Problems Caused By MiFID II

13th Jan '18 by Paul Scott

37 comments 14237 reads

MiFID II

I've heard a lot of discussion, and moaning, from my friends & contacts in the City over recent months, concerning the apparently onerous regulatory changes being introduced by the EU's MiFID II (Markets In Financial Instruments Directive). This is a European Directive, but before Brexiteers get over-excited, apparently UK regulators had major input into its drafting.

The intention behind Mifid II seems to have been to make investment markets more transparent, and for consumer protection. However, from what's happened so far, like a lot of regulations, the actual impact seems to be the opposite of what was intended.

Probably like most of you, I've recently had letters from my various brokers, asking me to sign bits of paper. I didn't really pay a great deal of attention, as admin bores me. However, my main broker just said that the new rules would restrict my access to research notes, so the easiest thing would be if I requested to be registered as a professional client. This means giving up some protections, but I went ahead with it anyway.

Segregation of Funds

My main broker (Spreadex) segregates all client funds already, whether they are retail or professional clients. Plus, my view is that if fraud were to occur with any broker, then the rules over segregation of funds would probably be flouted by determined fraudsters. So it's questionable whether this supposed protection for retail clients would actually be adhered to in a broker meltdown type scenario. I've always thought that the best way to protect against fraud or some unforeseen broker collapse, is to spread your money around several financially strong brokers.

Companies House

Plus, I always check the published accounts of brokers, which you can do free, for any UK company, at companies house website here - well worth bookmarking that page - I use it a lot. Spreadex has a strong balance sheet relative to its size, so I'm happy to leave most of my family's money with them. Larger spread bet companies IG Group (LON:IGG) and CMC Markets (LON:CMCX) also have strong balance sheets.

Companies House website is also useful in everyday life, e.g. when paying deposits to builders or other contractors. It's worth checking Companies House website,…

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Andrew L

15th Jan '18

Paul, I haven't looked closely but I think one mooted positive for some from MiFD II is that the cost of broker research for fund manager clients will be more transparent. It was previously hidden in commission costs and fund managers didn't necessarily want the research anyway. This may lead to more research competition rather than banks just blanket covering all areas. With regard to the other areas I haven't looked closely. The idea that "silly little private investors" aren't smart enough to understand research has seemed a bit suspect to me. I'm not sure what everyone else here thinks on that?

hayashi22

It doesn't seem too difficult to access research from say Edison and Equity Development. I have looked at many of these and they all put a positive gloss on the company which is being written about! You can find one today from Equity Development on the disastrous Carclo warning.. It's almost written in a fantasy style but is useful to get new lower numbers into the market so there is at least a base line.These companies are not doing cutting edge research they are being paid to put a positive gloss on everything..and very useful too.

cic

It has long been considered that insider sealing is a bad thing: indeed, it is illegal. So, isn't restricting the availability of information to some investors, excluding others, tantamount to creating a group of insiders and therefore a very bad thing? If FCA really want to help protect small investors they could start by cleaning up AIM and prosecuting some of the crooked directors of the frauds found there, and ensuring that house-brokers are held accountable for the so called research that some of them publish.

monzo

Here we go:

http://www.cityam.com/278786/gina-miller-planning-sue-fca-over-its-lenient-approach-new?utm_source=newsletter&utm_medium=email&utm_campaign=180115_CMU_Kaplan

RMundy

Hi Paul,

Just to clarify that last point, Brokers who are planning to not charge for their house research are defining it as "corporate sponsored" which means it will be widely available to "professional" investors. However, at this time I haven't heard of any that are planning on putting this out as commissioned research that is available to all investors (ie retail and professional).

The reason for this is there are extra compliance steps they need to take before publishing a report that can be read by retail investors (in the way that the likes of Edison, Hardman, ED and Progressive do). They don't want to do this...

But... I think that may change in the coming months. Listed companies pay PR fees, House Broker fees, NOMAD fees, and many pay a Commissioned Research Provider to access their retail investor base. This is a lot of fees for small companies who are looking to keep costs down... I think we will, in time, see pressure from these companies for Brokers to do the extra steps that make their research available to the whole share register.

Commissioned research providers we have on our platform have mentioned to me that they are bemused Brokers don't already do this as the extra compliance steps are not onerous (ie slightly different structure, different disclaimers, no price targets etc).

david brander

Did you realise that broker notes are not allowed to appear on company websites,has been the case for some time.No idea why..
Seroiusly wonder if it is worth smaller cos coming to the market at all if ,as you say Paul,potential new investors are not given enough info to make a rational investment decision.

Simon Cawkwell has some amusing comments on MiFID II. Probably the European equivalent of Sarbanes Oxley. It is probably a shift away from principle based regulation and towards rules based regulation. In the UK we have tended to be much more principle based.

I like Simon's key point. A lack of knowledge of the law is no excuse but given that MiFID II is 7,000 pages it is impossible to know the law. Something of a contradiction!!!!! Good for compliance managers, the legal profession etc etc. Will it actually help market participants???

https://masterinvestor.co.uk/evil-diaries/evil-knievil-world-needs-palm-oil-will-pay/

olijar

Hi Paul,

I work within the institutional investment consulting space serving pension schemes and allocating their capital to investment funds.

This regulation is primarily targeting asset managers who up until now have bundled the cost of their research into their trading using commissions from execution with brokers. The issue with this is they hide this (often meaningful cost) as it is not in the management fee clients buy. Instead it gets hidden in the TER and there is a lack of transparency. This cost can be meaningful 5-20 bp for many funds which when you consider the meaningful capital that clients invest (we advise trillions) works out at a rather large free lunch for asset managers. My view is that asset managers should pay for the cost of research (both internal, their staff, and external). Both should then be reflected in the management fee for running the fund. From my discussions with fund managers most say the majority of broker research is useless for them, and the whole industry appears bloated. I accept the point that it may hinder liquidity and coverage of small caps (where retail investor presence is larger) but this is unfortunately necessary to reform a broken brokerage industry. Moreover if liquidity and coverage of small caps falls which I very well may do it should create create inefficiencies and opportunities to add alpha if you do the work.

Alexgedla

MIFID II is a classic law of unintended consequences situation. Mass confusion is likely for months.

However, it is worth remembering the status quo. E.g. There is right now very little independent equity research produced on most companies below 500m mkt cap. The house broker, a paid for house and maybe AN Other is usually all you have.

So things can hardly get worse in terms of coverage.

Availability of research might well be an issue, but the actual research production is already at low levels in small/mid caps. In mega banks, they don't care about small/ mid caps anyway.

Companies pay PR companies for some sort of coverage. But maybe this is money down the drain.

Do companies actually want critical, objective and independent research ? I bet they dont

fleurs

What hope have we got. Been trying to move to AJBELL from Barclays Smarter Investor since last September. Still ongoing, with my SIPP portfolio now at AJBELL but the SIPP cash with Smarter Investor, One fund didn’t transfer as being told held up by MIFID 11. So until that’s sorted the cash remains with Barclays. Not traded since September as told if paperwork changed would have to start again. Damage done as couldn’t sell RBG on takeover so still holding and Pennon dropped like a stone. No longer any idea what the truth is as stopped talking to Smarter Investor long time ago and got my personal banker to take up the cause. Conclusions Barclays Smarter Investor if it ain’t broke don’t fix it and never apply change on change on change because we won’t know where it got broken. All the best peed of Fleurs

peterthegreat

Re: fleurs, Barclays problems
Just to reinforce your comments about Barclays sharedealing services for smaller investors. As chairman of an investment club I received appalling and totally unsympathetic service from them and ended up taking them to the Financial Ombudsman. When everything is going smoothly you might think Barclays are OK, but when you have a problem like you are having, you find that their customer service is hopeless.

Re: Debate on MiFID II
Thanks for the discussion Paul, I found this very interesting. It is just part of ther crazily overegulated financial sector. Just over a year ago I had to spend over an hour on the phone to Skipton Building Society answering all manner of questions before they would allow me to change from one mortgage deal (which had just ended) to another similar mortgage deal. I appreciate the need to protect people but an hour of questions is total overkill. This was one of the reasons I invested in Mortgage Advice Bureau which has the necessary technology to sell mortgages efficiently. I was wondering if there are any listed small company beneficiaries of MiFID II. I would suggest that Fidessa may benefit, but that is hardly a smallcap.

MiserableJacktPotato

I'm really struggling to believe that the EU has let a vested interest create regulation that stifles competition and increases regulatory costs for no obvious benefit.
#sarc

JohnEustace

How about companies tell us directly what their forecasts are and leave out the middlemen? Next (LON:NXT) seem to manage it, what stops other companies doing the same?
Or just admit that the future is inherently unknowable like Burford Capital (LON:BUR) do and decline to make forecasts to anyone.

This "managing market expectations" is a game that doesn't add any value.

Deegee Eff

I wonder whether institutional investors might now turn up at AGMs of smaller companies,if they are otherwise going to have to pay for private meetings ?
I have rarely seen an institutional investor at an AGM .

roddy10

16th Jan '18

I have read the above comments with some interest.

There are various aspects to MIFID. Some are arguably beneficial to investors eg the aim to limit how much trading is done 'off-exchange' in dark pools etc (though that rule has been suspended for three months as some dark pools could not provide sufficient data - which in itself raises issue re whether dark pools execute beneficially for investors).

The part of MIFID that impacts investors most is the unbundling of research payments. I have some (slight) knowledge of how this was pushed through. At a previous brokerage we employed a consultancy to help us work out how to collect CSA (commission sharing agreements). One of the consultants particularly had an issue with how research was paid for without any formal contractual agreements. Over the years I have seen him make multiple presentations on this issue at various conferences and I know he presented at the FCA and in Brussels.

The issues I have for the institutional market are (i) we are moving from a relationship to a transactional model of research (ii) this fundamentally misunderstands the relationship of fund managers and analysts with research brokers and banks (iii) itemised bill may provide more transparency but alters behaviour and also is not the objective of end clients (iv) the model is different in different countries. I hate to say it but the consequences for retail clients and people like Paul Scott are, in some ways, 'collateral damage'. Let me address these issues in more detail below.

Relationalship vs transactional model:
The idea of Mifid is that if I meet an analyst I pay him the value I ascribe to the meeting. However in real life you rarely make a decision, when real money is involved, on the basis of one meeting. Secondly the benefit and hence the value of a meeting is often months or years later. For an extreme example one of my most profitable investments last year was a company that I first met in 2000 in a meeting organised by a broker that I no longer speak to.

Relationship between fund managers and research brokers:

As an investor I often do not fully 'trust' an analyst or a broker / saleman until I have met him / her a number of times. And I very rarely, if ever invest immediately following a single meeting, or on the basis of that one meeting.

However fund managers often underestimate how useful analysts and broker research is to get upto speed on a company.

Itemised billing:

There is a whole industry of consultants that have appeared to analyse 'TER' (total expense ratio) and fund allocations for institutional allocators such as pension funds, insurance funds and endowments.

I am frequently asked in meetings things like 'How high is your AUM turnover?' and 'What is your hit ratio?' My reply is I don't know and deliberately do not measure it as I am concerned that the more data points I try to record, analyse and manage the more distracting it will be. My objective I believe is straightforward - make investments that I think will make a return. Also cut if a company reaches my price target and I believe it has no more upside. Measuring, and therefore even if at a subliminal level, I start measuring my AUM t/o and hit ratio I believe it will impact my primary objective.

I am old enough and grumpy enough to say these things - but my fear is that a lot of younger fund managers are almost 'bullied' into managing their portfolios to please consultants and are thereby doing a disservice to the ultimate end client - ie the pension or insurance fund. Surely the key issue for any asset allocator is net performance. I appreciate the claims that performance one year does not reflect performance the next - but my experience is that there are some people who are consistent and others are not. (Also if performance does not carry through then what is the value of all the consultants - surely a client can invest in ETFs without assistance).

Other countries:

In the UK on AIM companies have a 'NOMAD' to whom they pay regular fees, some of which might be able to fund research. Other countries do not necessarily have a NOMAD system and fee income is often transaction driven rather than ongoing 'advice' and hence the funding of research may be less straightforward from the investment banking arm. In many banks 'research' per se is loss making but helps banks win mandates and also engage with buyside clients for their deals.

Private clients / smaller investors and common goods:

Because the marginal distribution cost of research is so low it has tended to be widely disseminated and arguably provided some degree of 'common good'. However, a bit like the story of the 'tragedy of the commons' it has meant that fund managers and even private brokers have undervalued it - and underestimated the time and effort it requires to write research. I have been on both the buy and sellside - and hate to say that though the buyside is very confident about their own skills, a lot of buyside 'research' is copy and paste - and a lot would not be allowed out by a good head of research on the sellside.

I think the FCA / regulators have not contemplated the benefit of the 'good of the commons' in how research was distributed historically. As I have mentioned elsewhere on this site one of the consequences is that the field is being tilted to favour larger and larger fund managers.

One final point - the FCA is the lead regulator for financial services within the EU - so in practise if the FCA puts its foot down the EU will generally not pass a regulation. Sometimes the EU is blamed for regulation which may have originated out of London or that the FCA did not intervene or engage on early enough.

peterg

Secondly the benefit and hence the value of a meeting is often months or years later. For an extreme example one of my most profitable investments last year was a company that I first met in 2000 in a meeting organised by a broker that I no longer speak to.

I'm not really sure why this is an issue. If you meet an analyst you should pay them for their time, and work, at whatever their going rate is as you pay any other contractor. Not for some estimation of what the future worth of their research may be. That may affect your decision on employing them, but not how you pay them.

Peter

ricky65

17th Jan '18

Despite making a mess of the investment research market, one advantage of MiFID II I can see is that SEAQ has been phased out and all stocks previously SEAQ have been transferred to SETSqx. I was never a fan of SEAQ as, in theory, market makers could collude to manipulate prices. With SETSqx non Market Makers can place orders.

Nick Jacobs

18th Jan '18

My personal view on this is that the free broker research was worthless anyway.
An analyst who really understood the stock markets wouldn't be wasting his time writing research reports for a broker, he'd be trading for his own account and getting rich.

Problems caused by MiFID II

MiFID II

Segregation of Funds

Companies House

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Paul Scott

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