Mifid II is hurting, but there is no way back


Dominic O’Neill
Published on:

The damage done to mid-cap equities coverage by unbundling research is ever harder to ignore. It will not be easy to lower this self-imposed barrier to improved capital-markets access for fast-growing businesses in Europe.


One year on from the entry into force of Europe’s Markets in Financial Instruments Directive (Mifid II), the deleterious impact on equity research is now clearly apparent.

Mifid II’s squeeze on brokers’ revenues is industry-wide. Individual firms will always argue it is hurting rivals more, but it is clear that smaller houses specializing in stocks with a small and medium-sized market capitalization are suffering most.

“We are seeing the early signs of anxiety about coverage, liquidity provision, access to capital markets,” says David Mortlock, head of investment banking at Berenberg, one of Europe’s biggest and fastest-growing mid-cap equities houses.

This is especially disconcerting, as a central element of the EU’s financial policy is to boost funding for small and medium-sized enterprises (SMEs), and to mitigate European business’ reliance on bank loans.


Volatility in global markets this autumn has accentuated brokers’ Mifid woes. The bear market’s most acute effect on issuance has been on mid-caps, according to Mortlock, as weaker liquidity has seen many share prices half.

Signs of industry pressures and a consequent wave of consolidation are especially apparent in the UK, partly because of the added UK impact of Brexit on primary-market activity.

Cenkos Securities’ chief executive Anthony Hotson quit in October after a precipitous drop in pre-tax profits. New York-based AllianceBernstein announced the acquisition of financials specialist Autonomous Research in November. Rumours emerged that Macquarie was in talks to buy Liberum in November, following rumours of a takeover of Peel Hunt by Santander.

Berenberg, which is German but has an ambitious UK strategy, laid off about a quarter of its analysts the same month, largely because of Mifid and resulting in about 100 fewer stocks under its coverage.

Industry insiders also talk of intense pressure on Scandinavia’s smaller brokers. Germany’s MainFirst said it, too, was being bought in November, by US-owned mid-cap broker Stifel Europe.

When there are less than three brokers covering a stock, asset managers often can’t buy it. The companies will start to ask whether it makes sense to be listed 
 - Laurent Quirin, Kepler Cheuvreux

In the longer term, the thinner continental market – less rich in brokers – may suffer most.

This is ironic, as the UK may have left the EU by then. The Financial Conduct Authority’s Martin Wheatley was the bloc’s most powerful markets regulator when Europe devised Mifid II early this decade, so the British establishment’s concerns for its own arguably over-broked market might have played an undue part in its formulation.

Brokers that lobbied in vain for leniency now feel vindicated. The revenues pool for European cash equities has declined by about a quarter this year, they say, and could drop again in 2019.

The industry has reacted to Mifid II’s push for greater transparency by switching research costs onto the asset manager. Yet the price of research has failed to make up for the attendant fall in sales and trading commissions, hurting supply.

Falling by wayside

As global asset managers have had to choose smaller numbers of brokers, single-country specialists are falling by the wayside. Brokers tend not to bother with small and mid-caps outside their home market. Smaller houses argue that global banks’ willingness and greater ability to continue to subsidize their research is further dampening pricing.

“Mid and small-caps in Europe have fewer and fewer brokers following them,” says Laurent Quirin, chairman of Kepler Cheuvreux, which covers the highest number of European stocks, about 1,100.

“When there are less than three brokers covering a stock, asset managers often can’t buy it. The companies will start to ask whether it makes sense to be listed.”


Andrea Vismara,

It was naive to think independent brokers could flourish under Mifid II – and that the big American banks would not benefit most – says Andrea Vismara, chief executive of Italian investment bank Equita.

“Mifid II is killing smaller brokers,” he says, although Equita’s equities commissions are only down 7%.

“SMEs need research, brokers, investors. That won’t exist if Mifid II continues in its current form.”

These people say regulators are now listening, but the greater transparency Mifid II gives retail investors seems more important than ever in continental Europe.

Meanwhile, going back on research unbundling will be difficult, as assets managers in the US and elsewhere have started to adopt the fund-pays framework, making it a global standard.

Some tweaks are likely, but will take time, and entail more negotiating rounds between brokers and asset managers.

In any case, there is no emerging consensus on how Europe could alleviate the less desirable effects of the rules. Granting exemptions to smaller stocks, for example, would be hard to work because brokers’ mid-cap businesses are often mixed up with their large cap coverage.


Perhaps the authorities will at least be more careful about the side-effects of monitoring potential conflicts of interests when the issuer takes on the cost of the research instead.

Indeed, brokers are already taking on more corporate-sponsored research mandates, including arranging investors’ corporate access – mirroring the UK’s corporate-brokerage system.

This is partly how Kepler Cheuvreux has reacted. It says its size has helped attract about 200 more buy-side clients this year.

Multiple single-country primary-market agreements with local lenders – Crédit Agricole in France, UniCredit in Italy, Swedbank in Scandinavia – have helped it achieve this scale – in part because banks have sought ways to deal with Mifid II – but this is a unique model.

Kepler Cheuvreux has acquired about 150 sponsored research contracts, more than double its pre-Mifid II number. This coverage often has recommendations to sell, according to Quirin.

“It’s a way for small caps to be followed by brokers from big houses,” he says. “It’s a good compromise.”