Markets in Financial Instruments Directive II will turn one on January 3, 2019. How has the sweeping European directive impacted the U.S. equities market and how has it affected brokers’ relationships with EU and US clients?
That was the topic of a Thursday afternoon panel discussion at WBR Equities Leaders Summit.
As a European ruleset, MiFID II isn’t binding for U.S. firms that don’t do business on the ‘Old Continent’ . But that only goes so far, because the new rules around provisioning research and best execution are increasingly seen as the higher standard that all firms should adhere to. And there is the specter that U.S. market regulators may move to a similar regime at some point.
One theme of the discussion was that the research side of MiFID II is decidedly not good news for smaller buy-side firms that don’t have the deep pockets of their larger rivals.
A sticking point is that MiFID II calls for an unbundling of research and trading, which mean investment firms need to pay for research cash on the barrel, instead of using so-called soft dollars and having the cost lumped in with trading commissions.
“The business models of some of these smaller firms were not designed to pay for research out of P&L,” said Jason Vedder, Director, Global Trading and Operations at Driehaus Capital Management, which manages $8.1 billion.
If the soft-dollar system goes away, smaller buy-sides in “bake-off” competitions with larger firms will be tripped up on the question of how they pay for research, and many will be forced to either be folded into a larger organization or close their doors. “You could see a part of the ecosystem wiped out,” he noted.
Vedder said MiFID II is having a “butterfly effect”, where a localized change in a complex system causes large effects elsewhere.
Lori Hoch is Chief Operating Officer of $3 billion manager Cortina Asset Management, which operates in the U.S. only. She said one of Cortina’s clients, a large institutional asset owner, has said Cortina must comply with the MiFID II standards that investment firms who operate in Europe are meeting, or risk being cut.
Pension funds and other institutional asset owners at the top of the food chain can sometimes indicate a willingness to chip in to pay for research, “but it doesn’t always come out that way,” said Healthy Markets Executive Director Tyler Gellasch, who moderated the panel. “The challenge is asking how much and what is their budget.”
Panelists noted that for now, MiFID II standards are being implemented at the client level. The U.S. Securities and Exchange Commission will ultimately hold sway on what happens from a top-down perspective; panelists said ideally the SEC will push back on some MiFID standards and work to develop a compromise framework that’s less onerous for smaller firms.