Europe’s asset management industry has just encountered its largest set of rules changes in a decade, with the introduction of the Markets in Financial Instruments Directive II (Mifid II) on Wednesday (January 3). But the ramifications of this new set of rules is bound to affect many Asian fund houses and investors too.
Mifid II is an update to the initlal set of regulations launched by the European Securities and Markets Authority (ESMA) in 2007. The initial version had focused on markets and the trading of financial instruments, whereas Mifid II requires firms operating in the European Union to comply with the new Markets in Financial Instruments Regulation (MiFIR) and for them to hold a legal entity indentifier (LEI).
The new rules aim to make financial markets more open and safer, including the cost of research and bundling of charges. But the implications are far-reaching, and will include fund managers and brokers in Asia. The impact of the rules was discussed at a recent event in Hong Kong, hosted by AsianInvestor and sponsored by BNP Paribas.
Mifid II will require asset and wealth managers trading any asset class with European counterparts, including legal entities and structures, companies, charities and trusts to have an LEI registration. Plus buyside firms will have to pay for broker research they once received for free. And product manufacturers must designate ‘target markets’ for their products when selling them via European distributors.
That affects Asian brokers or asset managers servicing clients based in the EU and UK; they will have to comply with the new rules when trading in these two jurisdictions. The new regulations will also affect Asian funds entirely investing into Asian equities but with underlying European investors.
Natalie Shaw, head of cash equity distribution for Asia Pacific at BNP Paribas, said many Asian investors are Mifid ll ready but the impact it will have is not certain, particularly over how the unbundling of broker fees affects research production and distribution.
Shaw noted that an asset owner currently pays a fund manager a management fee for its expertise. If the fund then traded with a broker at a bundled rate of 20 basis points, it might effectively pay 13 basis points for advice (such as research) and seven for execution services. Every time the fund trades, it pays the broker for advice.
“Mifid II … is trying to remove the incentive [for fund managers] to pay brokers by trading more, because it’s the end client who’s paying.”
Shaw said BNP Paribas’ Mifid II clients pay for research via a structured mechanism, to remove any inducement to trade. Many Asian fund managers are not affected, but “fund managers who operate in Europe or manage money for European clients will have to follow some sort of unbundling”.
Counting the cost of research
Haitong International Securities is also largely insulated from Mifid II due to its Chinese client base, but head of institutional equities Mark Burges Watson also sees unintended consequences.
“The Japanese client base is impacted largely because many clients in Japan are large global institutions. What I am picking up is that Mifid II is an economic threat as much as a regulatory threat. Many US clients are not within Mifid II’s scope, but they like the idea of not having to pay for research and are putting pressure on their investors to absorb research costs,” said Burges Watson.
He sees firms responding by investing in smart execution platforms, cutting costs and reassessing client relationships.
A recent CFA Institute EU survey into Mifid II found fund houses preferred paying for access to analysts than written research, and most were willing to absorb research costs than charge clients.
“There are ongoing negotiations between fund managers and suppliers about the price of research,” said Mary Leung, CFA’s head of advocacy for Asia Pacific. “I’ve [also] heard some fund managers here were almost ready with RPAs (research payment accounts), client agreements and policies, but as the industry moved into paying, they were under ... pressure not to do RPAs.”
As Janine Canham, chief operating officer of Sanford C. Bernstein, put it, “It’s quite hard [for a fund manager] to justify [the need for] research if someone else is paying for it, but you’re not willing to pay for it yourself”.
“Mifid II doesn’t talk about research [in isolation]; it’s just that the unbundling of research gets caught up in the whole inducement argument. Trailer commissions ... will also get caught up [as part of Mifid II’s ban on EU firms receiving monetary and non-monetary benefits],” added Mark Shipman, global head of funds and investment management at Clifford Chance.
Assessing the risks
Shipman says firms are responding to unbundling in a few ways. Brokers subject to the new regulations will likely take a one-size-fits all approach and apply the EU rules across the world. Global asset managers with a heavy European footprint may take a different approach and absorb research costs or use RPAs in Asia Pacific too. Local managers with Asia-focused businesses may opt out of unbundling, unless forced to by an EU partner.
In effect, Mifid II is likely to create tiers of payments for research, potentially increasing risk.
“I see a risk for the regulators where there is defacto rebundling, which of course is quite the reverse of what they wanted, particularly with small and medium size asset managers who are under pressure,” said Shipman.
Keith Pogson, Asia Pacific financial services leader at Ernst & Young, was also concerned about repercussions in Asia. “Are we going to see a parting of the ways because of this regulatory impact? What happens in some of the less liquid markets in this region? There are a lot of consequences that people aren’t really thinking about yet,” he said.
As the LEI deadline approaches, Asian investors are keen to see if the regulators’ “No LEI, No Trade” warning is applied from Day 1, or whether the FCA and ESMA allow a grace period for trades. Shipman says colleagues in London believe the FCA will not start enforcement action immediately.
Societe Generale’s Stephane Loiseau, global head of execution for Asia Pacific, believed well under 10% of Asian firms are LEI compliant. But he noted HKEX has already based China’s new investor identification regime on LEI.
Why Mifid II matters
Although the full impact of Mifid II is yet to be felt, Loiseau said it offers an opportunity to adapt business models.
“We have to embrace these positive changes and we have to adapt our business models,” he said. “The cost of running an investment banking business has changed in the past five to 10 years.”
The need to cut research costs is also helping to drive innovative fintech solutions like Credit Suisse’s use of quantitative analysis and Narrative Science to generate its market reports. And Shaw said BNP Paribas is one of many to invest in this area by building an AI centre.
“Research has been stuck in [the same] place for decades. Things are changing. We are … finding better ways of getting value using technology to up our game,” said Shaw.
Mifid II may make markets more transparent, but it could accelerate the disruption of traditional information flows in favour or technology, big data and AI research solutions.
The rules will also force a review of traditional broker-buyer relationships, in Europe—but also, increasingly, in Asia.