OpinionAug 30 2018

Mifid II is driving smaller firms to the wall

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Mifid II is driving smaller firms to the wall
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The cost of complying with the European Union’s (EU's) gargantuan Markets in Financial Instruments Directive II (Mifid II) is not just forcing smaller independent financial advisory firms to revise their charging models, as IFA research group Platforum recently reported.

The 1.4 million paragraphs of rules that make up Mifid II are also tangling small and medium-sized financial firms in a twine of red tape so dense that they are sending them to the wall. 

Mifid II sought to drive down overall trading costs for investors.

The new directive, launched in January of this year, tries to emulate the dynamism of the US capital markets in Europe and boost economic growth. But pundits often overlook the heavy cost of regulatory compliance and its wide-ranging consequences. 

A decade ago, the culture of financial firms that were ‘too big to fail’ led to the worst financial and economic crisis in 80 years.

But a direct consequence of regulation that tried to dismantle this has seen younger firms increasingly ‘too small to comply’. 

The argument that Mifid II increases regulatory expectation without necessarily increasing the cost of compliance is just not true.

A decade ago, we learned the hard way that a financial sector dominated by a few firms ‘too big to fail’ is no good for anyone.

Preparations for Mifid II cost financial firms a total of $2.5bn (£1.9bn) in 2017.

The rules of the EU, as a major economic and financial player, indirectly influence financial practices - even change the culture of regulation itself - across the world. 

It’s estimated that the full cost of compliance is expected to rise to 10 per cent of a firm's revenue by 2021 - more than double current levels. 

My own firm, a proprietary trading company, has seen rapid consolidation in the sector over the past year. This is a direct result of the need to consolidate back office capacity to support front office operations. 

In direct contradiction to the optimistic forecasts of Mifid II supporters, UK mid-cap companies have suffered a sharp drop in liquidity this year.

Hardman & Co has found that liquidity levels in the London Stock Exchange have fallen by an average of 9.4 per cent per company since the beginning of the year. This market liquidity drought is leading to further disruption.

This is not simply the one-sided view of market participants like myself.

In June of this year, I made these points at a panel discussion on the future of financial regulation in Brussels. There was broad consensus that “more regulation” is not necessarily the answer that the financial industry needs right now.

For financial advisory firms, the story is much the same.

Mifid II regulations are making their work more burdensome, and as Catherine McBride, a senior economist at the Institute of Economic Affairs recently noted, a great deal of consolidation among smaller brokerage and advisory firms is happening because of the new regulations. 

While others in the industry have pointed out that the move to Mifid II suits larger firms.

The burdensome rules are forcing smaller independent financial advisers to take a closer look at their businesses and revise their charging models.

The victims are lower value investors who are now lossmakers for these firms, and the result is higher charges for them - this was one of the conclusions of the Platforum report, Adviser Market: Charging Models, published in August.

It is apparent in the trading, advisory and research sectors that Mifid II regulations threaten small and medium-sized firms, driving unnecessary consolidation.

A decade ago, we learned the hard way that a financial sector dominated by a few firms ‘too big to fail’ is no good for anyone. 

Daniel Schlaepfer is president of Select Vantage