MiFID II: implications for sell-side and buy-side
The second Markets in Financial Instruments Directive (MiFID II) came into force in January 2018 and could well be the biggest change in the capital markets since Big Bang in 1986.
Implications for the sell-side
For brokers, the impact of MiFID II will be negative and dramatic. Estimates as to how far research spending will change vary quite dramatically.
At the mild end of the spectrum, 53% of Portfolio Managers polled by Bloomberg expect a decline of 20-30% in payments for research. At the other end of the spectrum, Hardman & Co have suggested that payments for research could fall by as much as 75%.
If we assume a base case 45% reduction (following the price precedent of Big Bang 30 years ago, and somewhere between the best-case and worst-case scenarios) then the brokers can only really respond in one of two ways – either by losing 45% of their analysts or by paying them 45% less.
Anecdotal evidence would suggest that the brokers are actually doing both, already, and moving towards a business model built on fewer and cheaper analysts. No doubt the analysts who remain will be expected to cover more and more stocks and a further consequence will be a dramatic reduction in the volume of research produced per stock. By way of example, Panmure Gordon has recently revealed that it plans to reduce the number of stocks it covers.
Implications for the buy-side
The choice in how to pay for research suggested by MiFID II is tilted and perhaps deliberately so. The object is arguably to make the buy-side pay itself rather than pass the cost to the end customers. Establishing Research Payment Accounts will be a difficult exercise, in practice, as RPAs represent yet another layer of expense to the end customer.
There is a moral argument, moreover. As Edison has put it memorably, “Few industries have the luxury of using their clients’ money to buy the main raw material (research) in their industrial process.” Certain investors seem to agree. Neil Woodford, for example, has suggested that it is wrong to bill customers for broker notes as researching companies is more properly his job.
For both reasons, prudential and moral, most fund managers are likely to elect to pay for investment research from their own P&L accounts.
Most fund managers are likely to elect to pay for investment research from their own P&L accounts.
Most fund managers who have expressed an opinion – such as Jupiter, M&G and Woodford – have been quick to make a virtue of their approach in assuming the cost of research themselves. In the words of Martin Slendebroek, Jupiter CEO, “Now I can look clients in the eye when they ask me: ‘What else do you charge to our funds?’ The answer on research will be zero.”
Research spend: a race to the bottom?
The Jupiter example is illuminating in other ways too. Slendebroek expects the cost of research this year to reach £5m, compared with assets under management of £40bn; in other words, research spend will represent a mere 1.25 bps of cost in comparison with AUM and this sets the bar alarmingly low for the rest of the industry.
Most estimates put the size of assets under management worldwide at around $70trn and the total annual budget for analyst research, according to BCA, is $16bn; worldwide, this represents a full 2.3 basis points of cost. If the rest of the world were to follow Jupiter, then the annual budget for research would be reduced from $16bn to $9bn – a reduction of 45%.
Estimates as to how far research spending will change vary dramatically but they are all negative.
Estimates as to how far research spending will change vary dramatically but they are all negative. With so much less commission to go round, the number of brokers which the average fund manager deals with will have to be cut; Amundi has already halved the number of external research providers it uses over the last 10 years.
The buy-side customers are effectively putting their sell-side suppliers out of business. And in the absence of free and abundant research from the sell-side, the buy-siders will also have to build up their own in-house research teams.
A final, and perhaps unintended, consequence of MifID II could therefore be a more concentrated buy-side as well as a more concentrated sell-side. Baillie Gifford, Jupiter, M&G and Woodford are all electing proudly to pay for research from their own P&L accounts.
This is an option for the bigger institutional investors who can afford to employ an army of their own analysts. But it will not be an option for the smaller institutional investors many of whom may fall by the wayside. It will be ironic if a directive intended to protect end investors has the ultimate effect of reducing choice in the market.