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MiFID II: Another Well Intentioned Regulation that Could Undermine Investment Boutiques Managers

Traders Magazine Online News, December 28, 2017

Tina Byles Williams and Floyd Simpson

The Markets in Financial Directive (“MiFID”) is a European Union law that provides harmonized regulation for investment services across the 31 member states of the European Economic Area (the 28 EU member states plus Iceland, Norway and Liechtenstein). MiFID II, the amended law which goes into effect in January 2018, stems from regulation that European Union law makers enacted to regulate how asset managers pay for the research they utilize in making investment decisions. This regulation has good intentions and the primary benefits are:

  • It creates more transparency for clients
  • It transfers the cost of research from clients (in the form of trade commissions) to the manager (if the manager doesn’t pass this cost back to the client)

MiFID II only applies to European firms, but recently a significant amount of large brokerage houses and asset managers seem to be adopting the regulations on a global scale, which we believe will transform expectations on how investment managers should allocate and report their expenses incurred for securities research. The purpose of this research note is to evaluate the impact of these changes on boutique or smaller entrepreneurial investment managers.

Investment managers have traditionally used trading commissions generated through their portfolio trading, or so called “soft dollars”, to pay for research. A late 2016 MiFID II discussion paper by PWC implied that security or sector based research, economic insight, access to company executive management on roadshows, analyst conferences, and excel company models can all be considered research products that will have a cost attached. Basically, almost everything that brokerage firms’ offer will become a cost for managers. Additionally, based on recently published articles, most brokerage firms are being conservative in their approach and are indicating that they plan on charging for a majority of their research in order to avoid the administrative and regulatory burdens of maintaining two pricing models.

At FIS we globally source, evaluate, and retain smaller/entreprenuerial managers because of their greater flexibility to identify alpha opportunities across the capitalization spectrum and their ability to trade more nimbly, particularly in less liquid markets. While this ruling creates much needed transparency in manager expense reporting, it could present yet another headwind for smaller/entreprenuerial managers for whom third-party fundamental stock research is integral to portfolio management.

In summary, we believe that widespread adoption of MiFID II, while well-meaning in its facilitation of greater transparency on research expenses, represents yet another regulation whose costs will be disproportionately borne by smaller, fundamentally driven investment boutiques, and thus will further exacerbate the increasing concentration of investment assets towards very large firms. Therefore, we expect further declines in new firm formation, as well as more firm closures and/or further consolidations/collaborations among small investment boutiques to leverage operational synergies.

MiFID II’s Impact

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