A year ago, the Markets in Financial Instruments Directive II, commonly referred to as Mifid II, came into force. Arguably the most ambitious and wide-sweeping regulatory reform of the financial services industry in the last decade, it was touted as the death knell of sell-side equity research.
Mifid II’s aim was to enhance transparency and investor protection. One of the most high-profile requirements focused on how asset managers pay for the research used for investment decisions. Sell-side research costs now must be budgeted separately from advisory or trading execution fees, rather than being packaged within trading fees – a cost that was often passed on to end investors. This change therefore removes the perceived conflict of interest or possible inducement to trade identified by the regulator.
Most asset managers had unbundled research costs before the implementation, making distinctions between the payments for research and trade execution. However, with the advent of Mifid II, institutions have largely chosen to absorb the research costs internally, rather than charging end investors. Some of the established sell-side banks and brokers slashed the price of their written research, keen to maintain their positions on the list of asset management research providers.
Meanwhile, many of the smaller broking houses lowered prices, often to nominal sums, to maintain access to institutions in order to sell primary deals. Anecdotally, we believe that industry-wide payments for research decreased by 20 to 40 per cent in 2018, with much of the price deflation led by the sell-side. The unfortunate result was that asset managers consumed the same research as before, but paid substantially less for the privilege.
And now, 12 months on, both sides of the industry are facing continued pressure. Asset managers have had to contend with the worst year for shares in a decade, as well as increased competition from passive funds. While brokers also must contend with market uncertainty, the last few months have seen lower market trading volumes and weakening corporate deal flow, which have dented their ability to offset the decline in research fees.
So, who – if anyone – are the winners?
Small and mid-cap brokers have benefitted by providing a rare commodity: thorough research on companies that are generally less well covered by the larger players. The biggest FTSE 100 firms tend to be covered by a dozen or more analysts, and it is harder to offer unique and valuable insights when there’s so much competition.
Extel’s 45th annual ranking of European brokers provides a useful benchmark for the performance of the broking industry. Numis, Peel Hunt, and Liberum took the top spots for 2018 in the UK small to mid-cap category. At Numis, all of our major institutional clients are still paying a substantive amount for research post-Mifid II, leading to a growth of six per cent in our equities business in the last year.
I believe that this is as a result of continued investment in our platform and talent, with high-profile new hires across research, sales, and execution. Peel Hunt also made good progress, coming a close second in the Extel survey. Numis and Peel Hunt have broad coverage across UK-listed companies, with a particular focus on the mid and small-cap segments of the market. Liberum and Investec continue to be well regarded in this same space, both securing top four places in the Extel poll.
As we enter 2019, institutional budgets are likely to remain under some pressure, with increasingly selective criteria for research to ensure value for money.
This will impact both the large bulge bracket banks and independent broking houses. The relative winners among both the banks and the brokers will be those with broad and well-invested equities research departments, who are writing and broking differentiated and thought-provoking research.
In conclusion, Mifid II has forced our industry to place a greater focus on the quality of individuals, service level, and investment insight offered to clients, which can only be a good thing.
Attracting and retaining the right talent is more critical than ever to the survival of the research industry, which is one of the reasons why we at Numis have invested more in hiring new talent in the last year than ever before.
While we’re only one year into the new world of Mifid II, our experience thus far has shown that investor demand for high-quality independent equity research remains strong.
The shake-up of the industry represents an opportunity, rather than a threat.