The Reshaping of Global Finance: The 107 Unintended (and Intended) Consequences of MiFID II
The Markets in Financial Instruments Directive review, or as it is commonly known as MiFID II, is one of the most far-reaching and extensive legislative/regulatory securities markets initiatives in decades, if not longer. On its face, MiFID II provides fairly straightforward and laudable guidance for enhancing price discovery, improving execution quality, increasing transparency, reducing conflicts of interest and mandating better reporting.
While the underlying premise of reducing conflicts, and increasing transparency is laudable, the implementation of these goals through the MiFID II process will have a number of very severe intended and unintended consequences. Given these challenges, we are convinced that there will be a MiFID III in our future. The only question will be when.
MiFID II will consolidate the number of investment managers and brokers. It will heavily benefit larger and deep-pocketed brokers and fund firms with multi-asset and global capabilities and those with a robust technology heritage. It will also benefit passive funds and funds with more lucrative fee models (such as hedge funds, and long-only funds with incentive fee structures).
Research budgets will be slashed, with the more renown analysts/firms gaining and the vast bulk of the industry losing. While independent research firms will do better in aggregate, it will become increasingly difficult for research providers to get paid. Many analysts will migrate over to the buy-side, where unique investment insight will become more important. However, the bulk of these analysts will leave the industry.
This will not only hurt analysts but will also hurt small- and medium-sized enterprises that will have a harder time having their firms covered. This will also negatively impact owning small and mid-sized European companies as well as making it more difficult for European companies to IPOs. Private equity investors will benefit as they will retain their ownership stakes longer and only introduce IPOs once the firms have reached critical mass.
The market structure changes will reduce dark pool and dark MTF trading. Initially this will help exchanges and dark MTFs that operate under the Large in Scale waver. After six months to a year, after the systematic internalizer models are more formalized, the SIs will capture between 15% and 30% of market share. This will hurt exchanges, displayed liquidity, price discovery, and unsophisticated investors. However, institutional investors will execute at tighter spreads and the increased transparency created by better liquidity source tagging, and best execution analytics, will improve execution performance for institutional investors trading in liquid names.
Illiquid names will become increasingly harder to trade. This enables bank brokers to increase the cost of providing capital. Capital provision will become an increasing important aspect of the bank broker as the algorithmic business will become increasingly competitive. Capital will be provisioned through banks’ Central Risk Books, which will eventually be implemented globally and across asset class.
While the investment management and brokerage communities may end up in turmoil, the overall impact to investors is a bit more nuanced. Investors will have less provider choice, as many mid-and smaller-tier managers will fold; however, they will be left with larger and more cost-efficient choices. In addition, the performance of hedge funds or funds with better (more expensive) business models should do better. That said, we don’t see any reverse in the current trajectory of the active to passive shift. In fact, MiFID II should accelerate this change, as the number of providers declines and the industry consolidates.
This note will discuss the impact of MiFID II across the global investing landscape. It segments the impact of MiFID II rules on Unbundling, Best Execution, Market Structure, Trade Reporting, and Fixed Income unbundling and price transparency. It also looks at the intended and unintended consequences to research analysts, buy-side money managers, investors, issuers/companies, and money manager technology and operations.
The report is 26 pages and contains 16 exhibits.