“You can’t get the crap back in the donkey,” bemoans one broking chief about the futility of trying to unwind EU laws that he claims have undermined the market for investment research in the UK.
But the British government is still going to try, even if it finds that — as with the unfortunate donkey — the five year old Mifid II regulations have made too much of a mess to clear up easily.
Ministers are launching a review of investment research led by Hogan Lovells’ partner Rachel Kent, including on the effect of rules that separated payment for investment research from services tied to trading.
This so-called unbundling was designed to boost competition, innovation and transparency by disclosing how much fund managers were being charged for research.
But ministers are concerned that there has been a decline in levels of investment research, making it harder to value companies and leaving London less attractive for businesses wanting to go public. The drop is one of the many reasons cited by brokers for the gap in valuations in the UK stock market versus Wall Street.
Fund managers have had to stomach the newly unbundled cost of independent research, or try to hand them on to their own clients. The upshot has been less demand for research that drills down into the investment case for individual companies.
European asset managers have cut research spending by three quarters from pre-Mifid II levels, according to research by Frost Consulting.
Brokers say that as standalone businesses, research teams barely cover their costs. Substantive Research found that European brokers have shrunk analyst teams at least three times more than US counterparts since Mifid II’s introduction in 2018.
One fear is that some companies in the UK market are being ignored, particularly fast-growing businesses in areas such as life sciences that can require dedicated research to evaluate their merits.
In a survey of investors by broker Peel Hunt in 2020, about four-fifths said that Mifid II had diminished the liquidity of shares traded in London and about two-thirds reckoned it had hit the volume of listings.
The EU already plans to unwind Mifid II unbundling rules for companies with revenues under €10bn. While the UK’s own review into research is cited by ministers as a potential Brexit bonus, the reality is that British asset managers will be left behind unless the country moves as quickly.
So there are good reasons to look again at the investment research market. The problem is that in isolation this will be very much seeking to close the stable door after the beast has bolted.
There is unlikely to be a flood of company research if Mifid II rules are simply reversed. Asset managers have already spent time and money complying with them.
Global asset managers will be less likely to carve out separate pricing for research purely for parts of the UK market. The UK has already moved to “rebundle” research on companies valued at less than £200mn to no great effect.
In any case, the post-Mifid market faces a conundrum: investors may be less likely to buy shares in companies without analyst coverage, but brokers have few incentives to expand research if there is no investor appetite for it.
For some, the shrinking of research on UK-listed companies is simply a consequence of a lacklustre London market rather the cause. The US market has better research, in part, because it is larger, more liquid and with greater investor specialism — giving fund managers more reason to pay for equity research.
In contrast, UK pension funds are often seeking reliable dividends from large and well-known companies rather than hunting higher returns — and embracing greater risk — in buying younger, fast-growing businesses that need analysing.
Changes to Mifid II will not prove a panacea for London, but are still worth pursuing as part of a package of reforms to revitalise the equity market.
But reverting to a pre-Mifid II world, when inboxes were too often stuffed with bad research and lazy buy recommendations on stocks, is not the answer.
Rather, the onus on transparency at the heart of Mifid II alongside any new reforms must now translate into research houses offering greater value to clued-up investors, and helping to galvanise a recovery for the London market.