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Consultation responses

FCA: Markets in Financial Instruments Directive II Implementation

MiFID Coordination
Markets Policy and International Division
Financial Conduct Authority
25 The North Colonnade
Canary Wharf
London E14 5HS

December 22, 2016

Dear Sir, Madam,

Re: Markets in Financial Instruments Directive II Implementation – Consultation Paper III

Thank you for giving us the opportunity to comment on your Consultation Paper CP16/29.

The Investor Relations Society’s mission is to promote best practice in investor relations; to support the professional development of its members; to represent their views to regulatory bodies, the investment community and government; and to act as a forum for issuers and the investment community. The Investor Relations Society (IR Society) represents members working for public companies and consultancies to assist them in the development of effective two way communication with the markets and to create a level playing field for all investors. It has over 750 members drawn both from the UK and overseas, including the majority of the FTSE 100 and much of the FTSE 250.

On review of the consultation paper, Chapter 3 regarding inducements and research is of particular interest to our members, corporate issuers, who are in turn in receipt of corporate access services and equity research and will consequently be affected by proposed MiFID II regulatory changes. With this in mind, we will be providing more general comments on behalf of our corporate issuer members, rather than commenting specifically on questions 9-15 in this chapter.

Overall the IR Society welcomes the FCA’s implementation of MiFID II, as legislation around the use of dealing commission rules and research support the principles of competition, value for money, consumer choice and transparency of pricing. On behalf of our corporate issuer members we have considered the following implications of MiFID II implementation by the FCA and what this means in practice:

Impact on smaller-cap issuers: While the IR Society welcomes better visibility and transparency around the use of dealing commission and research, we do foresee potential unintended consequences impacting corporate issuers through the unbundling, pricing and sale of research and corporate access separately. But change can also create opportunity.  The greatest impact may initially be felt by the smaller issuers who with limited resources, will be challenged to retain a diverse shareholder base and research coverage. But over time, the IR Society also believes that full unbundling and the removal of economic incentives will present a more transparent market for research and corporate access and create a higher quality product in both areas. By their nature larger asset managers will tend to focus on larger stocks, so while MiFID II can be seen as an opportunity for smaller cap companies, they will still be reliant on stock liquidity and independent houses for research coverage.

Sell-side coverage: With cost pressures and changing market dynamics in investment banking we are already seeing contraction in sell-side coverage. With potentially fewer analysts covering fewer stocks, their focus may tend towards covering the larger companies and more actively traded sectors. This could impact mid-to small-cap companies who, with a reduction in coverage, may end up with limited visibility in the market, and the potential for a possible valuation gap.

From a buy-side perspective, the proposed new requirements surrounding the use of client money to pay for research, as well as record keeping and reporting requirements will place an additional cost burden on investment managers. The requirement to pay for research from a Research Payment Account (RPA) may encourage investment managers to be more selective in their choice and payment of sell-side research. Subsequently this may cut back the overcapacity and drive up the quality of research being written, as we see the requirement by analysts for more thematic research and revenue generating ideas for investors. As a principal, reducing the quantity of research if it increases the quality of research written is not our concern as long as there are sufficient incentives for the coverage of smaller-cap companies.  We believe research should have a value and pricing research in the future will enhance transparency of the economics of such services. 

The prospect of pricing transparency is also encouraging independent research houses to enter the market. With a level playing field on cost in the market for research, smaller boutique research houses may be presented with an opportunity to fulfil coverage at the small-cap end of the market. We feel those most at risk are the lower profile mid-cap sized companies. Emphasis will shift to companies presenting their equity growth story in a compelling way and careful targeting of prospective investors.
 
Corporate issuer resources: Structural changes in the regulatory environment as a result of MiFID II implementation should offer an opportunity for IR teams to take more control over their engagement with the shareholder community. This can include better targeting and prioritising of investor meetings, as well as more effective use of senior management and IR executive time. This would be a positive step forward. With new record keeping and reporting obligations around corporate access, innovation and new technology platforms will also play a significant role in investor engagement, roadshow planning and logistics support. This would also help corporates in more effective use of resources. However, smaller-cap companies may be constrained by both cost and time resources to adopt new technology as well as additional manpower to address these regulatory changes.

Analyst consensus and forecasts: With the likely increase in more thematic research and less results-led coverage, we have some concerns on behalf of issuers that there will be a heightened risk that “published” forecasts will become outdated. This could have a direct impact on third party collated consensus forecasts, which are relied upon by some corporates and also by investors and media. Establishing a market consensus forecast remains an important aspect in equal dissemination of information to all investors. This could become a particular challenge for small-and mid-cap companies, where sell-side research coverage potentially dwindles under the new rules. In this instance we would encourage those small- and mid-cap companies with less research coverage to give clear guidance so as to avoid any misinterpretation from published third party consensus.

In summary, we welcome the FCA’s implementation of MiFID II proposals. We support improved pricing transparency, and a more open marketplace with the assurance that investment managers are acting in the best interests of their customers. However, should market systems become too complex as a result of regulatory change, this may inhibit smaller, less well-resourced companies from a stock exchange listing. There is an increasing expectation that these MiFID II regulatory changes may come at the expense of the corporate issuer, as they face increased efforts and expenditure to maintain their company profile and sustain their investment story.

We hope you find these comments useful and please do not hesitate to contact me if you have any further questions.

Kind regards

Emma Burdett
Chair of The Investor Relations Society’s Policy Committee
020 7379 5151 / eburdett@maitland.co.uk

Published: 22 December, 2016