MiFID II
Let’s start with the Markets in Financial Instruments Directive (MiFID II), which was passed by the European Union (EU) and became effective on January 3, 2018. MiFID II imposes additional reporting requirements and tests on market participants in order to increase transparency and improve trade executions. It also places restrictions on inducements paid to investment firms or financial advisors by any third party for services provided to clients. Banks will no longer be able to charge for research and transactions in a single bundle, providing greater clarity while improving the quality of research available to investors. Brokers will have to provide more detailed reporting on their trades, including price and volume information, and archive all client communications, including phone conversations. Preparations for implementation of MiFID II have cost affected firms an estimated total of $2.1 billion, according to a report by Expand, a Boston Consulting Group company, and IHS Markit.
While the current rule is applicable to domiciled EU companies only, the nature of global financial markets has already produced a direct impact in the US which is only now beginning to manifest itself in the form of revised 2019 budgets. The bottom line is that most practitioners did not think it would pass, especially with Brexit looming, and little planning was done in 2017. The largest impact has been felt by small and mid-cap companies, as the number of sell-side analysts covering these firms has declined (some to zero), while research for all companies has been further impacted by consolidation. According to The Tabb Group, the buy-side has already cut over 1/3 of their research providers and research budgets have been cut in half. Naturally this has led to a direct reduction in the number of firms and analysts providing equity research and other services such as corporate access. While firms of all sizes have been affected, regional and specialty firms have experienced the largest reductions, and continue to be most at risk. This has left many small companies struggling to find quality research coverage and has placed an increased burden on IROs to increase their investor marketing resources as many sell side firms will no longer provide corporate access without direct compensation from the companies.
As the affects of these changes unfold over the next several years, it will provide unique opportunities for the surviving boutique firms, the stock exchanges and even the trade organizations like NIRI, to fill the void. Most small and mid-cap IROs are already stretched thin, and now they are being required to engage the buy-side directly while, at the same time, look for new sell-side coverage, just to maintain their traditional marketing efforts. One alternative today, that mainly exists in the micro-cap space, is company sponsored research. This approach has its own issues, chief among them, independence. For this to be a viable option in the future, the independence issues must be resolved and the practice become more mainstream.
It is conceivable for small and mid-cap companies to address many of these issues in- house but one complicating factor is time constraints. Most of these IRO’s wear multiple hats, i.e.,Treasurer, M&A, Communications Director, FP&A, etc., in addition to their IR responsibilities, and can hardly afford to adequately address these issues with their current resources. This leaves two viable options; hire additional skilled resources, or engage a third party, both of which require an increase in current IR budgets.
Harvard Business Review