The First Months of MiFID II

The first months of the long awaited MiFID II regulation have been both formulaic and eye-opening in different regards.

Implementation of certain parts of the rulebook was delayed, with firms clambering to get their compliance systems in place right up until the 3 January 2018 deadline. This was just one in a long line of red flags that signalled how the industry as a whole was not in ‘ship-shape’ to deal with the full range of change to their daily operations. Nowhere has this been clearer than with regards to the unbundling of investment research. With only some of the biggest asset managers announcing their MIFID II research setup before January; it was clear during 2017’s fourth quarter that many hadn’t completed the due diligence necessary to make the cut-off date. This lackadaisical attitude set the tone for the months to follow.

It is no surprise to see MiFID’s influence, or lack of, so far. Behaviours do not appear to have changed. The regulator simply hasn’t enforced, acted upon or monitored the situation to the level expected, and the best way to describe the unbundling rules so far would be a ‘damp squib’.

While the majority of the industry is acting within the spirit of MiFID II with regards to research unbundling rules, there are still some asset managers and research providers who are largely carrying on their business as usual or returning to old methods of determining research payments, such as broker voting systems. This may not be the fault of the individual manager; the regulator’s lack of direction has given them scope to charge on an ex-post, rather than ex-ante method for research. Unfortunately, because of this, it is difficult to say whether MiFID has taught us anything to date.

It is hard to see this changing until the regulator becomes more active in its role. If MiFID II is going to have the impact intended, there needs to be greater oversight and pressure on those who are not complying with the rules. This will require more specific guidance and monitoring, which, although more demanding, will be necessary to ensure a fair, consistent and diligent auditing process.

One reason for the lack of engagement may be that the regulator is content that most asset managers now appear to be paying for research from their own profit and loss accounts. The main purpose of MiFID II is to secure better outcomes for the end investor – if research costs are being absorbed and not passed on to investors, they are of much less concern. With the larger asset managers opting to pay for research themselves, the message emanating from the industry that the ‘man on the street’ is benefiting from MiFID II is one that the regulator will be wary of disrupting.

However, a prominent mistake that we are seeing is the structure of certain agreements that have been put in place between some asset managers and research providers. These have involved low retainer fees for access to entry-level research, and an arbitrary pricing structure for more advanced services. Any opaqueness around the costs for research services is counter-intuitive to what MiFID II is trying to achieve, and such grey areas could be viewed as inducements.

It remains unclear how soon the unintended consequences of research unbundling rules can be addressed. The regulator is likely to continue its leniency on areas where research pricing is unclear, in favour of pursuing any firms that are more overtly breaking the rules. While the Financial Conduct Authority confirmed in January that it would act if pricing reached a stage where research appears significantly undervalued, to the point it could be considered an inducement to use a provider’s other services, we are yet to see any sign of this.

It is plausible to think it could take up to 18 months to determine and then intervene in a research market where the product has been undervalued, but measures should be put in place sooner rather than later to ensure a fair value for research.

MiFID II was introduced to ensure transparency across European financial markets and to provide greater protection and value for investors. On the unbundling of investment research, the industry is at risk of allowing that objective to lose all of its credibility. The majority of research providers and asset managers have acted to forge new approaches to investment research and provider relationships aimed at providing value to the end investor. But a new set of clear guidance, and specific action targeting the worst offenders, is necessary to ensure all firms are up to scratch.

Russell Napier
Co-founder and Chairman of ERIC in Edinburgh.