Though the stock market has largely recovered since the end of the Great Recession, public trust in financial markets still has not. This has led to attempts from lawmakers around the world to further regulate the financial industry. In Europe, the EU’s sweeping reform of financial regulation, Markets in Financial Instruments Directive II (MiFID II), became law on January 3rd, 2018. The massive set of reforms seeks to further restore investor confidence and protect investors by drastically increasing levels of transparency in financial markets.
MiFID, the first iteration of the policy, was established as law in 2007. It sought to create a unified financial market in Europe that could rival that of the United States. While it did help create a “more competitive and integrated EU financial market,” as the European Commission intended, EU lawmakers believe that it failed to address the complex realities of today’s financial markets. The EU’s desire to “improve the way markets function in order to serve the real economy […] and restore investor confidence in the wake of the financial crisis” has provided the main impetus for updating MiFID into a more comprehensive regulatory framework. The EU launched consultations for the development of a renewed MiFID in 2010, and after several years of deliberations and delays, MiFID II
finally became law early this month.
MiFID II will have far-reaching effects on a multitude of financial institutions, a fact which has often attracted criticism. In what is perhaps its most notable statute, MiFID II requires that asset managers pay banks and brokers separately for research and for trading commissions. To date, under MiFID, research (comprised of written documents, discussions with research analysts, etc.) was included with trading costs without an explicit fee attached. In exchange, asset managers would place their trades through those analysts’ banks. Seeking to prevent investment firms from being unduly “induced to trade” based on factors other than the efficiency of trade execution, MiFID II requires that all research be charged for explicitly and separately from other services, in what is termed ‘research unbundling’.
Once research is unbundled from other services, research analysts will likely compete against one another in a newly formed market for research. Investors will probably only be willing to spend on the few analysts who best understand the companies and industries which are relevant to them. As 30 percent of asset managers worldwide plan to reduce external research expenses by a third, a substantial cull in the number of research analysts is expected.
By now, banks have considered many pricing models for their research. Morgan Stanley recently planned to charge its clients, on top of a $25,000 base fee for access to its equity research, $2,500 for hour-long consultations with its research analysts. This hourly fee is steep, even relative to the world’s most exclusive corporate lawyers, who charge about half this amount. Other banks recently quoted prices ranging between $800 and $10,000 for calls with analysts. These amounts are rapidly fluctuating, however, as banks aggressively compete with each other in an attempt to get as many asset managers as possible to subscribe to their research.
illing to lose clients over changes in pricing, many asset managers have already decided to absorb the costs of the research they purchase, instead of charging investors for it. This requirement could potentially disadvantage smaller asset managers, who are unable to absorb the high costs of research and therefore must charge investors for it, which might drive them away. This could result in less choice for investors, as large asset managers claim more market share, explain critics like Jamie Carter of New City Initiative, a group representing independent asset management firms. Making it harder for smaller firms to compete “plays into the hands of the big players,” which “can’t be good for consumers or the industry,” Carter claims.
Moreover, another criticism levied against MiFID II is that these far-reaching regulations inordinately curb globalization and free markets. MiFID II requires that European investment firms only trade on European platforms or platforms in countries where regulation is recognized as “equivalent” to Europe’s. If trading is prohibited in countries where more market activity occurs, this could lead to European investors “getting demonstrably worse prices because they’re trading where there is worse liquidity,” as Nick Dutton of CBOE Holding Inc. explains.
In order to prevent European investment firms from becoming insulated from the rest of the world, EU lawmakers are rushing to recognize “equivalence”—declaring other nations’ financial regulation to be as stringent as its own and allowing European investment firms to operate there freely—with other countries. If the EU does not recognize financial regulation in countries like Singapore, Switzerland, or the United States as equivalent to its own, it runs the risk of dramatically disrupting trading in those countries. As counsel Tim Cant of international law firm Ashurst LLP explains,
if equivalence is not extended to these countries “you’d have a form of financial nationalism on the part of the EU,” leading to something akin to “fortress Europe and rolling back two or three decades of globalization.”
Despite its noble goals, MiFID II has been the target of a significant amount of criticism. Moreover, due to its byzantine nature—MiFID II is reported to contain more than 1.4 million paragraphs of rules—markets and investors still require
time to adapt, and financial institutions need time to comply. In December 2017, one month before MiFID II became law, a survey of 500 small British investment firms and brokers revealed that as much 39 percent were entirely unaware of whether their business was MiFID II compliant. Regulators are wary of creating undue disturbances to the financial industry and have thus granted additional time for financial institutions to comply with the new rules.
One thing, however, is assured. In its quest to “[establish] a safer, sounder, more transparent, and more responsible financial system,” according to the European Commission’s description of MiFID II’s goals, this set of reforms is certain to cause major upheaval to financial markets in Europe, and beyond, in the coming years.
Edited by Shirley Wang