14 November 2017

Blog: The "Broker Exemption": An Inconvenient Question

By Scott Fulton | 14th November 2017

Investors really like meeting companies. We surveyed over 140 fund managers in January this year (here). Two thirds of them rated meeting management as critical to their decisions, twice the rating for investment research. Since then we have arranged over 2,000 investor meetings for over 70 UK companies.

But investors are not prepared to pay brokers for these meetings, at least not under the new rules. Our latest survey, out today (here), reveals that 95.0% of investors are either unlikely to pay or will not pay stock brokers to arrange meetings with companies when MiFID II comes into effect (3rd January 2018).

This causes a problem.

MiFID II – 34 working days and counting – states that if a stock broker arranges a meeting for one of its corporate clients with an investor on an “exclusive” basis (i.e. one-to-one), this is “material”. Payment from the fund to the broker should be made. For it to be “minor” (non-material), the meeting cannot use valuable resources from the broker and, critically, it cannot influence the fund manager’s investment decision.

Yet, “material” investor meetings are critical for companies and investors. They provide up-to-date information, support liquidity, reduce volatility and, potentially, offer the promise of new money when required. This is particularly true for small to mid-cap companies who may not enjoy the benefits of significant analyst coverage.

“Material” meetings are also the basis of many brokers’ economic models because they demonstrate their ability to raise funds for their corporate clients. Fees for this work dwarf those currently charged for trading, research and, corporate access. Maintaining non-deal corporate/investor contact under their aegis is far more critical to brokers than selling meetings to fund managers.

So, if fund managers are not going to pay for meetings with corporate clients, even if they are material under MiFID II, how has the sell-side responded?

By claiming the “broker exemption”.

This is an untested carve out which is said to allow brokers to provide corporate access for their company clients without receiving payment from the fund manager because the company pays for it.

However, recent guidance from the European Securities and Markets Authority (ESMA) which stated on 3rd October 2017 seems quite clear that the broker may not be able to charge the fund manager for any services related to the company client if it does not charge for access, irrespective of whether or not the broker has already been paid for it;

“ESMA notes that an investment firm (fund manager) can also treat corporate access as a commercial service and pay for it appropriately from its own resources. In such cases, it is important that the provider (broker) prices services at commercial levels and access itself is not linked to or dependent on payments for research or execution services (CAG emphasis) where the provider offers these other MiFID services. This should ensure there is no inducement risk under the MiFID II obligations.”

Our research today (here) reveals that over 90.0% of fund managers are not prepared to pay for broker meetings with companies While 75.0% of those fund managers who are prepared to pay for broker-sponsored meetings are only willing to spend £250 or less for them.

Thus, it is only by claiming a “broker exemption” that brokers can arrange investor for meetings for their corporate clients. Assuming this exists – and we have our doubts – it appears to preclude brokers from dealing in the company’s shares with the fund managers it meets.

This apparent contradiction between the rules and the “broker exemption” begs a few questions. Not least, “how many of my shareholders and target investors agree with you (broker) that the broker exemption exists and will you be able to trade in my shares for them if they do not pay for our meeting?”

The answer to this question will determine the nature of UK corporate broking and investor relations for some time to come.