored services that are flexible and responsive to the ever-changing regulatory environment in the sell‑side research space. Asset managers can also leverage our sectoral and regional expertise in bottom-up and topdown fundamental analysis with “original thought” and “substantiated opinions”, with the additional flexibility of using our arrangements to receive payments through soft dollars
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