The finance industry spent billions of dollars and years dismantling their research businesses to adapt to the European Union’s sprawling market reforms known as MiFID II. Now the UK and the EU itself look set to reverse at least some of those requirements — but it won’t be simple.
(Bloomberg) — The finance industry spent billions of dollars and years dismantling their research businesses to adapt to the European Union’s sprawling market reforms known as MiFID II. Now the UK and the EU itself look set to reverse at least some of those requirements — but it won’t be simple.
The complexity of MiFID II is reflected in the cost of introducing it: in 2017, the 40 biggest investment banks and 400 largest asset managers globally spent an estimated $2.1 billion adjusting their systems for it, according to Expand and IHS Markit.
Chancellor Jeremy Hunt is set to announce on Monday that the UK is rolling back a part of the law that governs how firms can charge clients for research, Bloomberg News has reported.
“Given the structural changes that European banks had to put in place as part of the unbundling, reversing those processes may now prove onerous,” said Simon Ballard, chief economist at First Abu Dhabi Bank.
Introduced to save consumers money, the rules were a way of ensuring that the research provided by banks and others would be higher quality. That meant dismantling a huge machine that critics said was, in part at least, as much about marketing as analysis.
But it led to asset managers cutting their budgets for research, making it uneconomic to keep tabs on many of the smaller firms that need investor support to grow and a further consolidation of market share among the biggest banks.
The rule reversal will “take a while” to be introduced by the regulators, said Sarah Jane Mahmud, senior analyst at Bloomberg Intelligence. And with the biggest banks now dominating the research market as a result of MiFID II, any rollback may come too late to have much impact.
Read More: Why Splitting Research and Trading Is Being Rethought: QuickTake
Adding to the challenge is the different status of the rules across multiple jurisdictions. While Hunt is expected to announce that the change is part of the government’s attempts to free the City of London from EU restrictions after Brexit, the bloc’s member states are also seeking a near total U-turn on unbundling. Meanwhile in the US, firms are only now adapting to the EU rules as a waiver on research charges expires.
Whack-a-Mole
The unbundling rule is just one element of the revised Markets in Financial Instruments Directive, which stretches from best execution to conflicts of interest to authorizing new companies. The industry is pushing for more changes.
“It’s a big step forward but a micro point,” said Barney Reynolds, global head of the financial services industry group at law firm Shearman & Sterling and author on post-Brexit regulation. “We’re playing whack-a-mole on specific policy points. If we do that 1.7 million times we’ll be here until eternity.”
Still, most in the City welcomed the change. “As a policy this did great harm and has had absolutely no benefits of any form,” said Simon Gleeson, a consultant to law firm Clifford Chance. Hunt’s proposal “will really help the stock exchange because it feeds very nicely into its existing proposals to expand access to equity markets and equity capital raising. There is a genuine benefit for the UK.”
Alasdair Haynes, chief executive officer at London’s Aquis Exchange Plc, agrees. “Removing this constraint on research will definitely help investors regarding growth companies and that has to be good news,” he said.
For the buy-side, Clark Nicholls at AXA Investment Managers said it makes sense to nix the rules. “Even though UK regulations had already reversed payments for fixed income research last year, stopping equity research payments would harmonize the regulations,” he said.
James Orme-Smith, CEO of hedge fund Sandbar Asset Management, said the move “would be net positive for the industry, both buy- and sell-side, because the restrictions had led to some unintended consequences for banks. Cost pressures caused talent attrition from the sell-side and as a result the buy-side received scarcer resource with variable quality.”
Seismic
Even if the reversal is seamless, the research business is unlikely to return to its former glories. Neil Shah, head of research at Edison Investment Research, says broader reform was needed. “The decline of research has been a 20-year trend. I think other solutions may come alongside that.”
Further measures that could be raised by the UK’s review include creating a portal to make research easier to access for more users, Shah said.
The separation of research from trading expenses triggered “a race to zero” in what buy-side shareholders were willing to pay for information, said Steven Fine, chief executive officer of London-based broker Peel Hunt Ltd. While he also welcomed the proposed reform, he said it would make little practical difference to his firm since it had continued to grow its research presence regardless.
He added that more changes are needed.
“We had to run the research business on the basis that the buy-side would pay whatever they could get away with,” Fine said. “The thing I’m more excited about is that this could be one of a series of reforms designed to improve competitiveness. In isolation some of these things will look like ‘so what?’ but in aggregate they will look pretty seismic.”
–With assistance from Laura Benitez, Shelley Robinson, Nishant Kumar and Mathieu Benhamou.
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