Earlier this month, the UK government revealed plans to establish a one-stop-shop research platform as it moves closer to reversing the ban on free research for clients inherited from the EU under Mifid II.
The unbundling regulation, introduced under Mifid II, required firms to separate the cost of investment research from trading costs – with the aim to increase transparency and reduce conflicts of interest.
However, many critics of the unbundling rules have argued that it has had a negative impact on the industry, including a reduction in the amount of investment research available.
“When research was unbundled, and the cost framework changed, it meant that less money was generally being invested into research and independent research companies had less of an incentive to get involved. There was still research being done for the blue chip names because that’s where the money could still be made, due to high trading volumes in these stocks,” Matt Short, equity trading desk manager at BNY Mellon Pershing told The TRADE.
“But small cap stocks and even some mid-caps that mostly traded on the AIM experienced lower trading volumes following Mifid II reforms because research houses withdrew their coverage of these companies.”
The proposed reversal of research rules comes as part of efforts to boost the attractiveness of the UK’s financial services sector, while also becoming the latest divergence in regulation from the EU following Brexit.
Short added that the new rules demonstrate that the UK is thinking innovatively about regulatory reform and is open for business and to new capital inflows. “The AIM is made up of more than just UK companies, and that’s what you want. You want overseas money to bring overseas companies to market. You want to be that centre of excellence – that place where those companies come and list,” he said.
Hogan Lovells lawyer Rachel Kent – who has led the UK’s Investment Research Review under the Edinburgh Reforms – published recommendations that the UK government has accepted, which includes paving the way for a new ‘Research Platform’ that will provide a one-stop-shop for firms looking for research experts. However, market participants still believe more clarity needs to be provided as to how this new platform will work logistically.
“There is some uncertainty about how this research platform is going to work. There needs to be a lot more detail about how it’s going to be paid for. There still needs to be that increased level of transparency,” Short told The TRADE.
“The Mifid II research agreement was proving difficult for lot of our clients. So, the reforms should make UK markets more transparent, and the research more accessible – which is especially important, for the retail investor. There’s very little downside, aside from the work that will need to go into changing some of the existing framework.”
A key challenge associated with the proposal is the reversal of costly and time-consuming frameworks established by firms to comply with the unbundling regulation under Mifid II.
Post-Brexit and following the UK’s plans to reverse the rules, there may be growing pains linked to restructuring practices to rebundle research.
“Post-Mansion House reforms, many participants feel that the conversation about investment research, and the cost structure surrounding it, will become more difficult to have with clients, given that only five years ago they were being told that costs were going to be lowered,” added Short.
“If costs now rise, that will be a difficult conversation to have, particularly given market performance over the past couple of years.”
Following the announcement of the UK Government’s reforms, the Financial Conduct Authority (FCA) said that it will ‘carefully consider’ the changes proposed, working closely with the Treasury.
Based on initial feedback, the FCA said that it will assess market opinion regarding an accelerated timeframe for rule changes – suggesting the introduction of relevant rules by H1 2024, subject to board approval.
Read more: FCA eyes first half of 2024 for revisions to UK research rules after Mansion House announcement
Speaking on the impacts the reversal will have on the industry, Short highlighted that clients who run AIM portfolios recognise that there has not been an abundance of research covering this part of the market.
“They are of the general opinion that the Mansion House reforms won’t move the dial and won’t change how they interact with the market, since clients have learnt to rely on their own research. They are of the mindset that the new rules will however give them a helpful second opinion on the performance of stocks,” added Short.
“We’re fairly confident it will improve intraday liquidity and bring the desired investment into the AIM and small cap sector.”