Mifid II will remain a textbook case des perverse effects of a public public policy. Acknowledging its negative consequencesthe European Union is taking a step backwards... which seems largely illusory. Faking fhe attrition of sell-side researchissuers need to engage in a dialogue " disintermediated " with investors.
More than five years after it came into force in January 2018, the EU has announced its intention to reverse one of the most controversial measures of the Mifid II directive: the requirement for brokers to charge separately for research and brokerage fees(unbundling). Aiming to introduce greater transparency, Mifid II seriously undermined research funding, which was based on cross-subsidies. From the investor's point of view, research was a "free" service. As soon as it became an explicitly paid-for service, many managers reduced their costs by forgoing research, or by strengthening their own analytical capabilities. Between 2016 and 2022, investment in external research in Europe was divided by more than three (from $5.5 billion to $1.5 billion), and the number of analysts in Paris plummeted from 700 twenty years earlier to 232 in 2020! While the situation remains satisfactory for the largest companies, small and midcaps have suffered an unprecedented drop in coverage, as capitalizations below €1bn are now followed by just three analysts on average (five before Mifid II) and must resort to sponsored research to ensure minimal coverage.
The quality of analysis has also suffered, since the absence of a robust research business model has logically driven the best analysts to the buy-side, particularly in hedge funds. All in all, an essential link in the functioning of financial markets has been permanently weakened, with damaging consequences for market attractiveness and liquidity, and, as a result, a marked underperformance of small and midcaps.
Unfortunately, all this was to be expected. As soon as Mifid 2 came into force, AMF Chairman Robert Ophèle put it bluntly: " Perverse effects are to be feared: attrition of research on small and mid caps, concentration of research activity, via its internalization by large investors, via concentration of the independent research sector, via 'competitive' invoicing of the service by large brokers. (...) However, the preservation of a dynamic ecosystem of listed mid caps is one of the conditions for the dynamism of our economy, and there can be no efficient market without the comparison of several independent analyses of high quality ".
It's reassuring that the European Commission is making amends and reversing the most deleterious provisions of the text, but asset managers have invested heavily in systems to comply with Mifid requirements. Above all, the loss of skills in the independent research sector is such that we cannot envisage a return to the previous situation. As one FT columnist put it, " you can't get the crap back in the donkey ".
A return to the "world before" therefore seems largely illusory, and listed companies are obliged to build a "disintermediated" relationship with investors, by stepping up their efforts to articulate and deploy their equity story.
Oscar Bonnand (Consultant) & Alexis de Maigret (Associate)