The UK and EU have initiated a rollback of one of their most prominent financial regulations in an effort to reinvigorate the region's capital markets. However, investors and brokers are cautioning that the move may have come too late and could have limited impact.
EU officials have been seeking to reverse certain elements of the Markets in Financial Instruments Directive (Mifid II), which was initially championed by the UK before Brexit. However, the UK has taken the lead in reversing the regulations this week. During his annual Mansion House speech, UK Chancellor Jeremy Hunt announced plans to encourage brokers to generate more research on small and medium-sized UK companies by lifting the Mifid II regulations that prohibited stockbrokers from combining investment research costs with trading commissions paid by clients. Since the implementation of the rules in 2018, asset managers have been making separate payments for research.
The more relaxed approach reflects widespread complaints from European brokers and investors who argue that Mifid II has added complexity and costs to what was once a straightforward, albeit flawed, relationship between fund managers and banks. It also indicates that regulators recognise the notion that Mifid II has restricted the research exposure necessary to attract investors to small companies. The scarcity of equity market listings across Europe has become an increasingly contentious political issue.
However, the challenge now lies in changing investor behaviour that has been influenced by Mifid II, which may prove difficult. Justin Schack, Head of Global Market Structure at Rosenblatt Securities, states that asset managers have adopted uniform practices globally and are unlikely to fundamentally alter their behaviour.
The architects of the original rules had anticipated that investors would welcome the transparency in research costs and benefit from more objective analysis independent of commercial relationships. Critics, however, argue that the changes have led to significant reductions in research coverage, particularly for young companies that are in greatest need of exposure.
Following the implementation of Mifid II, European asset managers have reduced spending on external research by two-thirds, according to research conducted by Frost Consulting. A survey by the CFA Institute found that 47% of asset managers believed research coverage of small and mid-sized stocks had declined. However, it remains unclear whether the EU regulations were solely responsible for these outcomes. The European Securities and Markets Authority stated in 2021 that the Mifid rules had neither significantly improved nor worsened research coverage for smaller businesses. The impact on smaller companies' access to capital also remains uncertain.
David Cumming, Head of UK Equities at Newton Investment Management, expressed surprise at the UK authorities' reversal of rules they had initially advocated. Nevertheless, he acknowledged that the previous legislation had a negative impact on UK equity investment coverage, as many brokers were let go, resulting in a decline in the quality of equity research.
Hunt welcomed a government review released this month, which acknowledged the adverse impacts of the Mifid II unbundling requirements on investment research provision and the unfulfilled anticipated benefits.
The unwinding of research regulations occurs amidst concerns about the health of Europe's capital markets. Policymakers on both sides of the Channel are striving to increase funding for domestic companies due to the scarcity of public listings and notable businesses, such as chipmaker Arm, opting to list in New York instead of their home markets. As part of these efforts, Westminster aims to redirect some pension fund investments towards high-growth British companies.
However, the sluggish pace of European capital markets cannot be solely attributed to the lack of investment research. Steven Fine, CEO of UK broker Peel Hunt, believes that the immediate impact of the changes will be limited. Nevertheless, he emphasises that the cumulative effect of these reforms should not be underestimated.
Independent research providers have struggled to compete on price with larger firms since the introduction of Mifid II, and they remain sceptical that significant changes will occur now. Mike Carrodus, founder of Substantive Research, points out the difficulty of unravelling the existing framework at this stage.
The European rollbacks have also heightened calls to reinstate a waiver to prevent adverse effects in the US. Mifid II's requirement for direct payments exposed US brokers to the risk of having to register as investment advisers domestically. With the expiry of the US Securities and Exchange Commission waiver this month, the Wall Street body Sifma has urged the SEC to reinstate it, arguing that it is unnecessary to harm US market participants and companies with European requirements.
As the UK and EU navigate the complexities of regulatory adjustments, the future of capital markets and research provisions remains uncertain. The potential impact of these changes on investor behaviour and the broader capital market ecosystem will unfold over time, ultimately revealing the effectiveness of these rollbacks in revitalising the region's financial landscape.
