The capital market and investor relations have been impacted by the regulations of MiFID II beginning in January 2018. What is MiFID II and why will it continue to have an impact on all the market participants? In this article, we will discuss what MiFID II is, and what you need to know.
What is MiFID II?
The European Union first published the "Markets in Financial Instruments Directive" (MiFID) in November 2007. It is a legal framework document that regulates the actions of all financial institutions in the EU zone. After the financial crisis in 2008, MiFID could not respond to the rapid development and changes in the financial market. Thus, the EU started to revise MiFID in November 2011. On June 12, 2014, the EU published the revised "Financial Instruments Market Directive II" (MiFID II) and "Markets in Financial Instruments Regulation" (MiFIR).
The revised "Financial Instruments Market Directive II" (MiFID II) and the "Financial Instruments Market Regulation" (MiFIR) came into effect on January 3, 2018. MiFID II emphasizes principles such as "optimal execution" and "transparency" in order to strengthen the supervision of the market and investor protection. The impact of the new MiFID is not limited to the EU region. For example, Asian companies having close contact with the EU are therefore affected by MiFID II.
Why was it implemented?
Goal
(1) Make the European financial market safer, more transparent, and more efficient
(2) Restore investor confidence and strengthen investor protection
(3) Over-the-counter (OTC) brokers will be regulated
Coverage
Stocks, bonds, futures, foreign exchange, and other derivative financial instruments
MiFID II's regulation for the asset management market
(1) Strengthen financial market supervision and transparency
(2) Prohibit receiving benefits from third parties
(3) Asset management companies are required to pay for research reports, of which the cost should be separated from the cost of placing an order
(4) Enhance information disclosure
(5) Avoid conflicts of interest
Affected Stakeholders
Under the supervision of MiFID II, all over-the-counter (OTC) brokers will be subject to regulatory constraints.
Although the directive was formulated by the European regulatory agency and the MiFID II legal framework applies to the European Union, which means that companies in the EU region will be the most affected, the influence of MiFID II extends beyond the European Union. For companies that are outside the European Union region but whose customers are not, they must also comply with these rules.
For institutional investors, one of the biggest differences is the new requirement on payment for investment research reports. In the past, they paid for research reports provided by brokers with the cost of placing an order, and therefore it effectively tied the payments of the two services together. Brokers provided research reports for free in exchange for orders and transactions which were placed and conducted by these institutional investors, thus, the broker's research remuneration was included in the order commissions.
However, under MiFID II, since the regulatory agency classified the investment research reports under impermissible non-pecuniary benefits, these transactions with a quid pro quo no longer exist. Institutional investors and brokers must now list the cost of research reports as separate items. Asset management companies are required to budget for, track, and report on the cost of placing an order and of research reports respectively and to show the value of these research reports. Once the two costs unbundle (Research Unbundling), asset management companies have to bear the costs of research, which lowers their profits, or they will shift the increased costs to the investors by raising the fund management fee.
For sell-side institutional brokers, the changes are more complicated. In addition to separating the cost of placing an order and research reports, brokers must also separately charge for related services, such as face-to-face meetings with analysts or teleconferences, company visits, roadshows, investment forum meetings, and monitoring how much and when the payment is received. In other words, it is the responsibility of sell-side institutional brokers to fully convey the value of the services provided, to prove that these services are not provided for free, and to ensure that customers fully understand the value of the services they receive.
Although there have been major changes in the payment for research reports and corporate access services, the specifications of MiFID II are mainly related to improving the transparency of transaction execution, and of transaction reports. In terms of institutional investors, asset management companies must provide order placing and transaction reports which are more complete for the details of increased assets. The data required by the rules of reporting has increased from 23 to 60 types. Even for large investment institutions, compliance with such complex requirements is a difficult and expensive task.
Under the specifications of MiFID II, whether it is a research report or corporate access services such as participating in an investment forum meeting held by brokers, teleconference, or a roadshow, institutions need to pay for the service. Due to the increase in costs, institutions have reduced their participation in investment forum meetings and company visits. This in turn has affected brokers' willingness to spend resources on smaller companies, whether it is research coverage or corporate access activities.
As an IRO, it is expected that you will need to take on more of the responsibilities traditionally sponsored by brokers which may include investor targeting and scheduling and preparing for meetings with investors. Hence, investor access will continue to consume even more resources from an IRO. In our next MiFID II series, we will discuss in more detail the impact on IROs (particularly IROs of small-mid-caps), and how IROs can address and manage these impacts.
Editor's note:
To give our readers a more in-depth and comprehensive knowledge about investor relations from the investor's perspective, DIGITIMES has invited QIC as a contributing partner to share their insights. The article is the six part of the QIC Inside Investor Relations Series, which was originally published on QIC website.
