Countdown to Mifid II


Remember Y2K and the global fear
that the turn of the millennium would bring IT systems crashing to a halt?
It’s worth mentioning Y2K because Mifid II – new EU
legislation for financial markets that comes into effect on 3 January 2018 –
has echoes of the Y2K problem. (Which turned out not to be that much of a problem,
but did cause a lot of work and overtime for the IT sector).
Some say that Mifid II (the second Markets in Financial Instruments Directive) is a welcome piece of securities market
reform, for others it’s the worst change to hit the City in years.
The first phase of Mifid was activated in November
2007 and was an attempt to increase competition in financial services and
harmonise rules. The latest phase, much delayed by the financial crisis, aims
to strengthen protection for investors and improve transparency.
The changes follow the principle of ‘unbundling’. This
will mean stockbrokers have to charge fund managers separately for research
produced by their analysts. Up to this point, most have lumped in the cost of
this with their broking commission, which in effect means the clients of the
fund managers pick up the tab.
Today, 1,248 analysts across 65 individual
sub-sectors within the FTSE All Share Index cover listed companies within the
UK.
But the fear is that Mifid II will lead to a
fall in the number of analysts, because the brokerages simply will not pay for
a long tail of analysts to cover companies or to produce low-quality, me-too
research. In turn this will put new pressures on investor relations teams who
will have to find new ways of communicating their companies’ story to the fund
managers and investors that buy their shares.
As fund managers and brokerages prepare for the
changes, a price war has broken out over the sale of research to asset
managers. There are concerns that independent providers of research could be
driven out of business. Ultimately the amount of commentary about quoted
companies could fall by as much as a third, according to some predictions.
Scott Fulton, director of Capital Access Group,
a consultancy that helps companies communicate with their investors, carried
out a survey on its FTSE and AIM-listed clients and concluded that unbundling
broker research could lead to a situation where just a third of the analyst
community will be paid by investment managers and meetings with companies are
not paid for at all.
‘Paying for analysts and company meetings from
other sources is unlikely to be allowed under the new regime, potentially
placing considerable pressure on investor relations to maintain capital market
communications,’ Fulton says.
While this is less of a concern for the UK’s
biggest companies like Vodafone and Shell, it is an issue for smaller
companies, who already struggle to get analysts to cover them. There is a real
challenge here for investor relations teams. But there is also an opportunity.
‘I speak as an ex-broker but from an investor
relations perspective this change should be liberating. UK plc has been
somewhat cosseted because of corporate broking. Since Mifid II will impose
limits on corporate broking, investor relations will need to become more of a
core function. Perhaps IROs (investor relations officers) will even need to
become officers of the company,’ Fulton suggests.
Because fund managers will now be
paying for research alone, Capital Access Group predicts three tiers of analyst
will emerge. Big-name firms will charge a premium for a full subscription,
second tier will offer research on an ‘on demand’ basis and the third tier will
produce Mifid-exempt, non-specific ‘market commentary’ paid for by corporates
and given out for free.
Further
down the line, Mifid II could lead to an even more fundamental shift in
analysts' roles, says Fulton. ‘Star analysts’ in the City's top firms may
realise that their research is raking in millions for their employers, and
decide that they could keep a better cut by operating on their own.
Lyndsay Wright, director of investor relations
at bookmakers William Hill, says: ‘It will take five years for the implications
to be fully understood. However, there are some good things that may come
about. In particular we may start to see analysts taking a longer-term
perspective on companies and focusing less on financial results. They may provide
more substantive, longer pieces. We are already seeing analysts moving to more
thought pieces already.’
Cressida Curtis, interim head of investor
relations at British Land, agrees. ‘This is probably good from the company
point of view. It’s an opportunity to get much closer to investors and it works
in the investors’ interest – that doesn’t mean it won’t be a pain in the
backside.’
As far as analysts’ coverage is concerned there
will be greater scrutiny on the accuracy of their forecasts. Does this mean
that analysts will be more provocative or punchy in the way they cover stocks?
Curtis says: ‘If you’re not putting out a ‘buy’
or a ‘sell’ what will be the point? We may see the ‘hold’ recommendation
disappear.’
There are many more implications for IROs to
get their heads around, and that also means implications for directors of communications,
where they have responsibility for the IR function.
For a start, there may need to be more people
added to the IR team, to deal with greater demands for access from investors
and analysts. There is likely to be more work generated by responding to
analysts’ requests for new data points as they seek to provide better coverage.
IROs will probably have to take more
control of institutional targeting and directly organise shareholder meetings.
Even booking meetings with investors – the
company’s actual owners – will be a challenge, as IROs in the UK have often
used brokers to arrange these. Wright says: ‘We are certainly seeing a lot more
direct access requests at the moment.’
She also foresees issues around consensus management,
where a company seeks to manage the consensus of forecasts that analysts have
for company. Wright says it sounds counter-intuitive but it can be easier to
manage 25 analysts and their forecasts, than ten.
There are new ways of producing consensus
figures, including crowd sourced forecasts such as Estimize, which operates in
the US, or tools based on algorithms. However, these are not thought to be as
reliable as company-distributed forecasts. Certainly it may be harder to
explain outliers to the executive team and to investors, when there are fewer
analysts covering the stock and when the highest rated analysts are behind a
paywall.
‘I expect there will be a period of transition
where we are having to deal with a lower quality of reporting, before the
economic consequences kick in and weed out some analysts,’ Wright says.
It is not yet clear how ‘roadshows’ – when a
company’s executive team are taken to meet investors – will be affected.
If smaller and mid-cap companies are not
getting the coverage they want or seek, they may have to turn to paid-for
research to get their story out, in much the same way that companies pay a
credit agency for a rating when they need to issue a bond. This could lead to
the emergence of more boutique analysts.
Smaller companies could yet be exempted from
parts of Mifid II, as the European Union has said it will review the
implications for them over the next few months. However, the UK’s Financial
Conduct Authority has previously said that it is minded to embellish rather
than lighten the EU legislation.
Brexit will certainly not provide any get-out
clause for UK listed companies, either.
Some people have suggested that since sell-side
analysts will need to get access to companies, they will inevitably become more
positive to win favour. But Wright dismisses the idea that IROS would be so
easily influenced. ‘I certainly relish the idea of going into see an analyst
with a sell recommendation,’ she says.
Those IR professionals who have been busiest
preparing for the changes are clear that their companies will need to spend
more time targeting investors directly, in order to develop a diversified
shareholder register.
There are also implications for communications teams
who deal with business journalists who often talk to sell-side analysts.
Financial journalists have long used analysts’ notes
to help them get up to speed quickly and to assess whether a company has
managed or failed to deliver what was expected. There are concerns that quality
research may be harder to come by in future but Fulton is not worried.
‘If anything the financial media will be more
important in terms of communicating companies’ messages to wider investors,
including retail investors. Corporates will have to make more of an effort to
try to speak to fund managers and investors through the channels that are
available to them, so that could be good for the financial press,’ Fulton says.
Those analysts that want to be ranked highest in their
sector will no doubt use the press, as many do now, to communicate their value.
Fulton thinks that FTSE companies are largely
underprepared for Mifid II, mostly because they lack the large IR teams of
European companies – which don’t have corporate broking intermediaries. Fulton
says there are probably only 45 companies in the FTSE 100 of leading businesses
that are able to conduct their own IR and communications.
He adds: ‘This is not a regulation that anyone really
wants, especially in the UK where there is a corporate broking structure that
doesn’t exist elsewhere. But unbundling is consistent with the Financial
Conduct Authorities views on the customer and transparency.
‘You could say that the UK’s championing of unbundling
[within the EU] has come back to bite us, to an extent.’
Laura
Hayter, head of policy and communications at the IR Society, says: ‘This is an opportunity
for IROs to take control of their investor relations programmes. However, they
will need the commitment of company management to empower and fully resource IR
when the changes come in. But the basic tenets of good investor relations will
not change. IROs will always need consistency
of message, in good and bad times; clarity of the investment story and investor
communications; and credibility in both the management and the IR team.’
As to what will happen on 3January, pessimists can
sleep easy. Like Y2K we are not going to wake up and find the world in chaos. This
is an evolution, not a revolution.