MiFID who? What was that again? Is it still around?
In this article we’ll discuss how MiFID 2 and its intended unbundling have – or rather haven’t – been enforced, what changes in the industry it has led to regardless, what the recently passed watered-down rules by regulators mean, what COVID has to do with it and what it all means for investor access (meetings between issuers and institutional investors) going forward.
MiFID 2, short for ‘Markets in Financial Instruments Directive 2', has been in effect since January 2018 and some younger people who have started their job in finance in the last couple of years have probably never heard of it.
This article will not go into the details of the bureaucratic monster from Brussels, but touch on the aspects of MiFID 2 that are relevant for equity research and corporate access.
To simplify, we will be talking about the so-called ‘unbundling’ – the idea that research, sales/trading and corporate access should be bought and paid for separately by institutional investors.
Let us take a look what has (or hasn’t) changed since 2018 and what could be on the horizon still.
1) Unbundling was not enforced by regulators
GDPR (DSGVO) and MiFID 2 have been around for the same time more or less. But their enforcement could not have been handled more differently: Some very large players received painful fines due to GDPR violations.
On the other side, we have not seen a single company that even got so much as an ‘educational’ snub from the regulator following an inadequate execution of the unbundling principle. And this despite the fact that several players have proven to be very creative when it comes to their interpretation of the new rules (“Oh, of course we have put unbundling into place, we aren’t selling bundles anymore, we call them packages now”).
The lack of enforcement of MiFID 2 is in somewhat of a contrast to its predecessor. While it took a while to gain traction, companies such as UBS and Goldman Sachs were fined considerable sums for violations of MiFID 1.
2) Big asset managers adapted to it but the concept hasn’t been accepted globally yet
MiFID 2 left asset managers with two options how to ‘unbundle’. Out of the two, the ‘cleaner’ has become the choice of large asset managers. For more details you can read our article on LinkedIn.
For a while, it looked like the concept would be adopted globally, also at smaller asset managers outside Europe but this hasn’t happened so far.
However, the large asset managers will probably not go back to the old system. Firstly, they are spending less than they used to for the same services. Secondly, a return to the old system and switching back their IT tools would come with a hefty price tag.
3) Research teams have been ‘rejuvenated’
Due to reduced commissions being paid by the large asset managers, banks have opted to replace older, more experienced but also more expensive analysts with more junior ones.
This trend, while it had started before MiFID 2, was accelerated once more. Presumably, the peak of this development has already been reached.
4) MiFID 2 was a push for corporate broking…
Brokers have taken up the opportunities that were presented to them by MiFID 2 meaning they have adopted the concept of corporate broking, especially in Germany, a bit less so in Switzerland.
Corporate broking, originally practiced mostly in the UK, means that companies pay a fixed yearly fee for the all-round service including research, market making and the organization of investor meetings.
Companies who have offered this model even before, e.g. Baader Bank, were able to increase their client base (+25% in 2020) while there was still space for new players that just recently started offering this (e.g. Exane).
Market growth stems above all from larger companies (market cap-wise) which have been forced to take on these services as brokers have materially reduced their ‘broker-sponsored’ research.
5) COVID led to a comeback of ‘broker-sponsored’ events
At the end of 2019, brokers were still open to organize in-person NDRs (non-deal roadshows) for most companies for free, at least in the larger financial centers. However, the same was not true for smaller companies, or events taking place in smaller financial centres.
This took a turn when we all ‘masked up’, retreated to working from home and the whole world turned virtual. Suddenly, brokers have become very keen to set up virtual events for (almost) all companies. We believe there are three reasons at play:
No expenses = better contribution margin
A classic ‘broker-sponsored’ roadshow (which is free for the issuers) has brokers pay for meeting rooms, catering and transportation, on top of their own travel expenses. A virtual event has no such costs but at the same time investors did not cut their payments to brokers for corporate access. In other words: Expenses turned into contribution margins.
No limit to one city = easier to set up
When brokers organized events in a specific city (say Frankfurt) in the past and the schedule was not filled completely it meant that either the issuer was not satisfied or the broker had to put in extra effort to close the gaps, in some cases with other investors who did not pay the brokers.
While virtual events nowadays are still organized by specific locations, issuers are more ready to accept meeting an investor that is not based in the target location because meetings are virtual anyways. On top of that, empty slots in the schedule do not present a real problem when the delegates are staying in their own office and can just use the free time to work on other things.
A safe bet from a regulatory standpoint
As stated above, regulators show little interest in enforcing the MiFID 2 rules regarding unbundling. The regulatory risk has been low for brokers as well as for asset managers.
Virtual events further decrease this risk. A broker can offer a meeting and the asset manager can accept it for free if it can be considered a ‘minor non-monetary benefit’. This is questionable for a physical meeting, which can easily amount to total costs of over EUR 500. A virtual meeting could fall much more easily into that category – if the regulator even bothered.
6) The watering down of MiFID 2 helps banks especially
Unbundling increases transparency. More transparency is never beneficial for the margins of producers. Banks have lobbied strongly against MiFID 2 and in the end were successful.
In the last months, the EU as well as the FCA (the UK regulator) diluted the unbundling rules to “support the economic recovery in Europe”. ‘Re-bundling’ is now allowed for smaller companies. The EU puts the threshold at EUR <1bn, the UK at GBP <200m. Further dilution is possible.
The official statement also argues that improving the ‘research offering’ is one of the objectives. We do not believe that the dilution will contribute to that goal. Neither will brokers offer more ‘broker-sponsored’ research on smaller companies, nor will prices fall for ‘issuer-sponsored’ research. We are however happy to change our view if anyone can offer evidence to the contrary.
The dilution offers brokers the opportunity to increase trading fees for small and mid caps ('You know, we are increasing the fees to support the European recovery'). This scenario does not seem unlikely.
Kudos to the banks’ lobbyists: The results aren’t helping the economy, they are great for banks and the official reasoning (‘to support the European recovery’) is magnificent. However much the lobbyists were paid - they deserved it.
7) Outlook for the time after COVID and the MiFID dilution
Let us hope that COVID isn’t only temporarily disappearing from headlines over the summer and life can go back to ‘normal’, even if some of the changes will stick around.
These are our predictions:
- Physical events will see a comeback, probably a very strong one in the beginning since (most) people crave in-person interaction.
- After the initial catch-up, we will see the market share of physical events decrease again in favor of virtual events, simply because ‘they work’.
- Work-from-home will remain widespread also in asset management. The organization of physical events will hence become more difficult because the days where ‘everyone’ is in the office will be even sparser.
- As a result, physical events may become ‘hybrid’ i.e. part of the meetings will take place locally in person whereas another part will see investors dial-in remotely.
- Brokers will again offer physical broker-sponsored events at major financial centres for large companies.
- We believe however, that brokers will show more restrain compared to 2019. Firstly, the alternatives (virtual events) are more attractive to them. Secondly, it has become more tedious to set up physical events.
- Especially smaller companies will face the choice of either replacing physical roadshows by virtual ones or organizing their physical roadshows on their own or with the help of third parties.
- Brokers will offer broker-sponsored virtual events to most companies. Issuers should accept their offer if it aligns with their outreach strategy
- Issuers should take charge of their relationships with their key investors and offer them interactions pro-actively whenever there is relevant news flow
Read on about ‘virtual events’ in our article about the topic.
How we can help
If you are looking for a solution for software & data focused on the needs of midcaps and want to approach your key investors more proactively (including organizing virtual or physical events) – we can help you.
If you would like to continue doing physical roadshows ‘post COVID’ and are looking for options: We also offer an all-inclusive service for organizing physical events such as roadshows (targeting, invites, follow-ups, logistics, accompanying you throughout the day, feedback report) to our software clients, also done through our platform schedulR.
Non-software clients can also use this service for roadshows in Switzerland and Italy (Zurich, Geneva, Lugano, Milan) – however software clients benefit from a reduced rate. Other locations are possible as well – via our partners, e.g. in the United States.
If you are interested in our ‘digital investor engagement’ software solutions, if you would like to discuss a potential event in Switzerland or Italy, or if you have another view on MiFID 2 that you would like to share: click here book a 15min virtual meeting with Kilian.