by LIONEL LAURENT/ pic by BLOOMBERG
WHEN the European Union’s (EU) MiFID II financial rulebook was rolled out in 2018, asset management veteran Martin Gilbert warned of the unintended consequences for bankers and brokers supplying trading services and investment research to his industry.
With fund managers suddenly forced to budget and pay for investment research ideas separately from their actual trades, it seemed inevitable that overall costs would rise and spending on research would fall. The unknown was the size of the hit on investment bank revenue, with research and advisory work in European equities worth about US$1.4 billion (RM5.81 billion) a year previously.
Plus, there was the danger of small company stocks becoming uneconomic for some firms to cover. Two years on, the damage is clearer. Big asset managers have cut their research budgets by an estimated 20%-30%. That has led to a price war among providers that only the biggest can win, with bulge-bracket banks charging about US$10,000 a year for coverage of a company, whereas independent analysts hope for about US$2,000 per PDF.
And there are fewer analysts overall. Europe, the Middle East and Africa headcount for equity research at 12 major investment banks fell 14% between 2013 and mid-2018, according to research firm Coalition. There are fewer independent research firms and, as expected, there’s less coverage of small stocks.
City of London Brexiters might see this as evidence of the kind of business-killing EU red tape that Britain could ditch happily. The UK Financial Conduct Authority (FCA) has been pitching its post-Brexit regulatory regime as one based more on principles than “detailed rules”; one that adapts to real world, “practical” experience. But it turns out British regulators rather like rules, too, sometimes even more than their continental peers. The FCA was the loudest supporter of the research curbs when MiFID II was drafted. As a preeminent European financial regulator, it had influence and a compelling argument for unbundling spending on research from spending on trading: The cozy, clubby old ways of the city had resulted in wasteful spending and a deluge of analysis on companies that was of questionable value and dubious independence.
This is why, even as Brexiters like UK Prime Minister Boris Johnson bash regulations for everything from kippers to socks, the FCA still thinks everything’s peachy with the new rules on investment research. In September, it published a review saying it found that they were “working well” for investors, citing smaller research budgets as a cost saving for consumers and saying there was no evidence of a big drop in analyst coverage of small companies. Those hoping for some action on “predatory pricing” by the big investment banks were disappointed.
It’s in France and Germany that a MiFID push back is gathering steam. France’s markets regulator AMF is studying ways to limit the impact on small-cap stocks, and has called for “no-action” waivers for potential rule breaches. Germany’s list of objections seems to have convinced the EU to think about “tweaks”, according to the Financial Times. There appears to be a negative impact from the rules on fund performance too. An analysis by Evercore ISI Research and Frost Consulting Ltd found that funds paying for research out of their own pockets in 2018 generally did worse than those that didn’t (such as hedge funds and American firms). Still, David Berney of Ergo Consultancy, a trading advisory firm, doubts that MiFID II will be rolled back much in an era when the EU and other trading areas are using regulation to exert power. Where does that leave London’s brokers? Ask any research analyst whose business has been cratered by the cost of regulation and you won’t hear much optimism about Brexit. Political uncertainty has made UK stocks less attractive and pressure to sign a post-Brexit trade deal will probably keep financial rules aligned with the bloc for years. Even in London, the regulators will stay in charge. — Bloomberg
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.