Mifid II ruffles fund research practices

Second, regulation is hardly something that gets the blood racing – it’s not why we get up in the morning, is it?

But the impact of regulation, specifically the European Commission (EC) rules under the Markets in Financial Instruments Directive II (Mifid II), really could matter for both wealth managers and their end investors. Running money for those investors, and providing intelligent advice, is of course what wealth management is all about. In doing that, the depth, range and quality of market insights and research from brokerage firms plays a pretty fundamental role in the investment decision process.

The Mifid II rules, which will come into effect across the EC in January 2017, cover a multitude of sins, and carry with them a real change in the way such research services are paid for and the clear possibility of much-reduced coverage and availability of these services. Put simply, under Mifid II wealth managers, in common with all buyside firms, will have to budget and pay for all research – from brokers, independents, or whoever – as a distinct separate charge, which is not related to or bundled with trading commissions in any way at all.

Much of the initial impetus for separate research payments comes from the Financial Conduct Authority (FCA), with the irrefutable aim of making the cost of research more transparent and reducing unnecessary costs for end investors. Given this, although there is still debate on the final wording of Mifid II, the position of the FCA is both clear and highly unlikely to change.

The FCA will be looking to asset managers to separate research and execution costs, and instead have distinct research budgets, which will lead ultimately to greater transparency and lower costs for clients. So wealth managers in the UK and, by extension, advisers, will definitely be affected by whatever changes in the scale and range of brokerage research that emerges as a result of Mifid II.

Wealth managers value independence of thinking most highly when looking at equities, and when examining insights on UK small and mid caps it is the ability of brokers to deliver meetings with companies that is of most value. Now, of course, wealth managers will use their own skills and judgements in making investment decisions or recommendations for clients, but they do make extensive use of brokerage services as part of this process.

While it is too early to be prescriptive about what changes will occur, there are some key facts that are likely to restrict access to brokers’ ideas and insights. Firstly, asset managers are not waiting until 2017 before doing anything. Already, research budgets are being defined. However these may be funded, they will attract VAT (unlike trading commissions) and hence at least a 20 per cent reduction in spend to brokers can be anticipated. In this climate, brokers will cut their cloth accordingly.

Furthermore, the smaller asset managers (and many wealth managers fall into this description) could find the services of the largest, normally international buyside firms, more difficult to acquire, and the opportunity for company meetings, especially in the mid- and small-cap arena, will diminish.

The corollary of this applies to companies themselves. Smaller stocks may struggle to get satisfactory coverage. Already, any stocks outside the FTSE 350 index are unlikely to have much more than the house broker writing on them. This can lead to a lack of understanding overall, making value discovery more challenging, and with that comes less liquidity, further cramping the attractiveness of investing.

Naturally, there will still be high-quality research and support – but the bottom line here is there will be less of it, concentrated at the high end of the equities market, and leading to uneven, less transparent markets. Yes, over time, the industry will adjust – and if wealth managers can find value in external research, that need will be addressed. However, the turbulence in this transition is a major issue for investors looking to identify and profit by their decisions.

Steve Kelly is head of Europe at WeConvene Extel

Mifid II: FCA definition

“The original Markets in Financial Instruments Directive (Mifid) was implemented in November 2007. It introduced competition to the EU trading landscape and provided a ‘passport’ for trading venues and investment firms to operate throughout Europe on the basis of authorisation in their home member state. It also introduced various investor protection measures.

On 20 October 2011, the European Commission adopted a legislative proposal for the revision of Mifid. The proposals take the form of a revised directive and a new regulation, which together are commonly referred to as ‘Mifid II’. The new proposals are designed to take into account developments in the trading environment since the implementation of Mifid in 2007, including advances in technology and gaps in transparency to investors and regulators. It is also a response to the financial crisis.”

Source: Financial Conduct Authority