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Research cost re-bundling should include higher-market-cap SMEs – EC executive

Raising the market capitalization threshold for small- and medium-sized enterprises captured under a proposed amendment to the EU's MiFID II financial markets regulatory framework may incentivize banks and asset managers to engage in SME research, Tilman Lüder, head of the European Commission's securities markets unit, said Oct. 9.

Raising the threshold to include firms with market values of up to €10 billion, up from €1 billion, could create a "vibrant ecosystem" of companies that both buy- and sell-side firms may find easier to focus on, Lüder said at the 4th Annual European Compliance and Legal Virtual Conference of the Association for Financial Markets in Europe, AFME.

Reversal of 'unbundling'

In July, alongside the announcement of several other amendments to the MiFID II framework, the European Commission proposed a partial reversal of requirements for the unbundling of research and execution costs for banks and financial firms when it comes to research on SMEs and fixed-income research. Buy-side and sell-side firms would once again be allowed to bundle the cost for research and execution instead of charging and paying for them separately. In the proposal, the Commission describes SMEs as "companies that did not exceed a market capitalization threshold of €1 billion over a 12-month period".

The European Parliament's Economic and Monetary Affairs Committee, ECON, considers the threshold to be too low. MEP Markus Ferber, who has been appointed by ECON to report on the MiFID II legislative file, previously proposed to raise the threshold to €10 billion "with a moving average over the past 36 months to avoid sudden cut-offs," in order to capture all small- and mid-caps and allow for an "ecosystem" for research on such companies to be established.

The MiFID II rules, first implemented in January 2018, introduced a cost unbundling requirement that controversially altered a long-standing practice of sell-side firms, such as investment banks, whereby they bundled together the fees they charged buy-side companies, such as asset managers, for research and execution. It rocked the research market as sell-side firms struggled to find the right pricing and buy-side firms cut research budgets by as much as 30%, according to estimates by the U.K.'s Financial Conduct Authority.

The SME market cap threshold is the main topic in the ongoing talks about the research rule change in MiFID II, Lüder told the conference.

Most SMEs listed on growth markets, such as the AIM in the U.K. and First North in the Nordics, have higher capitalization ranges, reaching €8 billion to €9 billion, and the €10 billion threshold will capture them all, he said. Growth market SMEs will contribute to the establishment of a "vibrant ecosystem" attractive to investors and would also benefit from more broker-sponsored research, Lüder said.

Buy-side wariness

As a buy-side representative at the conference, Martin Parkes, a managing director at the global public policy group of fund manager BlackRock Inc., said he was wary of the proposed research rule changes in MiFID II.

BlackRock has already done a lot of work into moving into an unbundled model and making sure it had a global model "that would work in the EU and the U.S. in terms of valuing research on the same basis to avoid conflicts of interest and issues of cross-subsidization," he said.

It is important to maintain that in the future, he said.

While BlackRock would like to see a vibrant SME ecosystem in Europe and is keen to support it, he warned that the separation of small- and mid-caps from large caps would lead to fragmentation.

"We have concerns about siloing the market this way," Parkes said. He noted that evidence of a potential decline in SME research as a result of MiFID II is still patchy and expressed doubts about whether the re-bundling of research would really have the desired outcome of establishing a thriving SME ecosystem in Europe.