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The authors of MiFID I had high hopes too, but that regulation failed to further the integration of European financial markets.
MiFID II may tear up existing business models, but could just shift conflicts from one area to another. Costs may simply move from commissions to wider dealing spreads and issuer payments.
Financial markets compose a complex global system, and remodelling one sector in one region may have unintended consequences. London could lose business to countries with lighter-touch regimes, and the EU as a whole could see activity migrate to New York or Asian centres. Adjusting to this will be a challenge for global investment banks and asset managers.
Certainly, clients deserve control of research costs. MiFID II will shed some light on the workings of the asset management process, but many clients are more interested in outcomes: in returns, control of style, and risk management. Discussing the new system with clients and reporting on research will require additional attention by managers — possibly at the expense of other important issues. Clients are becoming more interested in governance and sustainability, and would rather have data on that. Can the bandwidth in client relationships really be stretched to accommodate all this?
In the EU, the industry does not currently expect that research budgets will fall, but a shift away from the largest investment banks seems likely. Many smaller brokers will fight to keep some sort of relationship with investment firms alive. While this will not be free under MiFID, low charges for research would still offer brokers the opportunity to provide fundraising, institutional access, and IPO services to corporate clients.
Regulators cannot encapsulate the business models of all the firms on each side so it will be difficult to tell whether profitability is being recaptured in dealing spreads or corporate transactions. Many of the new specialist research providers that present their work as “independent” research will actually continue to be paid by corporate clients. Most smaller or mid-cap listed companies will likely need to pay for the research provided to investors. In the same way, research from brokers with corporate advisory relationships is already questioned.
In theory, the new regime will bring a return on investment into research, but in practice, there will remain workarounds and fudge. Ideally, innovative dynamic pricing models should develop — where the price of research varies as it is disseminated. Major buy-side firms using research will potentially suffer more of a price effect than boutique asset managers, quickly exhausting the value of the insight. A specific research piece or analyst team might capture more value by selling to smaller asset managers to minimise the impact.
Early in 2018, regulators might be tempted to make some high-profile examples in order to highlight best practice. But the industry will be in turmoil for months, and any intervention should be taken with care.
Instead, regulators should be alert to any emerging systemic risks encouraged by the new regime. MiFID II’s problems may surface more quickly than the benefits.
North American and Asian regulators are unlikely to follow the EU until the results become clear.