The 2018 reform of the Markets in Financial Instruments Directive (MiFID II) is gradually coming undone, with its separation of payment for research and trading being revoked under new proposals in the UK.
Jeremy Hunt, Chancellor of the Exchequer, is expected to announce proposals to re-bundle payments for research and trading, by assets managers to brokers, in his Mansion House speech tonight, alongside reforms of the UK pension and investment industry and plans to strengthen the UK’s position as a listings destination.
Gareth Exton, head of execution & quantitative services for EMEA at Liquidnet, told BEST EXECUTION: “Until we see the full details of any proposals, it is hard to fully appreciate the impact any changes to these rules could have.
“However, there have been discussions on changing research payment rules for some time as part of the MiFID reviews taking place, and what’s become clear from buy-side firms is that any changes to how this is administered will be difficult to implement in practical terms.”
The UK has seen levels of primary market activity decline, and the proposed reforms will be seen collectively as a way to kickstart capital markets. But is it the right time?
According to Mike Carrodus, CEO of Substantive Research, “If the review confirms research rebundling, the Treasury’s gamble is that asset managers will feel brave enough to call up their clients and say “You know those costs we took away from you five years ago when MiFID II came in? The Treasury and the regulators are now saying that they are making it simpler for us to return those to you, and we think doing so will benefit not only our investment process but also the UK economy as a whole.
“How pension funds and other asset owners respond to that pitch is the only question that matters. Asset managers are not keen to open up a discussion about fees in the current tough economic and investment climate, so these changes from the Treasury may need to wait for a bull market before anyone feels tempted to even have a try.”
Payments for research and trading were unbundled, or forcibly separated, under MiFID II as part of a longstanding effort led by UK regulators to increase transparency over what payments to brokers were for. Concerns around the use of the funds to provide gifts to clients, which in turn led to the clients routing more trading activity via a broker, were first raised by in the late 1990s. Latterly, these concerns turned to research being paid for out of investor money and not directly from each fund.
Unbundling these payments was a major tenet of MiFID II and was championed by the UK’s Financial Conduct Authority.
An unintended side effect of making asset managers pay for research has been a reported reduction in coverage of research into small and medium sized enterprises (SMEs). Some market participants have argued that this in turn led to fewer firms investing in these securities, thus reducing their market capitalisation and liquidity.
However, analysis by BEST EXECUTION of the UK’s small and midcap stock market, AIM, shows no pattern of reduced money raising by small firms after MiFID II was introduced in 2018, or in the period after (see Fig 1).
There was a reduction in listings during 2019-20, years which were marked by the uncertainty of the final Brexit agreement, a change of Prime Minister and an election, but in 2021 issuance bounced back to be the highest number since 2015.
In secondary market trading (Fig 2), AIM data also shows no overall pattern of declining activity post-MiFID II, with a dip in volume but not number of trades in 2018, and a recovery of volume after that which exceeded pre-MiFID II years.
Industry views of any repeal are far from confident about the outcome for SMEs, Exton observes.
“At the FIX EMEA Trading Conference back in March, panellists were unanimous in saying that the re-bundling of research would not result in any significant increase in SME coverage,” he says. “It’s not clear whether quantitative evidence exists that would prove there is a link between the availability of research and trading volumes or available liquidity in small or mid cap names. The issue appears to stem from the lack of investor appetite in small and mid-cap UK companies, and this is exacerbated by a lack of liquidity.”
Rebecca Healey, co-chair of the EMEA regional committee & EMEA regulatory subcommittee, for the FIX Trading Community, tells BEST EXECUTION: “There is a tendency to revert to things that have happened in the past as the solution for what needs to happen going forward.”
She notes that delivering better access to capital markets is a shared goal in the markets but will require new approaches to supporting investment.
“It is more about matching the right investor to the right company which you can do far more effectively with technology than just reaching out to your top clients,” she says. “So there’s, there’s opportunity here, but if we just see it as rolling back, that would be an opportunity lost.”
Other proposals expected in the speech include a commitment from certain pension funds to invest 5% of assets in UK securities, and a new platform for supporting investment in private markets, along with a focus on strengthening the UK’s position as a listings destination.
“That’s a really laudable decision because you need to put money to work faster, but at the moment, the system is set up to make it incredibly difficult,” says Healey. “But if you’re willing to say tie your money up for a 10 to 15 year period you should be able to have alternative opportunities.”
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