10/05/18

The unintended consequences of MIFID II are hitting home

(The Yorkshire Post) -- The recently released survey of small and mid-size company investors from the QCA and Peel Hunt shows that the Markets in Financial Instruments Directive II (MiFID II) is living up to the expectations of those who identified that it would be the single most impactful change on public markets for the last 10 years.

The unintended consequences of MiFID II are starting to have an influence on the way investors, brokers and companies interact. Our survey indicates that it is resulting in a decrease in both the volume and quality of research into small and mid-size quoted companies.

Asset managers previously received research for ‘free’, with the cost built into the trading fees paid for by the fund managers’ clients. Now, fund managers must pay for research and trading costs separately, reducing demand for services traditionally offered by institutional (and corporate) stockbrokers. The impact is not going to be felt just in the short-term; there are far reaching implications for the volume and quality of research, for how much is paid for research and the health and number of the broking houses that intermediate between investors and issuers.

Investors believe that MIFID II will lead to a decrease in the number of broking houses and that the reduction in research will negatively impact the liquidity of mid and small-cap companies. For quoted companies, there are things that they now need to pay more attention to. For example, investors see corporate websites becoming more important as the primary source of information. Companies will also need to know whether their broker is able to send research under the new regime to their own, and to potential, investors. Obviously companies will suffer if their own shareholders are not receiving such key information.

Investors say that, if asked, they are generally willing to disclose whether a company’s broker can send research to them, but they are less likely to intervene in the relationship between a company and its incumbent broker to recommend moving to a broker whose research is more widely distributed. In our survey which was carried out for us by YouGov, we have also explored some wider issues regarding AIM, corporate governance and the quality of non-executive directors.

AIM is seen as a market that continues to improve as a venue for IPOs, with its credibility improving over the last year or two. Fund managers are overall cautiously optimistic about what AIM can offer. “I’m very wary of AIM” contrasts with “It’s a great platform for growth”. In line with this, fund managers are generally positive towards corporate governance amongst mid and small-caps with many thinking it has improved. Perhaps this is a major contributor to the way AIM is perceived.

Further changes to the AIM Rules will see companies required to set out their governance structures more clearly using a recognised corporate governance code such as our own QCA Corporate Governance Code. This will benefit individual shareholders especially. There are mixed views about the quality of non-executive directors. An over-reliance on executive teams leads to too many not securing regular contact with investors and, therefore not understanding what investors want from their companies. This dangerous combination of a lack of contact between NEDs and investors, and company research not being sufficiently distributed could harm small and mid-caps in the long-term. Fortunately, our survey also shows there are grounds for optimism, with AIM doing its job well. Overall, MiFID II is causing everyone to consider their relationships with each other. The unintended consequences are now becoming a reality and market change is inevitable.