For smaller companies on the capital markets, institutional investors play a vital role in accelerating growth. A strong and engaged register of independent shareholders is valuable but it is often institutions that bring the financial muscle and long-term approach that companies crave. Clearly, anything that hampers access to fund managers presents a challenge for listed companies. Enter MiFID II. Two years on from the implementation of this sweeping set of regulations, the effect is only magnified the further you look down the market.
Overview of MiFID II
When The Markets in Financial Instruments Directive II (MiFID II) came into effect in January 2018, anticipation was high in the City. Seven years in the making, this European-wide regulatory framework was intended to restore confidence in financial markets by improving transparency and protection for investors.
Crucially, this included the ‘unbundling’ of trading and research fees, a major change to the traditional business models of many brokerage firms. Whereas the cost of sell-side research had previously been wrapped into fees for executing trades, brokers were now forced to charge clients separately for access to these two different services.
In the intermittent years, the economics of sell-side research have come under the spotlight. As part of its review of the impact of MiFID II released last September, the Financial Conduct Authority (FCA) surveyed 40 asset managers and found a “material reduction” of between 20 and 30 per cent in their budgets for buying externally produced equity research. Much of this can be attributed to asset managers loathed to pay for research using client funds and baulking at the prospect of their margins being eroded by additional costs.
Two years on: small caps feel the squeeze
Coupled with aggressive lowball pricing from big banks, this cut to buyside spend has created a “perfect storm” for boutique research providers, according to trade body Euro IRP.
It has created the conditions for a swathe of M&A activity in the small and mid-cap broker space over the last two years. For example, the merger between SP Angel and Northland Capital, and the acquisition of Stockdale Securities by Shore Capital last year. Meanwhile, the demise of Daniel Stewart and Beaufort Securities (albeit for ancillary reasons) has laid bare the impact of a harsher regulatory climate on brokers at the micro end of the market.
Amid these shifting sands, it is smaller listed companies that are hardest hit. 82% of investors in this year’s QCA/Peel Hunt Mid and Small-Cap Investor Survey reported less research being produced on mid and small-caps since MiFID II was introduced, and 77% believe it will continue to decrease over the next 12 months. Alarmingly, 52% of companies and 48% of investors believe the quality of mid and small-cap research has also declined, a trend which they expect to continue.
Cuts to research budgets is heaping pressure on analysts’ workloads and with only so many hours in the day, their time is increasingly squeezed. This leads to a trade-off between quality and quantity of research reports.
It also puts thematic analysis under great pressure. If this style of longer-form, considered research cannot be used to attract new business and does not serve a purpose for asset managers, it will fall by the wayside.
The end result is that small and micro-caps – already underserved by sell-side research – are most at risk of dropping off the radars of fund managers. After all, the economic reality is that these companies generate less revenue from broking fees than their larger peers on the market. The knock-on effect can be reduced liquidity in traded shares, a problem which already blights many of the smaller listed companies on AIM and the Standard List of the Main Market. This can lead to significant mispricing of stocks and dampened investor appetite.
Keeping analysts and investors engaged: the role of financial PR
The evolving sell-side environment is reinventing the way that companies approach analyst research and also the channels they use to disseminate information to the market. In this respect, it presents both a challenge and an opportunity for financial PR professionals.
One key aspect of the role is liaising with sell-side analysts to initiate and maintain coverage of clients with bullish ‘Buy’ recommendations. For listed companies, this research can play a vital role in outlining the investment case and providing expert comment on their industry or addressable market. Not only is it used by asset managers, it is also a reliable source of comment for city journalists and pundits.
A general reduction in sell-side interest makes it even more important for targeted analysts to be kept properly abreast of the investment story behind small cap stocks. This relies on the financial PR maintaining a regular dialogue with analysts and acting as an effective advocate for the company.
Once companies do have the opportunity to present to analysts, they need to be aware of exactly what the audience is looking for and how best to communicate this information. Not only does this include the content of the deck but also the form of the meeting and the way in which the story is told. It creates an opportunity for financial PRs to draw on their experience and understanding of the analyst community to help craft a compelling presentation.
The same goes for meetings with fund managers, wealth managers and high net worth individuals (HNWIs) that companies meet on investor roadshows. By advising their clients effectively on key investment messages, it is possible for financial PR professionals to add real value to these meetings, preparing management for standing up to investor scrutiny and helping them to build profitable relationships.
Meanwhile, in the analyst community, corporate sponsored research services are stepping into the space vacated by brokers. These serve a purpose in laying bare the in-depth investment case for a company and, by sitting outside the regulatory scope of MiFID II, can prove an invaluable free resource for those investors starved of the research produced by traditional brokers.
These research houses do, however, grapple with rumblings over impartiality and distribution reach. The best of these are able to effectively produce reports on companies written by industry specialists and boast an impressive distribution reaching wealth managers, HNWIs and retail investors.
The FCA has said it intends to carry out further reviews of the impact of MiFID II over the next two years, while rumours suggest a forthcoming European Commission report may seek to smooth over some of the rules’ sharper edges. Small caps will certainly be paying attention. In the meantime, turning to financial PR can sweeten the pill.