Speaking at the London Business School Annual Asset Management Conference last month, FCA chief executive Andrew Bailey said the regulator would launch an investigation into Mifid II, as well as Priips, after concerns from the asset management industry over unintended consequences of the regulation.
Describing Mifid II as “probably the largest single change ever in European financial market regulation”, Bailey said the regulator’s initial priority was to implement the regulation in a way that did not stop the effective functioning of markets. However, he recognised that implementing rules in a market that wasn’t functioning would be “getting the cart before the horse”.
Announcing the review, he added: “Our supervisors have a programme of work to assess the state of compliance and to evaluate how effective the regulations have been in meeting their aims. In order to undertake that work properly, it is appropriate, as we generally do following major pieces of regulatory change, to allow the market time to evolve and to allow an adequate period of time to pass to make meaningful observations of trends and patterns.”
Get tough
At this stage, it is hard to predict what the regulator might conclude from its review, but in the meantime industry figures believe a tougher stance is necessary on those firms deliberately flouting the rules.
Matt Smith, chief executive of compliance tech and data analytics firm Steeleye, says the effectiveness of the transparency regimes under Mifid II will come down to the regulators taking it seriously and enforcing regulation. Put simply, he says some firms are not conforming and the FCA needs to make it clear that is unacceptable.
He believes this non-conformance could be because firms are waiting for the regulatory framework to be established first.
“I think there are a lot of financial markets firms out there waiting to see what precedent is set as regulators start to seek out people who have failed to conform and meet their obligations,” he says. “But the question is: will the regulator do that any time soon? If it doesn’t, people will continue to try to avoid the cost and distraction of having to build systems.”
In April, SCM Direct founding partner Gina Miller said she was underwhelmed by the latest remedies offered by the FCA’s proposed actions to tackle concerns highlighted in its asset management study published last June. Miller was particularly peeved the regulator did not include enforcement actions for firms in breach of Mifid II cost disclosure requirements.
Unbundling
Chris Turnbull, co-founder of Electronic Research Interchange (Eric), says the big issue with Mifid II remains the unbundling of research.
He says to make sure that the spirit of Mifid II is addressed properly, the regulator has to get a better understanding of how the broker vote is working in firms. The broker vote is a process by which asset managers can assess the value of brokers’ research in order to determine how commissions will be allocated.
Turnbull says under the broker vote firms consume research and then decide who should be rewarded, so if a research provider doesn’t get paid it won’t hand research over. This, he adds, favours larger broker players who have more people to service asset managers.
“It seems like there are small payments upfront for access to research and then interactions are monitored and given a value after the fact. So, a situation arises where a firm can agree to service a client on quite a low retainer in the hope of getting a large discretionary payment – and that to me seems to fly in the face of what Mifid II is all about.
“The whole thing needs to be looked at as it is an integral part of determining how to allocate research budgets under Mifid II.”
How the regulator can help
Smith believes there are two ways the regulator can do more.
First is assessing the regulations and making sure the objective that the European regulator (Esma) is trying to achieve is being delivered and pushing back where it believes something will not bring transparency or quality.
The second step is actively helping fintech firms to create solutions to help companies address the changing regulation.
“I understand [the regulator] has few resources and is cost constrained but it doesn’t have to spend a lot of money and we can carry a lot of the burden that would be on them to help us to help them.”
Part and parcel
From the asset management side, Hector Kilpatrick, chief investment officer at Cornelian Asset Management, says the upfront work to get Mifid II in place within a short time frame was onerous but since then, it has become “part and parcel of normal process”.
“I don’t notice it in terms of added work flow,” he adds. “I am quite relaxed about it.”
Kilpatrick says for Cornelian AM the hardest part was negotiating new research contracts with third-party providers for its direct UK equities offering.
“The new model under Mifid is having an impact on third-party research providers and it is yet to be seen how the disruption it has caused is going to impact on understanding of companies further down the market cap spectrum. Will third-party research providers be able to afford to cover stocks further down? That will be good from a stock picker’s perspective but bad from a liquidity perspective.”
Kilpatrick says the answer to this question will probably not come before this time next year once the next round of annual negotiations around research has taken place.
“Then those third-part research providers will have to decide what they want to do with their research teams and coverage, so there is a lot of flux and uncertainty – that is an area we keep close tabs on.”
