28 March 2017

Blog: “Masterly Advice”

by Scott Fulton | 28th March 2017

When Alex Masterly (from The Alex Cartoon) comments on MiFID II it is clear that debate regarding the impending regulations has moved from the academic to reality. In a recent strip, Alex Masterly approaches his compliance officer highlighting that none of the bank’s clients have agreed to pay for its investment research. As ever, Alex views this as a positive;

“If they don’t think our research is worth anything then it can’t be a bribe can it? So we can scrap all this MiFID nonsense.”

Understandably, the compliance officer is not be swayed by this logic.

The lack of a public consensus about research and corporate access under MiFID II compliance is what underlies the Alex joke. What is not so funny is that MiFID II takes effect from January 2018 and confusion is growing about payment for corporate access and research under the new regime.

To be clear, MiFID II is designed to improve the transparency and efficiency of payments for financial instrument transactions. In particular, brokers’ services must be unbundled. Where this relates to the cash equity market, it requires that fund managers demonstrate the efficient use of client monies. Specifically, this relates to best execution, requiring funds to show that they dealt at the best price at the time. By extension, MiFID II also requires that funds disclose how much client money has been spent on corporate access and investment research.

MiFID II does not mandate the level of fees that funds pay for corporate access or research. However, it does ask that fund managers assess the value of these services on a standalone basis.

As Alex Masterly highlighted, the experience of charging investors for a service which were previously “free” is not strong. This is particularly true where the new fee does not produce an improvement in service levels or quality. Our analysis suggests that this conflict cannot be reconciled entirely by the broking community and that both funds and corporates are likely to look to alternative providers of both research and corporate access once MiFID II is applied.

Fund managers have long complained that most of the broker research they receive is “care and maintenance” which updates forecasts but does little to add to the investment thesis. Under MiFID II and separate research charging, it is likely that funds will not pay for this form of research. However, companies require a reasonable forecast basis in order that there is an orderly market in their shares. The obvious solution is for companies to pay for “care and maintenance” research but the equally obvious question is whether brokers will be able to distribute such commentary to funds under MiFID II.

The position of corporate access is similarly opaque. Fund managers are unlikely to pay for meetings with companies in which they own shares on the not unreasonable grounds that they should know the company sufficiently to organise their own catch up. Even when they do not own shares, it is a brave fund manager who would use client money or his/her own funds to pay for meeting a company with whom they have an existing relationship.

When no fee is charged for meetings by brokers, we are sceptical also that this provision is sustainable under MiFID II. For example, will a broker have to inform the fund manager that it cannot trade with the broker in the underlying equity in case this is seen as cross-subsidisation? If that is the case, for how long does this restriction last? These questions have not been answered as yet but appear to us pertinent given the detail of MiFID II.

Like research, the solution may be to seek alternative provision to avoid the pitfalls created by MiFID II. By using firms such as CAG, companies may not be constrained by the brokers’ trading relationships with funds or the potential issues with cross-subsidisation. On the same basis, funds are not beholden to brokers for free meetings which may cause problems when dealing in the shares.

MiFID II could create an environment in which the brokers are no longer the gatekeepers for research commentary or access to fund managers. Companies may find this a difficult habit to break but there is sufficient scope for confusion to suggest that alternative provision should at least be considered when assessing investor relations in 2018.

Alex’ logic regarding this “MiFID nonsense” may be current wisdom but it does not take much to see the benefits of an alternative scenario.

For more of Alex's wisdom, please see http://www.alexcartoon.com/