We have seen this picture before, and it is a reoccurring theme in various bad Hollywood movies: a meteor is heading towards Earth and an inevitable collision will occur in less than nine months. In the movies, this is a clear sign for earthlings to prepare and take measures to avoid a catastrophe.

In real life, we know it’s not quite like that. A parallel to an announced meteor which is not raising the attention it should is the imminent implementation of the MiFID II regulation. Created by the European Union as a second stage of rules to enhance competition in the financial and capital markets, this regulation basically sets forth the unbundling of commissions charged by brokers. In simplistic terms, full service brokers will have to provide and price their services separately, explicitly charging for trade execution and investment research products.

The European regulator aims to solve the potential conflict of interest in the situations where research (which has a very clear cost for the broker) is provided as a “freebie” to attract more trading volume from the clients. In this model, the asset manager pays for research with funds from all its mandates, regardless of whether all of these services are needed for every mandate. That is, some mandates might be paying for services that they do not require and benefiting other mandates, which are paying less than they should.

As of January 3, 2018, managers will be required to provide full transparency on the costs related totheir brokers’ research services, which currently are transferred to investors as management fees, or assume those costs within their own cost structure. This change will have substantial impacts on the entire asset management industry, including all the services currently rendered by brokers to their clients.

The first effect will be in the amount of research services provided by brokers, as the buy-side will not pay for duplicated work. For example, how many analyst comments on a company’s quarterly result does an investment firm need? The answer may vary, but it’s probably going to be significantly less than the 10 to 15 reports normally published in a typical quarter. The expectation is of a drastic decrease (estimates range between 20% and 60% drop) in the number of research reports published. Although the impact will not be evenly distributed throughout the brokers, it is widely expected that a similar decrease will occur in the number of sell-side analysts.

The need for investment research will remain, but it will be outpaced by a combination of deeper and more detailed sell-side research executed by fewer brokers or independent research firms and buy-side itself taking over more of those responsibilities.

Another area that will be impacted is corporate access, the brokering between investors and listed companies provided by the sell-side, whether promoting conferences, organizing theme trips or travelling with companies for roadshows in major markets. These services are evidently analogous to research and likewise, the costs will become more evident and more clearly distributed.

Despite the fact that the MiFID II regulation is European, it seems very clear that it will impact global markets, due to the relevance of the European buy-side. In addition, it seems unlikely that a global sell-side operating in European markets adopts a model to serve this market and another one totally different for the rest of the world. We believe that the European model will be disseminated and adopted globally.

The implications of the “meteor impact” for the sell-side are noteworthy and substantial, with relevant changes in its business model. However, or maybe because of that, we are not hearing much about preparations, but the situation is worse for listed companies. Based on our discussions with Investor Relations areas of Brazilian listed companies, we note that there is little familiarity with this issue and little concern with its effects. To sum up, we can list a few of major effects companies should be preparing for:

  • Less assistance from the sell-side in the dissemination of investment cases. With fewer sell-side analysts and increased pressure for their reports to be paid by clients, we will see less willingness to include new companies with low liquidity or without strong catalysts. At the same time, companies will have to seek and expand their communication channels with investors, such as through their IR website, roadshows and conference attendance, investor days and expand their presence in traditional and social media channels. IR innovation will be para

 

  • Less consistency in buy-side expertise will mean more time required to educate by IR teams. With less assistance from sell-side and a substantial amount of research being done by buy-side, companies will need to dedicate more time and efforts to educate investors.

 

  • The cost of dissemination of information, which always existed but was implied and partially covered by the sell-side, will now become explicit and will have to be paid by companies in most of the cases. For instance, the logistics costs of a roadshow in Europe, which are relevant and usually assumed by the sell-side will likely have to be paid by the company. The same applies to group meetings, lunches and breakfast with analysts, visits to facilities and even conferences with investors. This will have an explicit cost that will be disbursed to the companies. The Companies intending to have a relevant presence will be required to increase their IR budgets.

 

The Companies must have a clear vision of their IR strategic goals and allocate adequate resources in order to achieve them. Note that the MiFID II regulation does not create new costs, it makes them more transparent for all the parties involved, which will result in a reallocation of costs. A potential positive outcome of this new rule is to generate greater efficiency for IR efforts, with less wasted time and resources in activities which generate little impact.