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The UK and EU are rolling back one of their most high-profile pieces of financial regulation in an effort to revitalise the region’s capital markets, but investors and brokers warn the move may come too late.
EU officials have been seeking to reverse some elements of the bloc’s Markets In Financial Instruments Directive, which was originally spearheaded by the UK before Brexit. But the UK beat them to the punch this week.
In his annual Mansion House speech this week, UK chancellor Jeremy Hunt said he would encourage brokers to generate more research on small and medium-sized UK companies by reversing Mifid II regulations banning stockbrokers from wrapping investment research costs up with the commissions clients pay for trading. Asset managers have made separate payments for research since the rules landed in 2018.
The softer stance reflects widespread complaints from European brokers and investors that Mifid II has added complexity and cost to what was once a straightforward, if flawed, relationship between fund managers and their banks. But it also suggests regulators are taking seriously the notion that Mifid II starves small companies of the research exposure they need to draw in investors, just as the feeble trickle of equity market listings across Europe has become a hot political issue.
The challenge now is that shifting investor behaviour shaped by Mifid II may prove tricky.
“[Asset managers] have adopted uniform practices around the world and I don’t see them going back on that,” said Justin Schack, head of global market structure at Rosenblatt Securities. “I’m not sure this is going to change behaviour in a fundamental way.”
Architects of the original rules had hoped that investors would cheer the transparency in their research costs, and enjoy more objective analysis that was independent from commercial relationships. Critics however claim the changes instead led to severe cuts in coverage, particularly of young companies in the most need of exposure.
Faced with the prospect of paying directly for research, some investors simply chose not to. European asset managers have cut spending on external research by two-thirds since Mifid rules were introduced, according to research from Frost Consulting. After the rules came into force, 47 per cent of asset managers surveyed by the CFA Institute believed research coverage of small and mid-sized stocks had reduced.
But it’s not clear whether the EU regulations were to blame. Smaller businesses are often covered by a lower amount and quality of research, but “this situation appears to have been neither improved nor worsened” by the Mifid rules, the European Securities and Markets Authority said in 2021. The impact on smaller companies’ access to capital, meanwhile, is unclear.
David Cumming, head of UK equities at Newton Investment Management, said “it’s odd” that UK authorities are now reversing rules that they first pushed for. But he added that “the impact of the previous legislation was negative in terms of UK equity investment coverage” since “lots of brokers got fired [and] the equity research base was deskilled”.
Hunt welcomed a government review released this month that described a “virtuous circle”, where effective research contributes to better valuations and greater liquidity, and ultimately increases the overall attractiveness of the UK as a listing destination. “There is a general acceptance that the Mifid II unbundling requirements . . . have had some adverse impacts on the provision of investment research and that not all of their anticipated benefits have been achieved,” the review also noted.
The unpicking of regulations around research come in the context of political angst over the health of Europe’s capital markets. Policymakers on both sides of the Channel are scrambling to increase the funding of homegrown companies in a dearth of public listings and a series of high-profile businesses, such as chipmaker Arm, choosing to list in New York instead of domestically. Westminster is also seeking to funnel some pension fund money towards high-growth British companies as part of these efforts.
But the slow pace of European capital markets is not all down to a lack of investment research. “I don’t think it’s going to make an enormous difference straight away,” said Steven Fine, chief executive of UK broker Peel Hunt. However, he added, “in isolation some of these things are a bit ‘so what?’ but in aggregate… we shouldn’t underestimate how seismic [the UK’s reforms] are”.
Independent research providers struggled to compete on price with larger houses after Mifid was introduced, and they are skeptical that much will change now.
“You cannot run research and distribution profitably, I think it’s impossible,” Fine said, adding that the benefits stem from relationships that high-quality research provides.
Large institutions have snapped up several research-only outfits in the years since the Mifid II rules were introduced, reflecting that independent firms need large backing to help them compete.
US asset manager AllianceBernstein bought UK boutique firm Autonomous Research in 2018. US bank Piper Sandler acquired research provider Cornerstone Macro in 2022, while Rothschild & Co fully acquired UK equity research firm Redburn last year.
“It’s quite late in the day to try and unwind a lot of this,” said Mike Carrodus, founder of Substantive Research.
The European rollbacks are also amping up calls to restart a waiver to avoid knock-on effects in the US. Mifid II’s requirement for direct payments left US brokers at risk of having to register as investment advisers at home, and a US Securities and Exchange Commission waiver for ran out this month. Now, Wall Street body Sifma has led calls for the SEC to reinstate it.
“There is no reason to harm US market participants, investors, and companies with a European requirement that both the European Commission and UK are planning to significantly roll back,” said Sifma chief executive Kenneth Bentsen.
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