Doomsayers who predicted the dire impact MiFID II would have on the business of equity research turned out to be spot-on. As regulators finally reach the same conclusion and prepare to reverse the rules, the market Cassandras have an equally gloomy message: The damage will be hard to undo.
(Bloomberg) — Doomsayers who predicted the dire impact MiFID II would have on the business of equity research turned out to be spot-on. As regulators finally reach the same conclusion and prepare to reverse the rules, the market Cassandras have an equally gloomy message: The damage will be hard to undo.
Five years after the regulations forced asset managers in the UK and European Union to pay for research separately from trading, sell-side analysis across the region is in a sorry state.
Research spending across Europe has dropped by almost a third since a 2015 peak, while a flock of top analysts has decamped to the buyside. Many money managers switched to picking up the tab for stock intelligence. And in the fight for investor attention, some smaller companies even wound up paying analysts themselves to ensure continued coverage of their shares.
These structural shifts will be near-impossible to undo, the thinking goes, even if so-called unbundling is completely reversed.
“The market has adjusted,” said Susan Yavari, senior regulatory policy advisor at the European Fund and Asset Management Association. “Being able to show what you’ve paid for your research and what you’ve paid for execution is pretty major now.”
Yavari says EFAMA’s members do support rebundling, which the UK has already announced and which EU member states are pushing for. But that is largely for the sake of flexibility — on a practical level, everyone is now adapted to the Markets in Financial Instruments Directive. “I don’t think anybody has any appetite to swing back the other way,” she said.
At the heart of the matter is the value that equity research brings to the market. Industry proponents say MiFID’s failure has shown it’s a bit like a public park: Not profitable on its own, but indispensable if you want to have a vibrant environment.
The question is if the park can recover once a chunk has been tarmacked.
Before Europe enacted MiFID II in 2018, brokers offered research ostensibly for free as part of a suite of services. The architects of the regulatory overhaul saw that as a conflict of interest which could lead to investors shouldering hidden costs.
But the new rules tore up the economic model that was supporting much of the research industry. Between MiFID’s introduction and the end of last year, the analyst headcount at the world’s largest banks dropped 26%, Coalition Greenwich data show.
The business was already shrinking before that, largely thanks to technological advances, falling trade commissions and a boom in index investing. But Europe has seen the biggest drop in both revenues and headcount especially after MiFID II, Youssef Intabli, research director at Coalition Greenwich, wrote in an email.
Meanwhile, by making everyone pay, MiFID was also meant to level the playing field for independent research providers. Instead top banks ended up increasing their market share by offering wide-ranging coverage at a low cost.
“Research only made commercial sense when it was part of the broad investment banking bundle,” said Simon Bound, former global director of research at Morgan Stanley. “You wouldn’t be able to pay analysts what they wanted to get paid if you just paid them at a MiFID rate. They’d go to the buyside.”
The drops in budget and headcount meant already obscure small-caps became even more invisible. In a 2020 review, the French regulator noted that the number of such companies paying brokers and research houses to cover them had climbed in both 2018 and 2019. At old-school brokers like Exane BNP Paribas, Kepler Cheuvreux and SEB, it’s now a common business.
The collapse in research could be traced back to a domino effect that began months before MiFID II took effect. Major money managers from BlackRock to Allianz Global Investors decided to foot the bill for analysis themselves rather than pass it on to clients, squeezing prices along the way.
Having opted to absorb the costs under MiFID, it’s unclear whether they would try to pass it back after any rollback — and, if they did, whether investors would be willing to pay.
“European pension funds aren’t likely to be eager to start paying for research again,” said Tyler Gellasch, president of the Healthy Markets Association. “While some asset managers will likely be able to shift research costs back to their European customers, I doubt the whole industry will.”
The quagmire has implications for the US market. Just as Europe prepares to undo the rules, the Securities and Exchange Commission has let a crucial reprieve from them for American firms expire. It means that, since July 3, US brokers taking hard dollars for research have had to register as investment advisors — accepting much tighter regulations — or find other workarounds.
The Securities Industry and Financial Markets Association says at least one of its members has since cut off research for European clients after failing to find a solution. Wall Street lobbyists are advocating for a Senate bill that will resurrect the reprieve and preserve the American model of investment research.
“The consequences to the capital markets resulting from the reduction of professionals serving as research analysts could compromise important investor protections,” said Marlon Paz, a partner at Latham & Watkins and former SEC official.
But not all the evidence surrounding MiFID’s impact is negative. Some academics have found, for instance, that the industry’s remaining analysts became more accurate, while coverage actually dropped more for large-caps than small ones.
And while it will be hard for money managers to add back the cost for their investors, that could start to change if a big firm takes the lead, according to Brijesh Malkan, chief strategy officer at Singletrack, which helps medium-sized banks deliver research.
“Ultimately it’s not so much about who pays—it’s about the transparency and valuation framework,” he said. “I’m not going to tell someone who’s building a house for me, ‘hey, don’t buy bricks,’ right?”
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