MiFID II Outlook – Cloudy for Consensus, Stormy for Small Caps.
by Oliver Juggins | 14th May 2019
There have been plenty of theories aired about MiFID II over the last few years, ranging from “Business Largely as Usual” to “Armageddon (MiFID) II”. It’s still not entirely clear where we will land, but the extremes, at least, look like they’ve been discounted.
A short paper has recently been released by the CFA Society, who took to the field to survey the sell-side, the buy-side, and corporates. It adds evidence to support the earlier paper from respected institutions QCA and Peel Hunt (QCA/Peel Hunt Mid- and Small-Cap Investor Survey, February 2019), and comments I’ve been hearing anecdotally since I re-joined the new, post-MiFID II, financial world in mid-2018.
The points that jumped out at me highlight the growing need for (i) company-controlled access, (ii) high quality independent research, and (iii) some form of new product to reveal the consensus view for all market participants. This all needs to be achieved without costing investors or corporates too much time or money. No small ask! I’ll attempt to address these key points below.
As most will now be aware, under MiFID II investors pay a fair price to attend meetings arranged by regulated brokers to avoid the risk of inducement. To avoid compliance issues and cut out this cost, this survey suggests that more asset managers are opening dialogue directly with, and offering feedback directly to, company management. As a result of this 90% of corporates say they either have developed, or plan to develop, their website to improve interaction with investors. This isn’t all though: investors tend to say that holding a capital markets day is the best way to improve visibility (Peel Hunt Investor Survey 2019).
This engagement may seem like great news for corporates, but adds considerable workload and cost, both of which would previously have been absorbed by the broker. Corporates faced with this changing business model will likely need to set up new CRM-style (Customer Relationship Management) systems to handle the increased demand. This can be expensive, time-consuming, and risky.
Indeed, many corporates are already starting out down this path:
Source: Peel Hunt Investor Survey 2019
One key solution here is for the corporate to outsource this work. This could be as simple as working with the more adaptable brokers, who can change their pricing model to comply with the new regulations. It could also result in a shift to video conferencing, which has environmental, cost, and time benefits. Providers like BRR media can be helpful here.
Finally, corporates could work with paid-for research and paid-for access providers like Capital Access Group (shameless plug!) who have developed exactly this expertise over decades. Because these businesses don’t execute trades or charge investors for any of their services, they are exempt from MiFID II restrictions under any reasonable interpretation. We can’t induce investors to spend their clients’ money because we don’t charge them anything.
What we can do is make life easier for IR teams by sitting alongside their regulated brokers to arrange access to a very broad segment of the UK investor market.
The sell side and buy side both agree that coverage of small- and mid-caps is declining (62% of investors report that there is less research being produced on small- and mid-caps since MiFID II came into effect, Peel Hunt Investor Survey 2019): interestingly there was a view from the CFA study that the quality of available research is dropping too.
To quote the CFA paper: “as investment banks have scaled back their research operations to reflect the lower revenues they receive, they have largely opted to reduce coverage of small- and mid-sized, rather than large-cap, equity stocks.”:
Source: CFA, MiFID II: One Year On.An Assessment.
The Peel Hunt survey agrees, demonstrating that a majority of investors saw a decrease in their list of research providers:
Source: Peel Hunt Investor Survey 2019
This isn’t particularly surprising given that research now must be paid for directly, and the vast majority of asset managers are making these payments from their own revenues.The FCA has undertaken research that suggests research budgets have fallen by 20%-30%.
Thus, the prices research houses can charge have fallen. As Andrew Bailey, Chief Executive of the FCA, pointed out in his speech to the European Independent Research Providers Association: “what is becoming clear is the price of written research is much lower than initial forecasts ahead of MiFID II”. This means it gets harder to recover the cost of writing research without relying on high volume distribution – something that’s generally harder to achieve with small-caps than with large-caps.
What’s more surprising is that the majority of corporates of all sizes have reported a fall in sell side coverage. This may come down to the ongoing consolidation of the sell-side market, which although well underway before MiFID II came into focus, has reportedly been accelerated by the new regulations - 86% of investors expect there to be fewer broking houses in the next 12 months as a result of MiFID II (Peel Hunt Investor Survey 2019).
If the sell side is reducing coverage across the board, then company-sponsored research is required to fill the gap. Naturally there’s concern from all parties about the impartiality of issuer-sponsored research, particularly where it’s the only research available.
At Capital Access we offer three levels of research, all of which are freely published on our own website, on research aggregators like Research Tree and Bloomberg, and sometimes on the websites of our clients.
Firstly, we offer full, traditional sell-side style notes. We don’t make recommendations, but we do make comments on valuation. Obviously we’re paid by our corporate clients, so the same accusation can be levelled at us. All we can do here is vow to keep standards up - and I can promise you that our research is more impartial than this blog post.
Secondly, we offer what we call our 3 Cs research - “Condensed. Concise. Clarified.”. These are like initiation notes, but they focus on clearly and concisely clarifying the business model and the key drivers of business and share price performance for the subject company. This is targeted at generalist investors who may not know the intricacies of the sector in question, or its jargon and biggest performance drivers. This research is aimed at someone who’s new to the story and has minimum assumed knowledge – as well as someone who hasn’t engaged with the company for a while.
I’ll leave our third research offering to the next point, because that’s where it fits…
True earnings consensus is now all but invisible, even to big players. With most research now hidden firmly behind paywalls, it’s unlikely that more than a handful of people in the market will have paid for access to all brokers forecasting on any given company. Nobody else will have a true picture of consensus.
This leads to the risk of increased confusion and volatility come results, as nobody knows what the market expects and therefore can’t judge how said results will be received. As we all know, in investing a share price doesn’t move because results are “good or bad”, but because they’re “better or worse than expectations”. If expectations aren’t visible, then uncertainty reigns, and volatility follows.
Corporates thus need to take more active control in managing consensus. Our third product (mentioned above) is called Consensus in Detail (“CiD”) and should become quite invaluable to investors who want to gauge the mood going into earnings or other big news releases.
CiD is a breakdown of the consensus outlook that collates estimates (provided by the corporate) from all analysts who provide a complete set of forecasts. Each set of estimates is anonymised and then charted in such a way as to demonstrate the current range behind the published consensus, as well as a true average of all estimates on the market. Where guidance is given, this is marked on the charts to allow investors to make inferences about how analysts feel about its accuracy, and providing a quick ‘dashboard’ view of sentiment.
We’re very excited about this.CiD is evolving all the time, and our goal is to make it a “one stop shop” for consensus data and analysis on the subject company.
So whilst the future still looks uncertain, there are clear opportunities to improve the landscape for both investors and corporates, and we’re here to help along the way. If you’ve got this far through, congratulations: to reiterate what I said earlier, this missive wasn’t ever supposed to be impartial, but I do hope it provides food for thought.