One of the more high profile aspects of the MiFID II legislation that came into effect across Europe last month concerns how asset managers pay for research and corporate access — two costs that were in the past, in one form or another, built into trading fees.
In this Q&A, we wanted to share some of our thoughts in response to a number of frequently asked questions we have received from our clients on this topic during the last few months. We also wanted to share a few easy-to-implement, practical tips for investor relations teams to consider going forward.
How has the market been preparing for MiFID II?
In line with its goals of greater transparency and accountability, MiFID II makes it clear that the onus is on the buy-side to pay a proper value for ‘substantive investment research’, the free provision of which would be considered an illegal ‘inducement’ to trade with a particular broker.
As such, investment managers in the EU were confronted by four key decisions in 2017:
1. How much research is worth, and how much they would be willing to pay for it.
2. What total budget they should allocate for research.
3. How this budget should be funded (i.e. whether the costs should be covered by the fund or passed on to its clients).
4. Which providers they would buy research from.
The MiFID II preparation process has had two main effects. The first is that, as a result of this ‘unbundling’ of research and trading execution fees, a new market has been created around paid investment research, with its own market-driven pricing model. The second effect is that many investors have already dramatically reduced the number of brokers from whom they purchase research, now that they cannot obtain it freely from all providers.
The same effects are apparent (with some notable differences and exceptions) for corporate access. Conference attendance, company meetings and group lunches hosted by third parties with trade execution capabilities all count as inducements, so must be paid for by investors. In practice, this means that investors are no longer able to accept company meetings from the sell-side unless either they are already clients of the organising broker, or unless they pay a separate fee, which many have expressed a reluctance to do. As with much new legislation, there are still some areas of uncertainty, for example whether it is ok for a broker to invite non-clients to a meeting at the company’s explicit instruction; some investors are choosing to err on the side of caution for now by refusing sell-side invitations where there is no existing relationship, but this question (and many others) will no doubt be ironed out during the coming months.
What is the impact of MiFID II on investor relations teams?
While it may still be too early to draw many conclusions (and the regulations will almost certainly impact companies of different sizes and in different markets to varying degrees), two universal themes seem to be emerging:
1. Investors will be increasingly reliant on IR teams to complement their own research
The strategic importance of company investor relations teams will grow as a direct engagement model with the investment community emerges. Quality IR staff will be increasingly sought after by investors, and rewarded with greater responsibility and recognition as their efforts become more explicitly linked with the fair value of the company.
2. Companies and investors will need to fill any gaps in corporate access coverage themselves
Investment banks will continue to play an important role in providing corporate access services both to companies and investors. This being said, gaps in coverage will inevitably begin to emerge and widen, resulting in a reduction in the quantity of investor/company meetings. Both sides will need to take up the mantle and fill the gaps themselves if they want to stay on top of meeting opportunities and other relevant developments.
A recent IR Society/Quantifire survey seems to validate this. Over half of the buy-side institutions surveyed believe they will rely more on companies contacting them directly for meetings during the coming year. Some have even reached out to companies to encourage them to take a more proactive approach.
Will institutional investors build out their own corporate access capabilities?
Institutional investors are already starting to take a more consistent and structured approach to corporate access. Many are quite far along in this process and have set up their own dedicated corporate access desks to track consumption, monitor meeting opportunities and proactively manage outreach to companies throughout the year. For fund managers and analysts, corporate access extends far beyond face-to-face meetings during conferences and roadshows: it encompasses all opportunities to interact – from requesting or joining a call to discuss a change in the company’s strategy, to validating an assumption in a financial model, to attending a site visit in a remote location or requesting to join a capital market day – thus it must be measured and managed effectively.
How will the independent research model evolve?
There are two main models of independent research which both continue to grow and evolve, offering an increasingly popular alternative to traditional sell-side research.
The ‘investor pays’ model allows independent research providers to compete on the same playing field as traditional investment banks. A number of buy-side institutions have started to send out research tenders to the market (sometimes even announcing them on their websites), with anyone eligible to participate. Typically independent analysts must have enough of a focus and expertise to differentiate their offering from established sell-side players, and also to be able to provide bespoke reports on request.
The ‘company pays’ model also continues to grow and attract more interest, especially from companies who have suffered from a loss of sell-side coverage during the last few years. ‘Company pays’ research (which is typically free for investors) tends to be factual, providing an editable financial model and staying clear in most cases of recommendations. Marketplaces which aggregate research have already started to emerge, simplifying the consumption process for the fund manager.
What about consensus management?
As investment research becomes less ubiquitous, there is growing concern in the investor relations community about how consensus estimates will be managed going forward. The paucity of meaningful ‘consensus’ (analyst average) estimates could have an adverse effect on stock price volatility, something highlighted by a recent UK IR Society survey. 69% of respondents anticipate changes in how they collect consensus post MiFID II; 43% of these respondents would not be inclined to trust data from third party aggregators, with another 45% believing that small- and mid-cap companies will not have enough data points to generate any sell-side consensus at all.
Is there a role for stock exchanges to play to address some of the challenges?
There’s little doubt that up until now companies have tended to rely heavily on brokers for investor access element of their IR strategies. Although the potential void created by MiFID II will increase the pressure on companies to be more proactive, it also creates other opportunities for collaboration, which may be more healthy for the long-term growth and cohesion of the capital markets.
Exchanges in particular may be able to play a more direct role in supporting and guiding companies through the changing landscape. There are many examples of this already happening. To use emerging markets as an example, Moscow Exchange, Dubai Financial Market, Borsa Istanbul and Warsaw Stock Exchange (amongst others) already organise regular investor conferences for their listed companies in major financial centres. Exchanges throughout the EU are starting to explore new ways of forging formal and informal partnerships to ensure that research and information continue to be widely available throughout the marketplace, especially for mid- and small-cap companies.
Some exchanges have set up dedicated internal teams to continue to support companies in the weeks and months following the completion of a transaction. There are also significant opportunities for exchanges to lead discussions around independent research, consensus management, investor events, and IR advisory services. This can only be a good thing both for companies and investors.
Does Brexit impact MIFID II implementation in the UK?
The short answer is no. The UK financial regulator (the FCA) made it clear that until the UK formally withdraws from the European Union (in March 2019), existing EU laws such as MiFID I will continue to apply, and firms should continue to implement all new EU legislation such as MiFID II. It is also possible that the UK will decide to keep MiFID II legislation largely intact even after it withdraws from the EU.
Would these changes have happened without MiFID II?
MiFID II regulations have accelerated and amplified a number of underlying trends which have been developing in the capital markets for several years. These include:
An increase in the amount of off-exchange trading, e.g. through MTFs, dark pools and other electronic trading, which has contributed to a drop in trading revenues for the sell-side, reducing the pool for corporate access and research;
A decrease in the number of IPOs following the global financial crisis, placing a further strain on sell-side revenues;
A consequent reduction in the size and scope of analyst and sales teams as the sell-side focuses on large-caps/highly liquid companies/main index constituents;
A steady increase in the number of investors with global mandates, and in the number of markets opening up to foreign investors for the first time;
The rise in popularity of ETFs, which has led to outflows from traditional active funds and caused asset managers across the board to cut costs.
Some easy-to-implement, practical tips for IR teams
Based on our conversations with company IR teams and investors, we have tried to pick out a few best practice suggestions for companies to follow:
Keep track of your meetings with shareholders during the course of the year and identify shareholders with whom you have had no contact in 8–12 months. Find out if meetings with these investors can be organised by your analyst or corporate access coordinator.
Publish your conference participation and roadshow schedule on your IR website calendar.
Publish upcoming roadshow plans on the last page of your investor presentation.
On your IR website, clearly display the name, email address and telephone number of investor relations team members who are available to answer investor questions.
If feasible, add some additional individual and/or group meeting slots to your roadshows for any investors who are not included in the schedule but may still be interested in meeting you.