In the 21st century, Wall Street has faced repeated crises, each of which each followed the same pattern. At first, the impending problem is ignored by all except a few experts, in specialty publications. A few months before the problem is due to hit, the pace of discussion picks up. Just before “going over the cliff”, the nightly news begins to mention the impending disaster. Soon… if it’s “too big to fail”, “the Great Recession”, or “Cybersecurity”… we all get a new word for our financial vocabulary. Today, we learn about, “MiFID”: our next Financial crisis.
MiFID or “Markets in Financial Instruments Directive”, is a European directive that started in 2004. This was a European reaction to problems in the Equities Market. Lack of transparency in trading and antiquated fee structures from the last century needed reform. MiFID delivered a laundry list of changes, and set MiFID II into motion, to drive further transparency.
On January 3rd, a key component of MiFID II takes effect. While the rules were released in 2012 and were to take force in 2017, implementation was delayed until January 2018. What are these rules? Today, when institutional investors buy stock, brokers charge a single fee, and research is provided for “free”. After January, brokers must charge separately for executing a stock purchase, and for research. Simple, right? Maybe not.
MiFID II technically applies to just European firms, and even if just Europe was the only market impacted, MiFID could still be the biggest change to the financial world in the 21st century. However, it may not be possible to just change Europe and leave the US market alone. Investment Banks have the largest equity research departments. Not only have I-Banks integrated both markets, but research departments have long since merged, now sharing staff and contracts for market data (Reuters, Bloomberg, Moody’s, etc.).
Separating the costs of these two markets will be difficult, and will create unexpected issues. MiFID demands that research and execution costs are separated, but it gives little guidance on how (or it) the cost of European research is separated from US research and research for other markets, such as China, Africa, the Middle East. Yet, in just a few months, every broker must start billing for research. Here’s why everyone is talking about MiFIDJanuary…
Billing: Just dealing with delivering the mechanics of billing by January is a tall order. Especially when so few firms have settled on billing details. Brokers that tentatively discussed how they will bill released new plans a few weeks later. Some plan to simply split the current fees into execution and research. Others will charge a flat monthly fee for research, while others will add an hourly fee for talking with analysts (perhaps as much as $10,000 an hour). The ongoing changes suggest that few clients like what they have heard.
Transactions: While the big issue is research, once execution fees are paid separately, it will become another argument with clients. Will there be a big enough difference in fees to influence which brokers are used? Brokerage fees today are a tenth of what they were a couple of decades ago and falling fact. Clearly, whatever the announced fees on January 3rd, we can expect them to fall significantly by the end of 2018. With billions of dollars of fees at stake, don’t expect negotiations to be… ahem … genteel.
Research: Today, just the top 15 Investment Banks produce 40,000 research reports every week. Most of these reports have a “buy/sell/hold” recommendation, with “buy” being the overwhelming recommendation. Surveys indicate that less than 1% of reports are actually read. Once research is paid for, how many reports will analysts need? Or, are analysts even getting ANY research that they truly want? In a paid world, the smart money says that research departments will need to shed staff very quickly.
Awareness: Bloomberg reported that in the last 5 months of 2016 there were just 10 mentions of MiFID II in company earning calls. That rose to 50 mentions in the last 5 weeks. For months, regulators have been rejecting requests for MiFID extensions, so expect mentions to rise into the hundreds over the coming weeks.
The news is our, MiFID is coming. We’re all going to see more stories about MiFID, starting with what some well-known research departments are charging for their work. In just a little bit, the news will shift to the loss of thousands of high paying research jobs. After that… it’s anyone’s guess, but in 2019 I’m betting that the top I-Banks will cut the number of reports and ask their clients what kind of research they want to pay for! That’s my Niccolls worth for today!