How is the world reacting to changes in research?
AMF to address Mifid II impact on small caps
French market regulator looking to improve coverage of small and mid-cap listed companies French market securities regulator the Autorité des marchés financiers (AMF) is looking at how to improve coverage of small and mid-cap listed companies in France as part of a study on the impact of Mifid II on research.
The AMF’s investigation will be led by Jacqueline Eli-Namer, an AMF board member, and Thierry Giami, president of the French Society of Financial Analysts, and will ‘explore concrete ways of mobilizing the marketplace and thus improving the situation,’ the AMF says.
The regulator notes that Mifid II has made coverage a major issue, as a fall in research budgets has seen ‘a reduction in coverage of small and mid-cap stocks’. At the same time, the AMF says research sponsored by issuers is increasing, raising potential conflicts of interest.
Since the introduction of Mifid II 18 months ago, the issue of research coverage has been a point of discussion, with some market participants expressing concern about Mifid II’s impact on the liquidity of small and mid-caps and the potential, in turn, to hit smaller company IPOs in what could be reduced investor appetite over the longer term.
‘The French stock market’s objective is to promote the listing of small and mid-caps and, while France has a broad base of financial analysts, it is desirable to explore initiatives that could be taken to ensure small and mid-cap companies are covered by high-quality research,’ says the AMF in a statement.
Different studies and surveys have supported the assertion that research coverage and quality has decreased under Mifid II, but this perspective has not been universal.
In some ways the AMF stands alone in its concerns about the European regulation’s rules on research, even calling for European authorities to review the requirements. But this puts it at loggerheads with the EU and other national financial regulators, such as the UK’s Financial Conduct Authority (FCA), with the latter earlier this year saying it is yet to see evidence of the negative impact on unbundling that is central to Mifid II.
‘Since implementation, we have watched for changes in coverage of smaller companies. I think the evidence is, so far, inconclusive, and does not suggest the dramatically negative impact that some predicted,’ commented FCA CEO Andrew Bailey in February.
‘Overall, we consider that the rules are already having a positive impact. We are seeing changes in behavior that are starting to deliver the intended effects: reducing conflicts of interest, improving accountability and producing cost savings for investors.’
In fact, the FCA has been keen to stress that Mifid II could save investors as much as £1 bn ($1.3 bn) on research.
Cut in equity research will be less dramatic under Mifid II, research finds
Greenwich Associates says research budget cut will be only 1 percent
Although some industry experts are projecting that new Mifid II rules will reduce buy-side spending on equity research by as much as 40 percent, a new study from Greenwich Associates predicts the immediate impact to be much less dramatic, with European institutional investors planning to cut research budgets by only 1 percent in the next 12 months.
That’s a smaller cut than investors projected last year, when participants in the same study predicted reductions of 6 percent to 7 percent.
Central to Mifid II, regulators are attempting to bring transparency and accountability to the market for investment research. Under the new framework, asset managers and other institutional investors will have to make discrete payments for research, either from their own balance sheets or through new research payment accounts (RPAs). In essence, regulators are trying to ‘unbundle’ research costs from trade allocations to the greatest possible extent.
‘Our research shows the seismic disruptions that many expected probably won’t materialize in the early months of 2018,’ says William Llamas, Greenwich Associates’ relationship manager and author of the new report, ‘As Mifid II looms, European fears subside’.
‘Immediate, substantial decreases will indicate to regulators and clients alike that these managers were wasteful in their research spending in prior years.’
As of mid-year, about one in 10 buy-side institutions plan to shift all research payments to ‘hard dollars’ from their own P&Ls in the next year – a move regulators will undoubtedly applaud.
‘While other institutions have already decided to fund research payments with RPA-based payments, about two thirds of study participants have not yet decided how they will pay for research under the new Mifid guidelines,’ says Llamas.
Greenwich Associates interviewed 164 buy-side equity traders and 198 portfolio managers in Europe about their plans for equity research budgeting and payments for the year ahead.
Advisory intelligence: A look at Canadian macro issues as Mifid II makes its presence known
Prab Sagoo, associate director at Nasdaq IR Intelligence, talks about the macro issues impacting Canadian IR professionals and how to prepare for the changes driven by MiFID II Sponsored content
Recent years have seen Canadian companies facing a number of macro issues – from the ongoing back and forth on the U.S.-China trade deal, to the discussions around Nafta and how those are impacted by tariff talks – and these have resulted in a 'valuation discount' versus peers in the U.S., explains Prab Sagoo, a Montreal-based associate director at Nasdaq IR Intelligence.
'Over the last few years there has been a subtle shift of assets away from Canada due to a number of headwinds the region is facing,' he says. 'Prior to the U.S. election, there were a lot of assets coming into the Toronto Stock Exchange [but] once the U.S. election had passed, a lot of that diverted back to the U.S.'
Although Canada largely benefits when the U.S. sees positive returns, Sagoo says the far larger market also 'tends to operate like a black hole in some respects' – sucking in assets Canadian firms are competing for. The result, he says, is that 'the valuation difference between the primary Canadian market and the core U.S. benchmark has widened – to the point that the valuation differential has been among the widest in several years.'
At the same time, the trickle-down effects of Mifid II – the European regulation that came into force in January 2018 – are now starting to be felt in the U.S. and, to a lesser extent, in Canada.
This means that even as things have started to pick up in terms of U.S. interest in Canadian equities over the past six months or so, which Sagoo says means 'Canadian IROs are starting to find a little bit more of a foothold in the U.S. market', the challenges of a shrinking sell side and the effects of a regulation that impacts corporate access and research coverage are also starting to be felt.
'Over the next two years or so we will see this becoming a bigger issue, especially for IR teams operating in the smaller to mid-cap Canadian market – which in U.S. equivalency terms tends to be small cap,' he says.
And while few are seeing real impact from Mifid II just yet, Sagoo notes that Canadian IROs are aware of what's ahead: they understand that these regulations require change in how the buy side interacts from a corporate access standpoint.
'As sell-side coverage changes and buy-side participation changes, the IR function is going to have to change as well,' he points out. He adds that one part of the solution for IROs is technology, with everything from corporate access and equity research platforms to artificial intelligence-powered targeting tools being driven by changing regulation.
As a result of these changes, the role of the IR professional is becoming more challenging, Sagoo says, noting that the increasing number of generalists in the market adds to the fact that companies are now competing more than ever for those investment dollars.
'If you're an energy company, for example, you're now no longer just competing with other energy companies for that capital,' he explains. 'You're also competing with tech companies, with industrials. If you're not adopting new technologies to address this, you're leaving yourself at a competitive disadvantage.'
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Investors see decrease in research for small and mid-caps
Trend expected to continue as Mifid II feeds deeper into the system Just over 40 percent of investors have noticed a reduction in the availability and breadth of research for small and mid-cap companies since the introduction of Mifid II, according to a survey by the International Capital Market Association (Icma), the Zurich-based trade body.
This trend is likely to continue as Mifid II feeds further into the system, warns Icma’s Asset Management and Investors Council (Amic), which carried out the survey for the second year.
More than two thirds (68 percent) of respondents say they used less research in general compared with last year. Banks and brokers took the biggest hit, with 71 percent of those surveyed saying they used less research from providers, and 82 percent saying they used fewer research providers.
But the survey suggests that fears about a decline in the quality of research is so far largely unfounded. The vast majority of respondents say they have not noticed any change in the quality of the research they have received, compared with 32 percent last year saying they expected research quality to get worse.
No respondents find a change in the quality of research from independent providers.
This year Amic finds that buy-side firms are split between unbundling research globally and only using paid-for research (35 percent), and segregating EU and non-EU businesses (35 percent). Last year 64 percent of respondents were planning to unbundle globally and only 7 percent were planning to segregate businesses.
‘The significant change in company attitude to the business segregation model may reflect that the costs and complexities of segregating their business geographically outweigh the costs and complexities that come from unbundling globally,’ says Amic in a statement.
Amic surveyed primarily asset managers and investment funds from EU countries.
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HSBC expands small and mid-cap equity research teams
Bank announces new hires in UK and Hong Kong HSBC has announced that it is expanding its small and mid-cap equity research teams, with new hires in the UK and Hong Kong.
The new additions to the equity research teams ‘demonstrate the increasing importance of small and mid-cap stocks to investor portfolios globally,’ says the bank in a press statement.
It adds that the newly expanded team will ‘address the significant gap between the investment requirements of small/mid-cap companies and institutional investors.’
HSBC notes that the UK small and mid-cap market – which it says is valued at £500 bn ($658 bn) – is not widely covered. David Phillips, head of equity research for developed Europe, says: ‘Our aim is to produce in-depth quality research, to understand the businesses and their supply chains fully.’
The news follows around two years of warnings that small-cap companies in particular would be hard hit by cuts to equity research after the introduction of Mifid II, which came into force at the start of 2018.
In London, five new analysts will be added to the small and mid-cap equity research effort. These are:
In Hong Kong, York Pun joins HSBC as head of small and mid-cap equity research for Asia-Pacific, with the bank noting that ‘the team will focus on ASEAN, Hong Kong and China-listed companies and add 150 small and mid-cap companies to its coverage’.
Fidelity International to pass on research costs to investors
Fund group does not want to differentiate between those covered by Mifid II and those that are not Fidelity International is to pass on research costs of more than $42 mn a year to investors.
The fund house has unveiled details of a variable management fee linking fees to performance and reveals that research costs amount to 0.0228 percent of the $185 bn in its equity funds.
Instead of absorbing European investors’ share of the resulting $42 mn under the new Mifid II regulations, Fidelity says it will pass research costs on to its clients. The decision leaves it among only a handful of large fund houses that have chosen not to absorb such costs themselves. Fidelity says it does not want to differentiate between clients covered by Mifid II and those that are not, and that it believes its chosen structure is the most appropriate.
‘We believe companies that adopt the hard-dollar approach for Mifid II clients are incentivized to lessen the extent and cost of research used to underpin their research decisions and that this will ultimately adversely impact client outcomes,’ Fidelity says in a statement.
The cost of research will ultimately be more than offset by a reduction of 0.1 percentage points on the base annual management charge under Fidelity’s new variable management fee, to be applied initially to 10 funds worth $31 bn in total.
The new charging structure is also designed to help resurrect the fortunes of active fund management by linking fees to performance, in response to huge outflows into passive funds that replicate the performance of an index. If managers beat benchmark returns after the deduction of the new base annual management charge and other costs, investors will then be asked to pay extra.
Outperformance of the benchmark by 2 percent or higher will cost clients 0.2 percentage points more than their standard fee, with performance between 0 percent and 2 percent above the benchmark charged on a sliding scale. Similarly, annual management fees will drop if Fidelity’s managers fail to beat their benchmarks.
‘We believe innovation in fee structures is essential if active fund management is to succeed,’ says Brian Conroy, president of Fidelity International, in the statement. ‘We believe this is a meaningful step and also one we hope will be adopted by the wider asset management industry.’
The charging structure will be applied to 10 of Fidelity’s pooled active equity funds from next March. Clients with their own segregated mandates, including pension funds and investment trusts, will be able to choose an adapted version of the model.
Investors switching into the new structure on the launch date will pay the base annual management charge for the first three months. Performance will then begin to be measured from the launch date, eliminating the possibility that investors pay for performance realized before the introduction of the structure.