The fact that MiFID II has been making waves across the European Union (EU) is no longer news. From equity research to darkpools, the finance world has been forced to dramatically change its approach and find ways to quickly comply with the new regulation. Equity research will be sold for what it is, not part of a bigger package including commissions and incentives, and will have a specific price tag attached to it. This is what is known as the great unbundling and it will reset and reshuffle the sell-side by the end of the year.
And MiFID II will have consequences around the world. Non-EU companies will have to come up with best practices to work with their European subsidiaries or European clients.
What MiFID II does for research is it forces the unbundling of investment research payments from trading commissions. In brief, the sell-side will no longer be able to put together a nice package of nondescript items, tie it with a bow and charge a hefty fee. The new regulation bans EU firms from paying any fees for third-party services unless those fees are transferred to relevant clients.
Most buy-side firms are paying for research out of their own management fees and only a few select players decided to use the newly-established research payment accounts (RPAs) with their research providers. They are also no longer able to pay for research directly with trading commissions but can do so through the RPA mechanism.
First effects? The way research is priced, and the buy-side being actively involved in choosing the products it wants. Remember the hundreds of emails of dubious quality research idling in one’s inbox? History.
A very clear impact will be on the analysts providing the research – the ones that have the experience and know-how to stay afloat will easily do so, and thrive. The need for research will continue to grow as funds are looking to expand their investment portfolios in the current “cheap money” environment.
However, MiFID will also impact the rest of the world, to various degrees.
The old school research model is still prevalent in the US. Research brokers would be unable to charge for research without breaching rules, stating that such an activity can be carried out only after registering as investment advisors. That, of course, would carry more responsibilities.
The EU’s new push for transparency has struck a chord with US investors too but, until the framework changes, their call for change will remain unanswered. Some US firms are looking to continue to access European research from global investment banks, but pay using soft dollars via their US relationship to get around any of the MiFID II restrictions.
The regulators have been so far understanding when it comes to the US’ dealings with the EU in equity research – they’re willing to overlook the problem and not prosecute any breaches when it comes to European clients. However, this cannot last forever and the US will have to find its own way – sooner rather than later. All the major US mutual funds have already moved to adopt the MiFID II framework – not having done so would have proven onerous and would have an immediate impact on the business.
Changing Business Practices
The EU regulation will also affect both the buy-side and the sell-side in Asia. The sell-side will have to unbundle its research and come up with pricing for the packages they offer to EU clients. They will have to find tailored solutions for different markets too. As mentioned, in the UK, the buy-side can operate an RPA when using clients’ funds to pay for research. Unsurprisingly, given its 150-year history with the UK, Hong Kong is closely aligned with the FCA framework.
In France, there is a tweaked version of the commission sharing agreement (CSA). Other EU countries will undoubtedly continue to develop their own solutions to MiFID regulation as the year progresses and everyone focuses on becoming fully compliant.
On the buy-side, one key issue is how research will be shared within a global group. Sure, the local subsidiary might pay for it and be MiFID compliant, but what happens when it goes on to share its insights with other entities in the group? At the same time, the way research is paid for in the EU might be non-compliant with regulation in other jurisdictions in APAC, which opens a whole new can of worms that has to be dealt with in the immediate future if issues are left outstanding.
The space remains fluid as regulators around the world are looking for long-term solutions to the issues MiFID II has raised. However, as the main goal of the regulation was increased transparency, this is likely to gather the interest of more and more jurisdictions. As the EU will lead the way, it will also provide others with best practices on how to successfully – and as smoothly as possible – implement similar requirements.
However, the process will never be fully pain-free. By the end of the year, the EU sell-side will be completely rearranged, and one should not be surprised by news that some big banks might shut down their research departments altogether. But for those providing quality research, the regulation will translate into clear-cut, ironclad fees for services rendered that will continue to generate strong revenues from a happy buy-side.
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