The UK’s Financial Conduct Authority (FCA) has recently finalised new rules reversing the 2018 MiFID II (Markets in Financial Instruments Directive) ban on bundling fees for trade execution and investment research. Under these new guidelines, asset managers are now permitted to make joint payments for third-party research and execution services, provided certain conditions are met.
Understanding the Rule Change
MiFID II, implemented in 2018, aimed to increase transparency in financial markets by unbundling payments for research and execution services. Asset managers were required to pay separately for investment research, leading to a significant reduction in research budgets. This, in turn, contributed to a decline in the number of sell-side analysts and a reduction in coverage, especially for small and mid-cap companies. The new rules allow asset managers to bundle payments again, which could potentially reverse these trends.
Impact on Equity Research
The reintroduction of bundled payments could have a positive impact on equity research. Now, asset managers might have more flexibility in how they allocate their budgets, potentially leading to increased spending on research. This could result in more comprehensive coverage, particularly of small and mid-cap companies, who often struggle to attract analyst attention. For IROs, this shift could translate into better visibility and more accurate valuations for their companies.
Implications for Investor Relations Officers
As the market adjusts to these changes, IROs should be prepared for potential shifts in how their companies are covered by analysts. The possibility of increased research coverage presents both opportunities and challenges. On one hand, more coverage could lead to greater investor interest and improved market perception. On the other hand, the quality of research and the nature of analyst relationships may evolve, requiring IROs to adapt their strategies accordingly.
IROs should also be mindful of how these changes might affect their interactions with asset managers. As the dynamics between research and execution costs shift, the priorities of asset managers could change, influencing how they engage with companies.
Insights from Industry Experts
Liz Cole, Head of Policy & Communications at the IR Society provided her perspective on the rule change stating, “The quality of investment research is crucial in shaping market perceptions and determining the fair value of companies, and is therefore a critical factor for the proper working of equity markets. However, following MiFID II unbundling, a great number of companies experienced a reduction of research coverage and quality. Analysts, now covering more stocks, often struggle to keep their models updated, leading to inaccurate market expectations and potentially damaging corrections.
Cole elaborated further, “The Society supports measures to enhance research quantity and quality, noting that the FCA’s PS24/9 could improve coverage, especially for smaller firms. However, concerns remain about whether the payment options introduced are sufficiently aligned with international standards to be effective.”
Laurie Havelock, Editor at IR Magazine, shared his outlook on the revised rules stating, “They may enthuse many IROs – particularly those at smaller cap companies – as the prospect of wider analyst coverage and increased visibility would certainly appeal. It may be that it’s a case of ‘the horse has already bolted’ and that the changes to the UK investment landscape have already become baked into the market, however. Many investors consider the quality of sell-side research to have dropped permanently.”
Havelock added, “Many IROs will still dedicate their time to cultivating deep relationships with research houses in the hope of generating good quality notes from analysts that understand their company’s proposition thoroughly. Hopefully, it will lead to a more competitive broker landscape.”
Darrell Heaps, Founder and CEO of Q4, contributed his thoughts stating, “MiFID II, aimed at enhancing transparency and reducing conflicts of interest, inadvertently reshaped the research landscape by reducing traditional sell-side research and boosting demand for independent research. However, this led to a significant drop in research coverage for smaller companies, as asset managers focused resources on larger, more widely traded firms. This decline made it harder for SMEs to attract investor interest.”
Heaps elaborated, “Now, the question is whether or not rolling back this regulation will lead to a resurgence of institutional research or if independent research will continue to thrive. We will have to wait and see if this shift proves to be beneficial or detrimental to smaller issuers.”
Looking Ahead
While the FCA’s decision to allow bundled payments is a significant development, its long-term impact on the financial industry remains to be seen. For IROs, staying informed about these regulatory changes and their potential effects will be crucial in navigating the evolving landscape of equity research.
In conclusion, the FCA’s rule change could breathe new life into equity research, potentially increasing the number of companies covered, especially in the small and mid-cap space. However, the full impact will depend on how asset managers respond and how the market adjusts to the new regulatory environment. As always, IROs should remain vigilant and proactive in adapting to these changes to best position their companies in the marketplace.
Sources
Morgan Lewis (2024) UK FCA adopts joint payment option allowing bundling of payments for research and trade execution. https://www.morganlewis.com/pubs/2024/08/uk-fca-adopts-joint-payment-option-allowing-bundling-of-payments-for-research-and-trade-execution (Accessed: 14 August 2024)
Investopedia (n.d.) MiFID. https://www.investopedia.com/terms/m/mifid.asp (Accessed: 14 August 2024)
