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How MiFID II challenges the sell-side status quo

There is a lot of discussion on Wall Street regarding the new European rules regarding payment to securities firms for stock research (sell-side research). The research, often industry specific, provides company reviews and earnings forecasts, usually with a buy/sell recommendation.

In the EU in early January 2018, payment for sell-side research was put under strict rules called MiFID II (Markets in Financial Instruments Directive II). The aim of the new rules was to curb supposed excesses because they were sometimes used to cover high trading costs, expensive subscriptions and non-research items.

In the past, trading was part of the money management business and the commissions were to be used at the discretion of the manager. The client had little or no information on the trading costs imbedded in the management fee structure.

Now, EU investment managers pay for research in one of two ways: from the manager’s own cash account, which may be recoverable by a specific charge to clients, or from a specific client research/payment account. This amounts to unbundling research, where the client values the research service separately from stock or bond trading. While some parts of MiFID are already part of the U.S. landscape, the new requirements in Europe are expected to further encroach on sell-side revenues in the U.S.

What is the projected impact?

The new rules may reduce coverage for smaller public companies and reduce the visibility of larger ones that are out of favor in the market, such as, currently, energy producers and real estate REITs. It may also reduce the number of brokerage conferences and increase the importance of hedge funds in the sell-side customer base, some of whom use their own capital to trade.

It might impact the tendency by the sell-side to make strong recommendations, which sometimes trigger trading. The MiFID rules could result in increased competition in research, opening it up to providers who do not have strong selling efforts. In the past, some commissions for “research” were directed to underwriting firms, to obtain shares of IPOs. 

Finally, many companies may not obtain the visibility in the market they had in prior years. Thus, individual companies may return to earlier methods used to attract investor interest, such as improved investor presentations, as well as holding specific company update meetings for analysts, where they can interact with the company executives.

Strategy to deal with the change

We would recommend organizing a consistent contact program. It would include the following:

  1. Regularly call and visit analysts and portfolio managers in investment firms holding the company’s stock.
  2. Initiate calls and visits to sell-side analysts, who specialize in the industry and who may know the company. The aim is to increase their interest in following the company.
  3. Call on buy-side analysts who may hold stocks in similar industries, in a rotating annual visit.
  4. Emphasize regional investors and analysts, with visits and calls.  
  5. Use social media where the company may have a following, and create a presence on particular sites. This may also involve increasing media relations efforts, in national news journals, trade magazines and even television business news.

In this new era of MiFID II, the old standby of relying on brokerage analysts to be the main carrier of information will not be effective. The time has arrived for a more aggressive and proactive approach.

Dix & Eaton recommends that public companies have the IR director and a key executive make regular trips to visit the “street,” and meet with both analysts and portfolio managers. Contact me if you’d like to talk about arranging investor meetings and conferences for your company.

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