Anthony Hilton: City still isn’t ready for Mifid’s rules storm

Mifid II: Rules are coming soon to the City

Matt Cardy/Getty Images

17 October 2017

You do not have to be deluded to work in the financial services industry, but there are times when it can help.

Ask any of the thousands of firms spending tens, if not hundreds, of millions of pounds throughout the industry to prepare for the biggest regulatory upheaval most of them will have seen in their lifetimes, known as Mifid II, and they all say they expect to be ready.

None will admit they will be the ones to suffer from a back office rendered obsolete overnight, a business model that needs a grinding adjustment, a collapse in revenues that can only be offset by brutal cost savings, and a completely different competitive landscape.

At times like these, being deluded can be a source of comfort.

But first to backtrack. If you list the fortunate people in the world who earn between £100,000 and £1 million a year, there is a significantly higher proportion in the European Union than anywhere else.

Some 39% are in this region, compared with 25% in Asia and 24% in North America with the remainder scattered around.

But despite having all this money, Europe has easily the lowest proportion of people owning investable funds.

About 44% of households in the US have some form of stock-market investments, whereas the figure in Europe is 11%.

Mifid II is all about trying to change this. The big idea behind this massive upheaval is to make equity investment more transparent and less riven by conflicts of interest, so that people trust the system more and become more willing to invest. The prize then is that, with more money going into equities, businesses will become less dependent on Europe’s troubled banks for the capital they need to expand. As the capital markets grow to challenge the banking system, so too will the economy.

But if that is where Europe wants to go, it would have been a lot easier not starting from here. Having to do so has turned the exercise into a nightmare of complexity, encapsulated in a directive which, according to a letter to the Financial Times last week, has 1.5 million paragraphs of regulations and runs to something over 70,000 pages.

The result is predictable. A speaker at a recent Baker & McKenzie seminar reminded his audience of how the comedian Eric Morecambe would respond to criticism of his piano skills by saying he was playing all the right notes — just not necessarily in the right order. Mifid ll arouses a similar feeling of frustration — it is hard to argue with what is wanted, but the way it is wanted is causing all manner of problems.

The problems are acute in the back office. Mifid II demands a huge increase in reporting and record-keeping from systems that were never designed to work together. For years, investment bankers have run their IT departments on a diet of instant fixes and annual bonuses — with the result that there has never been any incentive to design systems properly nor think about them strategically. The result, in the words of one systems head, is “technology which looks like a congealed bowl of pasta. You can’t tell what connects with what, nor how to untangle it”.

But untangle it they must as they struggle to convert what is largely post-trade architecture into something which can report across the whole life cycle of a transaction. In several firms, it remains a toss-up between whether this will herald a back-office revolution or simply put them out of business.

The front office is affected, too. Securities houses produce research which they supply free to fund managers to encourage them — and the companies they write about — to put business their way. They recoup the costs through the commissions on these trades so it is the client, not the fund manager, who pays. Mifid II says this has to end, and henceforth fund managers will have to pay openly for what they use.

The result will be a bloodbath in the analysts’ community because fund managers will be a lot more choosy about how much they spend on research or whether to buy it at all when it is their own money.

According to a report published this month by Capital Access Group, based on an extensive survey across the industry, the amount “spent” on research will more than halve. The report also points out that 96% of stock-exchange business goes through just 20 firms, which between them employ only 20% of the analysts. It predicts that the combination of less money and fewer hands will result in the number of analysts halving in 12 months and dropping to a third of current levels within two years.

This also has huge implications for listed companies. Large numbers of them will soon have no analyst coverage to speak of, and it may well be that they will start having to pay for their own research, the way they currently pay Moody’s or Standard & Poor’s for bond ratings. All this nonsense about consensus forecasts will end, too, given that there will not be enough analysts around to disagree in the first place, so no need to have a consensus.

It will also be even harder for companies to meet the fund management community, and in particular those who are not yet shareholders, because such meetings are usually arranged by the investment house they retain as the corporate broker. Henceforth, such meetings with potentially new shareholders will be seen as an inducement to trade. That in turn means fund managers will have to pay to attend, which they are unlikely to do.

It could be that new firms — such as Capital Access Group itself — or public relations consultants and investor relations specialists will step in to plug this gap. But it will be an interesting unforeseen consequence of Mifid II if its efforts to make markets more friendly to investors succeeds only in making them much less friendly to listed companies.

Anthony Hilton: City still isn’t ready for Mifid’s rules storm

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