MiFID II: This time it really is different

Managing the MiFID II changes will be difficult. For IR teams, the need to be quick-footed is the greatest challenge, as Steve Kelly reports.

Anybody working in investor relations who has a heart (and isn’t that everybody then?) must feel a warm glow of gratitude to the EU for the imminent introduction of MiFID II. How else would all those poor consultants in banking, IR, law firms, fintech and anywhere else, be able to put Chablis on their tables, and Rolexes on their wrists, without the myriad opportunities to pout and pontificate (and get paid for it too) that MiFID II offers?

Yet every silver lining has a cloud. With seemingly as much written on what MiFID II is, and what it means, as has ever been said about the second coming, it is all too easy to get lost in a forest of punditry, or to assume it won’t really matter (Y2K, anyone?). Well, bear with me, because it is fundamentally vital to everyone in IR, and despite the best efforts of many to confuse, it ain’t rocket science.

Yes, there is a great deal to MiFID II, much of which is very arcane. But there is one part of it which has direct relevance for corporates, and how you interact with investors and the investment community.

This is the ruling that asset managers must pay separately for the research and advisory services they receive from banks, brokers, and other research providers. Up to now, essentially, asset managers have paid a ‘bundled’ fee for these services, together with payments for actual execution. This impacts all financial instruments, where research and advisory services are provided. So not just equities, but fixed income too.

This will make transparent what the costs are in an asset manager using research and advisory services. As such, not only does MiFID II require this ‘unbundling’, it means asset managers will not be allowed to receive services they should pay for, unless they do pay for them.

Asset managers can pay for research and advisory services basically in one of two ways:

1. they pay for it with their own money.  This is the P&L route – the cost of research becomes a straight cost of the business; or
2. they set up a Research Payment Account (RPA). This is a separate pot of money, where money previously used for commissions payments, is re-assigned for use in the RPA only.  The RPA must be distinct, it must be made public to the asset owners, and run like any other budget.

As this is the EU, the overall regulations are then implemented at national level. Three points: one, the  fundamentals will not be altered, as EU rules do not allow it; two, the UK will be amongst the most stringent regulators, Brexit notwithstanding; and three, whilst Germany and other more reliable EU members will do as required, it is heroic to assume everyone will.
So why does this all matter for corporates, and for IR teams?

Less money spent
The amount of money spent by asset managers on research and advisory services will decrease. Estimates vary wildly on the level of decrease, from catastrophic to merely deeply impactful.  That is highly likely to mean any or all of the following: fewer analysts; less coverage of virtually all stocks (particularly mid and small caps); and a thinner spread of research, so less in-depth stock by stock analysis. It will mean less availability of corporate access services too, from conferences, to roadshows, to investor visits. Which all adds up to the army of ‘free cheerleaders’ that corporates have enjoyed being reduced in size, and in effectiveness.

Being selective
Now that asset managers will need to justify their spend on research and advisory, and will be urgently seeking value for that spend, they will become far more selective on how they do spend their research dollars. What most in the industry seem to agree will happen (and indeed, is happening already) is a simultaneous consolidation and fragmentation of research quality.
This is not quite the paradox it sounds. At the very top end, the bulge bracket firms will look to offer high quality in all categories and sectors; and hence some consolidation will take place. At the other end of the spectrum, appetites will increase on the buy-side for more independent, different sources of insights and ideas.

Now able to be paid properly without the need to offer anything except high- quality research, the further growth of boutiques and specialists does look likely. For IR teams, whilst you may have fewer analysts covering you, who they are – plus the influence they have and the web of relationships they have – will be more complex to understand, to track and to leverage.

Size will matter
It has long been an article of faith with larger asset management firms that their use of, and payment for, research and advisory services has effectively subsidised their smaller buy-side rivals. If research services are to be much more tightly rationed, as a ‘free’ service becomes clearly paid for, then smaller asset managers will struggle to get the level and range of brokerage research services they are used to. Already, one hears stories of smaller buy-side firms finding access to corporate  management and attending conferences hard to come by. Many of these investors may be holders, or could be holders, of your stock. Their interest will add to liquidity too. How do IR teams operate to keep those newly disenfranchised buy-side informed, aware and up to speed?

IR teams must be nimble
The above all points to a fundamental degree of change. This has been a long time a’coming, but many in the investment community do sense that this is happening. If that is so, then corporates have to expect disruption and fresh thinking, as people seek to take advantage of the disarray.  There are signs of this already, more around the use of technology to try to link asset managers, research & insights, and issuers together, often bypassing the established communications channels. IR teams will need to be increasingly nimble in how they tell they story, and who they tell it to, so that you can react swiftly as disruption takes hold.

There are so many other variables – market capitalisation, number of analysts, shape of stockholder base, and many more. So there is no silver bullet – but for sure IR teams will need to do more, think differently, and likely take full control for distributing and communicating your messages.

Steve Kelly is director of Steve Kelly Research.

Published 7 April, 2017