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Miffed By MiFID II?

7 June 2017 by Mark Holman

With just over 6 months to go before the latest Markets in Financial Instruments Directive, MiFID II, comes into effect we thought it was worth sharing our stance on the subject with investors.

The majority of firms should now be in full swing of preparing for MiFID II, and for asset managers, banks and brokers there is a clear burden of work and cost to be borne; some will certainly be miffed by MiFID II.

From a fixed income perspective, and being based here in the UK under the FCA’s jurisdiction, much of MiFID II is an enhancement to the existing framework within which we operate.

For end investors, who will ultimately be impacted by the new regulations, the result should in most cases be positive.

Before we opine on the impact of MiFID II, it is worth summarising some of the major changes:

  1. In equity markets research costs have been historically bundled into the execution price of trades, meaning that the investors and not the managers will have been paying for research provided by executing brokers and banks. From the 3rd of January 2018 this research charge will be unbundled from the execution cost and charged separately to the asset manager, who will in turn have to decide whether to bear this cost or pass it on to investors. Other financial markets will also have to pay separately for research even if it was not previously bundled into the execution price
  2. Higher standards for proving best execution will now become a European wide requirement for all trades
  3. It will become a requirement to post trading activity to the market within much shorter time frames, including over the counter transactions.

We would like to make the point to our investors that TwentyFour will not be passing any costs on to our investors and will be bearing the entire cost of MiFID II ourselves.

Research unbundling is a legacy issue of how equity markets used to be traded. In fixed income the price of a bond is purely the price of a bond, with no commissions and no taxes. Nothing is bundled. The banks and brokers do produce some valuable research which is written by some of the industry’s best talents, but much of this is for use in-house to support trading activities and other business areas. TwentyFour uses some of this research in our analysis and from January 2018 these providers will be required to charge for it.

The banks and brokers are now struggling to work out how much to charge, and how much the buyside will be willing to pay for it. Many have built complex models trying to gauge where to set appropriate research fees, but the outputs vary greatly. The quality and price of research needs to be consistent and complementary with the current offering and tailored to each firm’s needs.

It’s also worth remembering that there is a world of independent research out there already, and for these firms to survive, that research needs to be pretty good to compete with what is currently free from the banks and brokers. Many of these independent firms are staffed by former bank researchers and asset managers who wanted a more purist career or wanted to be part of, or create, a boutique.

At TwentyFour we have embraced a lot of this already and have been paying for external research for years, so this is nothing new to us. In fact, we are optimistic that the research offering from the banks and brokers might actually improve under MiFID II once their clients have to pay for it; so we welcome it despite the additional costs.

The new best execution requirements will build on what we have always been doing under the FCA’s supervision in the UK. It does require quite a bit of extra work, and actually it is proving best execution rather than doing it that takes the most time. However, when coupled with the new requirements on transparency and transaction reporting, it could be that proving best execution can become more automated. We await and see what new systems will be available to make our process more efficient.

Lastly, on to transparency and transaction reporting. At first our minds were focussed on the additional burden of work and the associated costs from which there could be no escape, but having overcome this initial frustration, we think that from a fixed income perspective, there may actually be an ancillary windfall benefit to liquidity. We have often said in the past that the plumbing through which we trade fixed income products over the counter was lacking in transparency, which must have a knock on impact for liquidity. By posting trades as they are executed in a timely manner, the transparency will be greatly improved and we no longer have to rely on individual banks and brokers posting trades that suit them. Everyone will have access to the same information almost in real time. This is potentially the best news for fixed income investors, no matter where in the chain they sit.

So overall, whilst being initially frustrated that the regulations and directives from MiFID II may be too onerous for a firm such as TwentyFour, we are now taking a more pragmatic view and think we may be surprised by some of the positives….and to be clear once again, we will not be passing on any costs to our investors.

Disclaimer

FOR PROFESSIONAL INVESTORS ONLY. NO OTHER PERSONS SHOULD RELY ON THE INFORMATION CONTAINED HERE.

This material is for information purposes only. Any views expressed are those of the author, and do not necessarily reflect the views of TwentyFour. TwentyFour does not warrant the accuracy or completeness of any information contained herein, and therefore it should not be considered as an indication of trading intent, personal investment advice, or a basis on which to buy, hold or sell any investment vehicle/instrument. As such, TwentyFour accepts no liability for any use, or misuse, of the material in this commentary. This material may not be reproduced, in part or in whole without the express prior written permission of TwentyFour.

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