The issue lies in the sheer ambiguity of the rules-as-written – particularly around the thorny issue of the concept of ‘inducement’ by an investment bank to an investor.
As with many of these things the devil is in the details, and this is proving to be the case as the industry starts to get to grips with the new regime. Once you start looking concretely at all the different things that could count as inducement, and start to question where the lines are drawn, lots of difficult questions emerge.
The Jefferies and Purplebricks example
Take for example an interaction between research house Jefferies and estate agency Purplebricks earlier in the year. A damning sell-note put out by Jefferies to its fee paying readers triggered a sharp price fall in Purplebrick’s stock – so sharp that the firm felt it had to put out an unscheduled trading update to counter the claims and quoting the content of the research.
The whole point of the new Mifid rules is that only paid customers of Jefferies should have had access to their assessment – yet the response effectively made Jefferies view open to all.
So were these investors that read the response effectively induced by proxy? You could say that maybe Purplebricks shouldn’t have been allowed to respond in the way that they did – but this is effectively arguing for limiting the information available to investors in a way that could critically impact their ability to make sound investment decisions. Surely not a positive thing for the market as a whole.
Quantifying the value of research
Tricky questions about to how to measure existing and unfamiliar research relationships are also coming to the fore.
Quantification is harder here than it first seems – what if it’s just one call a year, but that call is known to be highly worthwhile? How do you deal with the fact that the same research will inevitably be of different value to different buyers? Contracts will now need to be highly specific, with a precise sense of who is getting exactly what and for how much, and we are likely to see the emergence of a radically more granular pricing landscape. This isn’t just limited to calls and notes – it covers the whole buy-side, sell-side relationship, conferences and all.
Mifid impacts on independent research
The current direction of all of this is clear, and worrying. The danger is that this will all add up to smaller houses being effectively frozen out of the information system, unlike the few behemoths that can afford everything.
This is already starting to happen: Euro IRP, the trade body for European independent research providers, has sounded the alarm on falling revenues and the fact that smaller houses are essentially being ‘squeezed out of the market’ by aggressive lowball pricing from larger investment banks.
Reduction in overall analyst coverage will be a natural outcome as smaller houses do the math and recognise there’s no longer any benefit to covering all the sectors they once did. The smaller houses will have to make some difficult decisions – do they go it alone or merge to save operational costs?
Another related knock-on effect from this that could end up hurting the end investor is that companies in certain sectors could end up with only one or two analysts following, in the new landscape. Should investor budgets not stretch to these houses, liquidity could decline, widening spreads and ultimately hurting returns across large areas of the market.
Investors need to engage and understand the investments in a portfolio, and if research coverage continues to decline then access to information via management, media and doing your own homework will become increasingly important. Other investors could throw in the towel and turn to specialist funds to gain access to shares, which will drain further the liquidity and turnover from the market as retail investors avoid making direct equity investment decisions.
Doom-and-gloom would be the wrong attitude – it is still early days and it common for these sorts of dangers and issues to be ironed out over time as a new regime beds in (early days in the Market Abuse Regime ‘MAR’ provides a good comparison here).
The FCA are rightly reviewing all this and we shall see what emerges – but both investors and boutiques need to be aware of the dangers of the current road of travel.