Graham Bishop / Jul 2014
The European Securities and Markets Authority's Management Board. Photo: ESMA
The MiFID 2 monster is set to devour many summer holidays. The European Securities and Markets Authority consultation paper – with all the questions – on the latest Markets in Financial Instruments Directive runs to nearly 1,000 pages and the deadline for responses is 1 August. Recalling the need for an emergency extension of the enforcement deadline for MiFID 1, the European Commission has wisely set the implementation period 30 months hence. But there is much detailed work to be done, so the ESMA has been asked to provide its technical advice within six months. Its staff can expect to be deluged with comments. Part of the reason for the sheer scale of the project is the desire to develop a “capital market union” as a complement to the banking union. The over-arching objective is a truly single EU financial market and that requires an EU-wide “single rule book”. This means that all the detail that has been created in national rules now has to be converted into EU-wide rules, with the narrowest possible wiggle-room for national regulators to bend regulations in favour of their domestic players.
Top of the to-do list is bringing shadow banking into the light. Seventy-five per cent of funding for the EU economy comes from the banking system – a number that regulators want to see cut. There is, however, only one alternative source: marketbased finance. This is why shadow banking is undergoing a quick rehabilitation and “good” securitisation is now the flavour of the month. However, new opportunities for savers also spell new opportunities for them to be ripped off by the financial system, at least in the eyes of the elected politicians of Europe. Enhanced consumer protection is, therefore, a big priority.
Within MiFID, there are two strands at work. The first is focused on protecting individual citizens. Financial services firms will see brakes put on their ability to “induce” independent financial advisers to is clearly a step-change. However, far more profound consequences for the structure of capital markets may flow from rules governing substantive investment research.
Typically, an investment bank “bundles” research with execution services, making the research “free” as far as a large financial institution is concerned. That, however, has raised the potential for conflicts of interest between the bank selling securities and the client who buys them on the basis of the “free” research that advocates the purchase. Abuses during the dot.com boom in the US triggered a re-think of this several years ago and the UK’s FCA (and FSA beforehand) was in the forefront of pushing for clarity on the costs ultimately borne by the client. The consultation paper on level 2 looks set to clarify the boundary in the UK but it may shift it extensively in other EU states.
Although MiFID 2 has some relatively clear-cut aims, the questions are likely to come thick and fast. Here are some:
- In the original MiFID 1 article 24: “‘investment research’ means research or other information recommending or suggesting an investment strategy…” Does that mean a single research paper or could it cover a continuous service?
- “Investment firms providing the service of independent investment advice and portfolio management are not allowed to receive non-monetary benefits that do not qualify as minor… ESMA advises the Commission to introduce an exhaustive list of non-monetary benefits that can be considered to be minor and are therefore acceptable.” That list will be pored over by clever lawyers looking for a new gold mine.
- “ESMA proposes that for financial analysis to be acceptable [ie ‘minor’ and not likely to influence portfolio managers] it would need to be intended for distribution so that it is, or is likely to become, accessible by a large number of persons, or for the public at the same time.” What is “large” and who are the public?
- “ESMA is, therefore, clear that the restriction on research as an inducement does not prevent a portfolio manager or independent adviser, who requires bespoke or valuable external investment research services as part of fulfilling their duties to their clients, from contracting and paying for such research on a distinct and separate basis…” Is this the critical step that forces an unbundling and a formal contractual tariff of prices from all suppliers of substantial research?
- To preserve a level-playing field, “ESMA advises the Commission to consider the possibility of aligning the relevant provisions that fall under UCITS (Undertakings for the Collective Investment of Transferable Securities) and AIFMD (Alternative Investment Fund Managers Directive)…” But why stop at direct fund managers? Should it include insurance companies and pension funds that manage funds in-house? These are some of the questions that will pour in from the managers of €15tn of European investment funds as they contemplate potentially big changes in the way they purchase investment research. At stake is the ability of these managers to allocate the savings of Europe to the new and productive investments on which economic growth depends in the longer term. (Note: Graham Bishop is a member of EuroIRP, the association of independent research providers.)