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New MiFID II investment rules will force consolidation, push out small players

This article is one of a three-part series.

As asset managers prepare for the January 2018 implementation of MiFID II investor protection rules, S&P Global Market Intelligence investigates the impact on firms in Europe and beyond.

Click here to read about the implications for German fund managers, and here for how Asian firms will be affected.

New EU trading and investment services rules are likely to push up costs in the U.K. asset management industry and hasten consolidation, despite hopes they would level the playing field and help smaller firms, observers said.

Meanwhile, a new survey found nearly half of U.K. asset managers are not entirely sure of their obligations under MiFID II, a major post-financial crisis rewrite of the original Markets in Financial Instruments Directive of 2004, despite the fact that its implementation has been pushed out a year to January 2018.

Smaller firms will feel the impact of MiFID II more keenly and it will ultimately reduce the number of players. This is ironic given the directive's "overarching aim" was, in its own words, to "level the playing field in financial markets."

The survey released Jan. 23 by Electronic Research Interchange, a research marketplace that allows investment managers to buy research directly from providers, also found that 74% foresee a reduction in investment bank research. Three quarters of respondents expect research spending to decline or remain the same, while only 25% believe it will increase. And 38% of asset managers were considering expanding their internal research teams.

Double the data

"In terms of size, the largest have the resources to do what is required and they remain important counterparties of the main providers of research," Chris Turnbull, co-founder of the Edinburgh-based Electronic Research Interchange, told S&P Global Market Intelligence. "The smaller [ones] will have less ability to pay and are therefore foreseeing a problem, but it has not manifested itself yet."

"The intention of the rules actually was the opposite of that [consolidation]," said Bobby Jahal, managing consultant at Cordium, a London regulatory compliance firm working with asset managers.

One change will see the amount of information managers must submit to regulators for every transaction increase from 23 data points to 65, according to Jahal. Asset managers will need to retain this data for five years and actively monitor their employees' communications. A new requirement to record telephone conversations, Jahal said, has been extended to apply to "a much wider range of conversations, including internal ones which involve a transaction, and will apply to everyone, including investment managers."

SNL Image

MiFID II will require asset managers to record all telephone conversations, including internal ones.

Photo: Associated Press

A second important development is the unbundling of research costs from commissions, so that managers will either need to pay for independent research, or agree a budget in advance with clients. Unbundling research costs was meant to lead to transparency for investors and level playing fields among managers. However, it will more likely introduce compliance costs which will be easier to bear for larger U.K. asset managers — such as Aberdeen Asset Management Plc (with £312 billion in AUM) and Schroders Plc (£375 billion) — than for boutiques like City Financial Investment Co. Ltd. (£2.9 billion).

The EU authors of the regulations, Jahal said, saw the market for research as "an oligopoly of the very biggest banks" and regulators believed it was not always exactly clear what was being paid for and if it was value for money. Making research costs explicit will prompt some "difficult conversations" in which managers may have to carry the cost of unbudgeted research. Jahal said this will further encourage the ongoing shift from actively to passively managed funds.

There have been consistent net outflows globally from traditional, actively managed funds into lower-fee passive products, Moody's said in a 2016 report, with active funds' higher fees being particularly noticeable in a low-yield environment.

The largest U.K. asset managers, with with more £5 billion in AUM, have had compliance teams on MiFID II for about nine months, said Joe Vittoria, CEO of Mirabella, a London-based regulatory hosting platform which works with asset managers. "A lot of them are coming back with good questions to the regulators," he said.

Brexit unlikely to delay new rules

Meanwhile, the smaller and medium managers face a brisk year ahead. "Anyone relying on Brexit to create further delay, or even a repeal, should think again," Jahal said. "Even after it formally withdraws from the European Union, the U.K. is expected to follow the MiFID II regime."

MiFID II is accompanied by a new set of Markets in Financial Instruments Regulation (MiFIR) measures. A directive, like the first MiFID, can be adapted in implementation by each country's financial services regulator, but MiFIR the force of European law and must be implemented by each member state exactly as written.

Together, said Jahal, MiFID II and MiFIR encompass "thousands of pages of draft directive and final directive, and then the regulations and then implementing technical standards."

The challenge for medium-sized asset managers will be probably be "a lot clearer" by mid-spring, Vittoria said. He expects the Financial Conduct Authority to give the market some idea what to expect from the regulatory environment after Brexit within the next six months. Many firms are already asking themselves: 'How much do I actually rely on Europe?'," Vittoria said.

Technology companies have developed new tools that will be helpful for asset managers in fulfilling the requirement to record more conversations about trading

This includes technology to record mobile phone conversations and intelligent data mining tools which can search records for key words and spikes in trading activity, and can plug in market data feeds to review and analyze material intelligently, rather than have someone listening in for a few hours a day, Jahal said.