MiFID II – the tip of the Iceberg?

If you work in the City of London you will have no doubt come across the most recent of the EU’s directives, which was implemented in to UK legislation in January 2018. However, what I’ve come to find through discussing it with clients, colleagues and other advisers, is that many of us are dealing with only a tiny tip of the iceberg when it comes to MiFID II’s scope, and even that tip is covered in ambiguity and misunderstanding. Understanding this, and the reasons behind the updated legislation should help us to make more sense of it, improving our communications accordingly. 

What is MiFID II?

MiFID II, an acronym for the Markets in Financial Instruments Directive (mark two), updates the existing MiFID legislation originally introduced by the EU’s European Securities and Markets Authority (ESMA) in 2007. In 1999, the EU created the Financial Services Action Plan (FSAP), with the aim of creating a single wholesale market for financial services. Under MiFID rules, a firm can use their domestic authorisation to operate not only in their home state, but also in other host states within the European Economic Area (EEA), a process known as ‘passporting’. Since creating FSAP, the EU has issued various directives and regulations. Directives (of which MiFID II is one) are issued by the EU to harmonise laws across member states, which are required to implement legislation by a certain date either by creating new laws or updating existing ones. The EU also issues regulations, which are the most direct form of EU law and are immediately binding in all EU member states (incidentally, MiFID II was issued alongside the lesser known MiFIR (Markets in Financial Instruments Regulation) – which sets out several additional reporting requirements and extended MiFID’s scope to cover more asset classes). Whilst still technically in the EU, the UK must comply with these accordingly, and hence our legislation was altered to incorporate the changes directed by MiFID II by 3 January 2018.

Before we get bogged down in the rather complex EU regulatory structure, it’s worth considering the circumstances in which many of us have encountered MiFID II’s impact on a day to day basis. In the context of financial public relations, MiFID II has come to the attention of Buchanan and its clients for its role in the separation of commission and investment research. Institutional investors now must declare all transaction costs, which includes the ‘unbundling’ of costs/ fees (which previously have been largely wrapped into soft commissions). To recap, one of the aims of ESMA is to enhance consistent EU-wide investor protection. The unbundling, therefore, of research and commission, should indirectly provide more protection to the investor, as there is more transparency within the transaction process and less room for inducement.

…but has anything actually changed?

Although this seems a significant change to the way things operate in the City, what has surprised me is how tiny of a role the separation of commission and investment research plays in the context of additional legislation that has been introduced by MiFID II. Loosely, the key changes required by the directive can be summarised as follows:

  • Improved investor protection to safeguard clients’ interests by providing increased information on products and services;
  • Strengthening transparency requirements that apply before and after financial instruments are traded;
  • The notion of a regulated organised trading facility (OTF) has been introduced, to capture unregulated trades that are executed on non-regulated platforms;
  • A limit on the size of positions held in commodity derivatives;
  • Rules to avoid potential risks and creation of disorderly markets from increased use of technology performed electronically at very high speed;
  • Staff remuneration and performance assessments must not be against clients’ interests.

Notably, what links all the above is the intention to provide more investor protection. Many of the updates above won’t affect Buchanan and its clients directly, as the role that equities play in investors’ portfolios will vary hugely, and the legislation affects many other investment instruments within the market. However, what we can take away from this is that transparency in the context of investor relations is becoming increasingly important.

Before MiFID II came into force, there was much speculation that the requirement to unbundle research and commission would lead to a lessening of sell-side research coverage on Companies. Particularly in the UK small to mid-cap space, where the majority of Buchanan’s clients sit, many Companies will have only a handful of analysts writing research on the stock and so are at much greater risk than larger companies with a bigger following. Although I have personally not experienced a significant drop-off in coverage for many of my clients, what has been interesting is seeing the increase in direct requests to Buchanan from institutional investors requesting corporate access. It seems one of MiFID II’s unforeseen consequences is that the unbundling of research and commission has forced some investors to terminate relations with investment banks altogether, leading them to seek alternative routes to director face time. Furthermore, corporate access is in some circumstances also being billed as an additional cost to investors – with investment banks charging for management’s time.

What can we learn from this?

Although it is early days, what we can learn from the observations so far is that it is more important than ever for a Company to take real ownership of its investor messaging. If a Company can ensure itself that there is accurate, up to date and informative information on its investment case readily available, then it can mitigate any effect on its visibility, profile and liquidity that a reduction in research coverage and corporate access might incur. Smaller and midcap companies will need to take a far more proactive role in handling their investor relations, rather than relying on both research and investor access services from their house brokers or other brokers.

In its simplest form, a Company can make sure that information is available to all investors by having a best in class investor relations website. If there is anything we can take from how vast the MiFID II legislation is, it all points to increasing transparency and protection for the investor, and what better way to create a level playing ground than for a Company to issue ‘primary’ information directly, making it available for everyone on its website, rather than relying on third parties. This will require investment now, but will pay dividends in the longer term.

Conclusion

Many of us are dealing with just the tip of the iceberg of legislation when it comes to MiFID II.  Understanding how vast and far-reaching the legislation is, and the underlying reasons for the updated directive, gives us context as to why improving investor access is important, helping us improve our communications accordingly.

Buchanan is currently offering clients a three-hour consultancy session to review and present key recommendations on how to navigate the post MiFID II landscape, looking at ways to raise profiles within the buy-side and optimise IR content. For more information please contact Buchanan on MiFIDII@buchanan.uk.com

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