The introduction of the Markets in Financial Instruments Directive II (MiFID II) is less than a month away, but there remains considerable doubt about what its impact will be. This issue has been front and centre for banks and brokers for some time, since new agreements must be in place by 3 January 2018 if they are to continue trading equities.
Only more recently have the implications for companies started to be appreciated. This remains a rapidly evolving field, but here is a look at the current position from the perspective of quoted companies, institutional investors and banks/brokers.
Despite the many changing factors, one thing I am confident about is that companies can expect their investor relations teams to be much busier in 2018.
Why? Stepping back from the day-to-day, it could be argued that quoted companies have substantially outsourced the marketing of their investment case to the sell-side. This commenced decades ago in the era of fixed commissions when winning market share was the path to greater profitability for brokers.
Star analysts produced investment research that was rewarded by a higher proportion of equity trading business in the sector. Companies found the sell-side was very effectively doing much of the work needed on articulating the investment case and promulgating it to investing institutions around the world.
In future, this might cease to be the case and companies are likely to have to assume greater responsibility. I expect to see more examples of companies setting out their investment case on their website, holding capital markets educational events and becoming more proactive in investor targeting.
Consensus guidance
Companies that guide using consensus might also find life becomes more difficult. If there is less published investment research and if it is less widely distributed, good consensus figures could be more difficult to obtain. I would not be surprised if companies took a more active stance with the sell-side, for example by providing a spreadsheet or model to those wishing to follow the company. Analysts would be asked to submit their completed spreadsheets for comment where appropriate. The company would then calculate consensus figures and publish these numbers on their website. An alternative way forward, although likely to be resisted by some UK companies, is to adopt US-style one-year guidance, which is to say that in the current year, at today’s exchange rates, they expect adjusted earnings per share to emerge between Xp and Yp or that adjusted earnings per share will grow at between X per cent and Y per cent at constant exchange rates for investment management.
Over the summer it became apparent that most institutions will take the cost of sell-side research on their own P&Ls. Given the pressure under which many active managers find themselves, not least because of the competition from low-cost indexers, these decisions come as no surprise.
Key points
- Mifid II is coming into effect at the start of next year.
- Some UK companies might adopt US-style one-year guidance.
- A growing number of institutions are asking companies to organise their own roadshows.
Persuading clients to pay for research on top of a management fee looks tough.
I believe institutions will be looking to reduce the amount they pay to banks and brokers for investment research and other services. There is anecdotal evidence that some large fund houses are holding back from signing new agreements since the price for research services appears to be trending down.
It is widely accepted that the amount and quality of sell-side research has been declining for some time and Mifid II could result in further reductions in coverage and quality. There are signs that asset managers are already turning to the companies they are considering investing in for help understanding the investment case. Further, I am led to believe that fund managers are undertaking more research in-house.
Work with institutional investors has shown that many are planning to refuse broker organised roadshows because of the complications they will bring under the new rules. The institution would have to justify to the regulators that it has paid proper value for these services and was not receiving an inducement to deal.
A growing number of fund firms are, therefore, asking companies to organise their own roadshows and not to use a broker since it immediately introduces unwelcome requirements in terms of compliance, record keeping and costs.
These requests are coming not only from investors based in the UK and Europe, but also from some in the US. Fund managers that run funds globally recognise that it will be difficult to operate different systems for fund managers based in different locations investing in equities around the world. It might well be that the tougher European regime will be applied more widely.
Another reason asset managers are arguing against broker-organised roadshows is that they recognise that any individual bank/broker will not necessarily have agreements in place with all the investing institutions. As a result, future broker roadshows might not be able to offer such a comprehensive range of funds as before. These inherent difficulties would be resolved if investment companies organised their own roadshows.
Banks and brokers
Finally, a look at banks and brokers, many of which are pushing to sign contracts with asset managers to allow them to transact business from the start of 2018 onwards. Some of the big banks have sought to sell waterfront research covering all sectors, but a number of large investment managers are believed to have resisted this approach.
The smaller brokers and research houses have been more reasonable in their requests. It appears that most investment banks will price the access to research material at relatively low levels, but make access to analysts more expensive.
Some talk about their analysts being charged on a time basis, like lawyers and accountants. I have also heard that substantial discounts from list prices might be available to leading institutions which, in turn, might make life more difficult for smaller fund managers. If access to written research from the big banks is uniformly available at very low prices, the competition authorities might take a look.
Given that banks and brokers will be charging for research, it seems likely that the distribution of research will become more restricted. They will not want to send it to institutions unless there is a specific agreement in place because the regulator might interpret this as an inducement.
Further, they are unlikely to send it free to parties not covered by Mifid II, while charging their clients. The absence of relatively freely available sell-side material will represent a big change for financial markets.
Howard Coates is a director at KPMG Makinson Cowell
