Small- and mid-cap companies have always found it tough to get analyst attention and access to investors. Thanks to the law of unintended consequences, Mifid II is making it even harder.
Almost a year in, 1.4 million paragraphs of new rules, designed to strengthen investor protection and make financial markets more efficient, resilient and transparent, are challenging FTSE 250 companies in unexpected ways.
At one end of the spectrum they have led to cutbacks in sell-side analyst coverage at the large banks, particularly of small and mid-cap stocks. At the other they have provoked consolidation among the smaller brokerages.
For FTSE 250 companies that’s a double whammy, with a big effect on company coverage. They can no longer rely on analysts and sales teams to tell their story to the investment community. Instead, they must develop a deeper understanding of their investor base, closer relationships with their shareholders, and new tools for reaching the right investors.
Mifid II came into effect in January 2018, requiring banks and brokerages to charge asset managers separately for investment research rather than bundling the fees into the cost of executing trades. Many banks and brokers historically provided research for free to lure fund managers to trade with them. The legislation was designed to reduce conflicts of interest and inject transparency across the financial industry.
As a result, many asset managers, who now must pay separately for research out of their own budgets, have cut back their consumption of sell-side analyst research. Commissions have dropped as much as 28% in the UK during the first quarter compared with the same quarter in 2017.
For their part, banks have streamlined analyst teams, focusing on star analysts and key sectors. The result is:
A 3% drop in average number of analysts covering FTSE 250 stocks in the last six months
Evaporation of experience and quality in sell-side research content
Fewer expert voices contributing to consensus earnings forecasts
Difficulty identifying and engaging with new investors
Small- and mid-companies have seen research coverage fall to an average of 0.6 analysts, and roughly 200 companies have no coverage at all, making it increasingly difficult for companies to reach investors.
It’s tough too for the analysts. Several large investment banks appear to be offering lowball, “predatory pricing” for research services to guard market share. This has put pressure on boutique banks that rely largely on research revenues to survive. More than a fifth of boutiques surveyed by Euro IRP reported declining revenues in 2018. Lacklustre performance by small- and mid-cap stockbrokers such as WH Ireland, Cenkos, and Arden Partners has prompted predictions of consolidation across the industry. Recent news that Santander is in talks to acquire small-cap UK broker Peel Hunt shows that interest is not confined to UK players. One independent research provider predicted that half the boutique research houses could be out of business within 12 months.