MiFID II increasing pressure on margins on mid-to-small brokerages

Although regulators introduced MiFID II in order to bring about increased transparency and ensure that investors get a fairer deal, but with the reduced cost of market research, the market dominance by large financial institution is quickly becoming an issue. Medium and small brokerage firms are faced with only two options, merger and become bigger and pull the shutters.

Following a change in EU regulations which prompted banks and brokers to charge investors for equity research, the pressure on small brokerage firms has increased significantly as they find it more difficult to make ends meet. As a result, they are either opting for the merger route or plan on closing down shop this year.

According to more than a dozen of executives at brokerage houses, banks and asset management companies, the picture for small brokers is pretty bleak. They are being systematically undercut by large financial institutions and face increasingly cost-conscious asset managers.

The aim of bringing changes to the EU’s Markets in Financial Instruments Directive II (MiFID II) was to boost transparency and ensure that investors get a fairer deal. In practice, the dominance by big banks in the brokerage market is pushing many a regulator to have a rethink.

“MiFID is going to have continued significant ramifications. I always felt the fourth quarter (2018) or first quarter (2019) would be when the change starts to bite,” said Steven Fine, CEO of Peel Hunt, a mid-and small-cap broker.

Before MiFID II came into force in January 2018, banks and brokerages bundled the cost of research into their overall charges for executing customer trades, or gave it away completely for free. However under the new rules, they must itemize their services, including fees for meetings, conference calls, research and execution fees.

Itemization has caused havoc in the sector.

Dominance by big financial institutions

In 2017, JPMorgan Chase, a U.S. bank, offered research subscriptions to investors for as little as $10,000 a year; this is only a fraction of the six or seven figure sums some smaller boutique firms had hoped large banks would charge.

Large investment banks are more willing to fund research teams in order to maintain their edge in the equity capital markets, the pressure however is felt by their smaller rivals.

According to Nigel Bolton, co-head of fundamental equities at BlackRock, the recent merger talks between Liberum, a UK-based broker and Macquarie, an Australian investment bank, are signs of things to come, this year.

“That’s the sign that brokerages and banks are saying ‘now we’ve been trying this for a year, it’s not improving, we’re going to have to do something more radical’. And I think you will see that happening in 2019,” said Bolton.

The subsequent decline in research coverage and trading liquidity for smaller firms have been noted by market regulators in France and the UK; they could potentially take action.

In November, in an interview with the Financial Times, Robert Ophele, the head of the French markets watchdog, stated MiFID has had a “very detrimental” effect on market research, particularly of midcap companies. He has called for a review of the legislation.

MiFID’s impact

The fragmented nature of the UK brokerage market meant that brokerages are feeling the mximum pressure in comparison to their euro zone peers, who are comparatively under less pressure.

In November 2018, AllianceBernstein had announced plans to acquire Autonomous Research – an independent firm which has offices in New York, London, and Hong Kong.

In 2018, as per a report from the Financial Times, Berenberg, a private German bank laid off staff in its equities business midst pressure from MiFID II.

According to Fine, Peel Hunt will not cut on the amount it charges for market research. It expects the loss of revenue from some research clients to be compensated by other revenue streams, including corporate finance.

As per Matthias Desmarais, head of research at Paris broker Oddo BHF, research budget cuts are expected to kickoff in 2019. Bolton though was not so sure.

He said, his team’s research spending would stay lower as managers think twice about paying for a broker’s research or access to their analysts, with quarterly reviews and a massive monitoring and reporting exercise to check usage and spending.

One hour with an analyst can cost as much as 1,000 pounds.

Increased competition has forced many brokerages to look at selling their wares in new ways.

As per RSRCHXchange, an online marketplace for research, the number of firms selling research on its site has doubled to 400 since January 2017.

“People want to monetize their research more than ever before,” said co-founder Jeremy Davies.

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