The EU’s signature framework for the financial markets is starting to have major impacts in the US
What are the challenges and potential opportunities for companies in the life sciences?
On January 3, 2018 the Market in Financial Instruments Directive (MiFID) II was rolled out in the European Union (EU) as a signature piece of European financial services regulation, to create a level playing field for investment firms within the EU’s financial markets and restore confidence in the industry, particularly in the aftermath of the 2008-2009 global financial crisis.
What was this intended to accomplish?
The ultimate goal of the regulation was to increase transparency in the financial markets by shifting trading away from so-called “dark pools,” lowering the cost of market data and improving “best execution.” A key tactic to achieve this last goal was that the costs of trade execution, sell-side research and management access must be disclosed and paid for separately.
Payment for sell-side research has traditionally been bundled with trading commissions, and European regulators worried that that this “bundling” made research costs opaque to end investors. Also, they believed that asset managers were inclined to overpay or to sacrifice best execution in exchange for this access to research, as well as to gain access to company management (corporate access).
MiFID II mandated the unbundling of fees for trade execution, research and corporate access. European asset managers taking sell-side research must pay for it now from their own P&L or with a research payment account funded by client money, and it must be explicitly priced. Most asset managers have chosen to pay fees from their P&L. Similarly, corporate access services must be paid for separately.
What have been the unintentional consequences?
Unfortunately over the past eighteen months, MIFID II has, according to one source, caused the slow death of European investment banking. The inevitable squeeze in revenues for brokers has resulted in less research coverage for smaller cap stocks, liquidity concerns and diminished access to the capital markets. — ironic as a key goal of the EU financial policy was to boost funding for small and medium sized businesses and lessen company reliance on bank loans.
According to a Europe-wide report by the CFA Institute, research budgets have been scaled back, with a particularly acute decrease in coverage for small- to mid-size companies, and what research coverage still exists has decreased overall in quality. Similarly, Greenwich Associates estimates that brokers earnings from equity research have decreased by approximately 20%, or $300 million.
In terms of corporate access, because brokers must charge to facilitate discussions between fund managers and the companies that they invest in, fund managers are now bypassing brokers and going direct to companies. And European investment conferences, where these payment rules can be quite complex to navigate, have taken a hit in terms of attendance.
What starts in Europe doesn’t necessarily stay in Europe
It’s inevitable that in a globally interconnected financial marketplace, such a far-reaching regulation would impact the US. Big US pension fund managers, in particular, are not enthused about having to pay a single, bundled bill for all brokerage services in the US, but then write multiple checks in Europe. A number of large firms have been vocal in support for a framework in the US similar to MiFID, feeling that it will lower costs and ultimately benefit investors.
Further complicating the issue, Wall Street firms are all but prohibited from selling stand-alone research to U.S. customers unless brokers are also registered as “investment advisers,” a direct conflict with MiFID II regulations. The SEC provided relief with a “no action” letter allowing US brokers to take payments from European asset managers, but that expires in April 2020. We expect to see continued debate on this, with the SEC looking for industry input this year.
And on the corporate access front, MiFID is having a negative impact as well. There has been a notable decline in U.S. in the total number of bank-sponsored conferences announced in Q1 2019 vs Q1 2018, down some 17 percent. This tracks with an even more dramatic 27-37 percent decline from 2018 to 2019 in bank-sponsored conferences in the EU.
“More than anecdotally, we’re starting to see MiFID II effects starting to take a bite out of U.S. investor meeting access,” said Sharon Choe, SVP of IR and director of corporate access at LaVoieHealthScience.
“This has been particularly acute for foreign listed companies who have seen declines in access in the EU, and are now feeling the effects as they engage here in the US with diminished sell-side interest in setting up investor meetings, and sponsored investor conferences that are less vibrant than in years past.”
The challenge, and the opportunity
All of this creates challenges, particularly for small-cap life sciences firms who struggle to get their story across to investors. With potential reductions in published research, fewer analysts covering a stock, the buy side taking meetings with fewer brokers, and overall diminished efforts by the sell side, IROs will have more work to do get in front of the right investors.
It’s not all bad news, however, as the opportunity for management to reach out and interact directly with investors is, if anything, increasing.
Recently, five of the largest U.S. institutional investors announced plans to organize a series of meetings, starting in Boston, to meet directly with company management – without the intervention or interaction with the sell side. Fidelity Investments, Capital Group, Wellington Management, T. Rowe Price Group Inc. and Norway’s government fund will host a series of private conferences where their fund analysts can meet directly with CEOs.
And other large institutional investors, like Black Rock and Janus, have set up their own internal corporate access teams to go directly to company management for their stories.
“While the corporate access/investor meeting landscape will continue to change in the coming year, it’s clear that investors are eager to hear directly from companies themselves. And this gives IROs a terrific opportunity,” said LaVoieHealthScience’s Choe.
“The impacts that we’re beginning to see from MiFID mean that many more investors will be inclined to contact your directly,” concluded Choe. “But why wait? The information and insight that you provide is the biggest factor in delivering alpha to investors. They are eager to hear from you.”
LaVoieHealthScience IR Contacts:
Paul Sagan, AVP, Investor Relations
Sharon Choe, SVP, Investor Relations