MIFID 2 & Corporate Access: What happened, what didn’t and why. Will that change?
Back in 2017 the end of the broker-sponsored roadshows seemed imminent. This obviously did not happen in 2018. We believe this will only change if either a regulator starts to enforce MIFID 2 rules or a 6-9 months doldrums in the ECM market forces brokers to look long and hard at economic viability of non-deal roadshows on fully-loaded cost and stand-alone basis.
Background: MIFID 2 rules have been in place since January and the implementation guidelines at least in the UK are clear. Roughly summarized they say research and corporate access should be priced separately and at commercial levels, acceptance of broker-sponsored events for free by asset managers not allowed.
What did happen: Paying out of the own profit & loss statement for research and corporate access has become the industry standard, quite early and somewhat surprisingly (see here for background). While this alleviated the administrative burden for the investment managers it also reduced their willingness to pay for these services.
This reduced willingness to pay for affected research, but even more so for corporate access. A fair share of investment managers, especially those with a long-term horizon understandably ask themselves why they should pay anyone to receive updates on their investments. The case is a little less straightforward with potential new investments. However, in most cases overall willingness to pay for corporate access is quite low to non-existent. This especially applies to smaller firms or IR only events.
It is a badly kept industry secret that non-deal roadshows (NDRs) are hardly profitable for the brokers. Calculating with fully loaded costs most NDRs will probably be loss making on a stand-alone basis.
In light of these developments (massively reduced willingness to pay) and MiFID 2 implementation guidelines in the UK, one might have expected brokers to vastly reduce the number of broker-sponsored roadshows. However, that did not happen. At least not to a material extent.
Why? In our view, there are two reasons for that.
Firstly, so far there was zero regulatory enforcement of MiFID 2 rules and understandably market participants apply their – partially quite creative – interpretation of the rules. Think about it like a college party in a fraternity house with liquor flowing freely. Everybody knows its not allowed and that at one point campus police will show up. However, everybody also knows that campus police cannot arrest everyone and the vast majority will be able to sneak away. Even if you are caught, you will get off with a slight slap on the wrist if you are a first time offender.
Secondly, ECM (Equity Capital Markets) business has been booming, IPOs are still very lucrative. And NDRs are a great tool to keep the distribution channels for ECM deals open. Or to put it differently, if you show up at an asset manager on Monday with a NDR, and this helps you to sell an IPO on Friday then a broker will clearly look at combined profitability of the two.
Will that change? For a material change in the way roadshows are organized and paid for we believe one of two things need to happen.
Potential Trigger 1: A regulator steps in and enforces the rules, ideally by naming, shaming and potentially fining a major player. If this then makes it to the frontpage (page 3 would be ok too) of the FT or a similar publication compliance officers at banks, asset managers and corporates would be very quick in becoming compliant. Most likely massively encouraged by their own PR departments. However, while the UK’s FCA has initiated a review into corporate access and inducements in June they also flagged that their review will take at least 6 months. We think it will be hard for the FCA to come back empty handed, but we have no strong view on what and when there will be an impact.
Potential Trigger 2: A 6-9 months doldrums in ECM forcing the brokers to have a long and hard look at the stand-alone economic viability of their Corporate Access activities. ECM – a traditionally very cyclical business - has been very strong for most of 2018 but weakened more recently. It could well be the beginning of a downturn, or only a temporary dip. In any case, brokers like Berenberg, Redburn and others have seen their profits falling and have started to let people go. A general critical review of NDRs however has not taken place yet, as far as we can tell.
Summing it up: The current behaviour of all players to maintain the status quo with regard to corporate access is perfectly rational. This will only change if a regulator starts to enforce the rules or subdued ECM activities forces brokers to critically review the economic viability of NDRs. While there are early indications that this might happen, we have no strong view if and when this will actually play out.