Victoria Geddes, Executive Director
A hot topic at the recent National Conference of Investor Relations (NIRI) professionals in the US was the rapidly approaching January 2018 implementation of MiFiD II (Markets in Financial Instruments Directive) which has significant implications for Australian market participants and listed companies who seek their support. Because markets are global, the impact of these changes is felt beyond Europe with MiFiD II practices adopted in other markets, without the corresponding need for legislative change.
MiFiD II will tighten regulations around trading, compliance and governance as well as introduce a range of measures to improve the protection of investors and avoid conflicts of interest. However many IROs are particularly focussed on the implications for broker research and corporate access.
MiFiD II will confirm a trend that has been underway for the past 10-15 years, of corporates and IR taking over the primary responsibility for communicating their strategy and investment thesis to the market and investors. And building great relationships directly with investors will be crucial to a successful IR strategy.
Is Broker Research Dead?
Companies frequently complain that the quality of research is not what it used to be. It is clear that the broking community has yet to find its point of relevance in this brand new world, but the solution might be as simple as asking what their clients need. With brokerage commissions compressing at alarming rates, funding research teams has become a huge challenge for brokers. MiFiD II presents even greater challenges.
Under MiFID II investment firms will have to treat research as a fixed, predictable cost, not linked in any way to trading. In the interests of transparency, these costs will have to be accounted for by fund managers to their clients and the regulatory authorities. They will need to establish what research they actually need and how much they plan to spend before actually consuming it.
The global investment banks and fund managers are already devising global protocols on how to pay for research rather than having to make up rules on a country by country basis. So whether you are in Europe, the USA or Australia these changes will affect how funds and brokers deal in research.
With research decoupled from trading, where market capitalisation and the value of trades once dictated where a broker would invest its research capability, the emphasis will now turn to research that provides strong value add and therefore pricing power.
This might take the form of sector specialists and greater coverage of small cap stocks that previously would have found it next to impossible to get attention from analysts. Post GFC, brokers have been cutting costs, letting their most highly paid and experienced analysts go, and increasing the work load on the more junior analysts that are left. Compensation for analysts in US has been declining with the average cost now one third to a half of what a top analyst was paid in 2000.
When asked what they valued most in broker research, panellists at the 2017 NIRI conference highlighted the value of industry or thematic research, which statistics show is read up to 20 times more than any individual company research. Fund managers are looking at big picture trends and are hungry for research that educates them rather than providing a news feed on company announcements or results briefings. The answer is not in the micro but the macro view.
For Australian listed companies there are clear implications for the large cap stocks where a reduction in analyst coverage is already being felt. On the positive side this can free up internal IR resources that would otherwise be tied up with keeping their many analysts in check, for other key IR priorities such as investor targeting. As is the case now, some smaller companies will still struggle to get coverage under the new regime.
In this context, direct engagement with investors will be more important than ever.
Who pays for Corporate Access?
In the UK, the first MiFID three years ago effectively stopped fund managers being able to pay for corporate access with client money. In reality however, nothing much changed as investment banks and brokers simply continued to provide it ‘for free’. With MiFID II their ability to continue cross subsidising corporate access will depend in large part on what happens to their research revenue base.
The rules around corporate access are, however, not as clear cut as they are for research. MiFID II leaves room for conflicting interpretation amongst the EU member states as to whether corporate access is treated the same way as research. What we do know is that the unbundling of research will inevitably lead to a further increase in direct contact between investors and companies. On the one hand brokers will be forced to retreat from providing a service they cannot charge for, while fund managers will find that complete transparency in relation to the costs of services they are receiving becomes a non-negotiable reporting requirement by their clients.
It is likely that corporate access costs will become shared between fund managers and companies. With the unbundling of service charges, fund managers will probably become more selective about whom they meet with and when. Companies will once again have to assume more responsibility by committing more resources to corporate access activities and getting in front of investors who won’t necessarily come knocking on the door themselves.
Nevertheless there will still be a requirement for corporate access expertise to ensure quality meetings between corporates and investors. Some brokers will continue to offer the service (for a fee) alongside IR firms that have always provided this service to the mid and small cap part of the market. However, the big change in this space will be the new technologically-driven platforms emerging such as Fundexa, Meetyl, Ingage and ELITE Connect. They are essentially online ‘dating services’ for companies and investors, eliminating the middle man (broker) by providing a means for the two to connect.
Like it or not, fund managers and companies are quickly learning that nothing comes for free.