FCA warns of ‘loss-leading’ Mifid II research price distortion
The Financial Conduct Authority warned bank cross-subsidies and deliberate undercharging may be undermining post Mifid II research competition.
The Financial Conduct Authority (FCA) has pledged to launch a sector-wide review of post-Mifid II research prices as it warned bank cross-subsidies and deliberate undercharging may be undermining competition.
An initial multi-firm review of the impact of a wholesale shake-up of the research market found it had largely ‘steered the market towards the intended outcomes’, but it noted that ‘it is clear that research valuation and pricing are still evolving’.
A ‘wide range of sell-side research pricing levels’ could be consistent with ‘an ongoing process of price discovery’ it said, but it added that banks may be using their size to undercut independent houses and smaller brokerages. Some banks may also be pricing below cost in order to capture market share.
‘In general, lower pricing can be positive,’ the regulator said. ‘However, we are aware of the potential negative effects on competition in the medium term if some firm’s ‘loss leading’ prices drive out competitors, reducing choice.
‘It is possible that some of these services are being under-charged in a way that poses a conflict of interest or inducement risk.
‘While we saw some examples of low pricing, we did not see direct evidence of conflicts of interest in how brokers offered these services […] we also saw one example of a firm using an RPA [research payment account] to pay for corporate access, which we consider is a breach of the rules.’
Independent specialist research businesses in particular warned that the largest banks are using their scale to set pricing uneconomically low, while user caution about the compliance of research marketing practices, such as free trial periods, was inhibiting switching.
Overall however, the regulator said the reforms – which banned the use of de facto payments such as placed business in return for access to research – had largely produced the desired outcomes.
It estimated that increased market transparency saved around £70 million for UK fund investors over the first half of 2018. It added that ‘most’ buy-side firms were still able to access the research they needed and it had ‘found no evidence of a material reduction in research coverage’.
That may be hard to square with some industry testimony, however. Numis in February estimated that the quantity of research on UK equities had fallen 8% over the year following the launch of Mifid II.
Peel Hunt chief executive Steven Fine has testified that the change has impacted his business in less obvious and assessable ways, with staffing cuts increasing the burden on remaining employees.
‘We believe that the optimum number of companies an analyst can have and remain credible is about 15,’ he said, adding that the number has almost doubled under Mifid II.
BDO director for financial services Binit Shah noted that research teams were still ‘absorbing the pain’ inflicted by Mifid II.
‘The impact of MiFID II has been fairly fundamental and very few houses have recouped all their lost revenues or done all the slimming down of teams that they need to,’ he said.
‘In a shrinking market, top calibre analysts who are able to provide quality research, particularly on smaller companies, will thrive and possibly be able to charge a premium.’
He added that going in-house at asset management firms was also increasingly appealing. ‘Sell side analysts switching to the buyside has always been a fairly well trodden career path but that process seems to be accelerating. If the most experienced analysts do move into fund management or leave the industry altogether then this will affect the quality of research in the market.’
The rule change has also been cited as a causal factor in several recent broker mergers, as the small cap coverage universe has consolidated.
FinnCap merged with corporate finance specialist Cavendish at the end of last year as its owner, veteran private equity supremo John Moulton, sought to boost scale economies ahead of a flotation on AIM.
That was followed this year by the purchase of small cap broker Stockdale by Shore Capital.
The FCA reviewed the market between July 2018 and March 2019, speaking to 40 buy-side firms, visiting 10 on both sides of the market and five independent providers, plus testimony from trade associations. It said it would conduct a further review within the next two years.