MiFID shake-up gets real as wary traders see volumes dry up

Bloomberg

After seven years of preparation, $2 billion in compliance costs and one false start, the biggest shake-up to European regulation in a decade is finally here. With so much at stake, investors are likely to sit on their hands for now. Trading volumes slumped ahead of the changes, according to two brokers with knowledge of the matter, with client business at one major brokerage in Europe almost non-existent as the rules were poised to take effect.
The finance industry is bracing for one of the most seismic regulatory shifts in history, affecting everything from research to dark pools. There’s no official time for flicking the switch to the new rules, and brokerages were still meeting to discuss how to trade under MiFID II as companies race to comply with the law that provides as many opportunities as problems for banks and asset managers.
TP ICAP Plc, the world’s largest interdealer broker, expects trading volume in bonds, swaps and other securities typically traded off-exchange to be lower than usual across the board and across most markets this month, according to a representative at the firm. Another brokerage told clie-
nts that it wouldn’t accept swap trade orders from the last trading week in December through Jan. 3, said one of the peo-
ple, who asked not to be named because the information isn’t public.
“Reality is, it’s going to need a lot of refining as we see the market and clients take on the rules,” said Neil McLean, head of execution trading for Asia ex-Japan at Nomura Holdings Inc.’s Instinet Pacific Services in Hong Kong. “We have some challenges with categorizing clients and making sure they receive only what the rules allow.” His firm expects less business in the short term from Europe as clients get used to the rules, McLean said, adding that trading in Asia was quiet on Wednesday with Japan shut for the New Year holiday.
The rules present banks with opportunities to grow businesses offering passive investing, research and systematic internalizers but also leave them facing competition from research boutiques and platforms that offer low-cost trade execution. Retail lenders may also suffer from the ban on some inducements for investment advice and portfolio management. That’s because banks that distribute mutual funds to their retail clients often receive and retain a portion of the initial sales charge from the fund manager, or receive an annual fee, S&P Global Ratings analyst Giles Edwards wrote in a note.
“Over the longer term, the disruptive nature of this major regulatory change will become more apparent, and the winners and losers will likely emerge more clearly,” Edwards wrote. “There will likely be more losers than winners.”
The legislation may also dissuade companies from becoming publicly traded, as the unbundling of research and execution is widely expected to lead to less coverage of smaller firms by analysts.
“If a corporate broker would only market a firm to investors who pay for research, getting new money in the door will be far more challenging,” said Nick Burchett, UK equities manager at Cavendish Asset Management. “Limited access to capital is going to be a huge hurdle for companies coming to market if they now find they have only a very concentrated shareholder base. It may also be tougher to secure those cornerstone investors who are prepared to support a company for the long-term.”
The regulator is unbundling research in an attempt to get a better deal for asset owners. That means asset managers must stop receiving analysis they haven’t purchased. One investment bank, in an attempt to stem the hundreds of research emails that have traditionally been received, is sending automated emails asking not to be sent analysis and seeking written confirmation that the sender will comply.
“There’s going to be a lot of fund managers who have to walk over to the compliance person and say, ‘look I’ve been sent this, or opened this envelope, what do I do?’” said Alistair Haig, who teaches financial markets at the University of Edinburgh Business School.
Firms in Asia will also be affected by the changes, according to Sumit Indwar, a financial regulation lawyer at Linklaters LLP in Hong Kong. “Everyday, you’ll be dealing with European-regulated counterparties and they’ll be looking to you to change the way you service them,” Indwar said in a Bloomberg Television interview with Rishaad Salamat. ”You’re going to find a lot of indirect compliance being pushed out here in Asia and that’s the thing that my clients and the regulated industry here in Asia is really struggling with.”