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Equity research quality declines under Mifid II

A survey of 242 European companies contradicts the findings of the Financial Conduct Authority’s review into Mifid II
Equity research quality declines under Mifid II

Introduced across the European Union at the beginning of last year, the new Markets in Financial Instruments Directive II (Mifid II) was designed to make the financial industry more transparent. The regulatory overhaul mandated the unbundling of products provided by brokers, meaning asset managers must now be charged separately for research and execution services – previously research costs were included in the fees for executing trades.

With less incentive for fund managers to explicitly pay for third-party equity research, there were fears the quantity and quality of analyst reports would diminish. Following a review, the Financial Conduct Authority (FCA) concluded last month that while anecdotal reports suggest some sectors are not covered as widely as before, “asset managers told us that they can still get all the research they need”. According to the regulator, there was “no evidence of a material reduction in research coverage, including for listed small and medium enterprises (SMEs)”.

But the latest annual survey from financial communications consultancy Citigate Dewe Rogerson seems to suggest otherwise. Surveying almost 250 investor relations officers from leading companies across Europe, its findings point to a decline in both the quantity and quality of analyst coverage since Mifid II was implemented. The adverse impact has been more pronounced for UK-listed companies, with 52 per cent reporting a year-on-year drop in the number of analysts covering them and almost two-fifths revealing a fall in the quality of research. By comparison, for European companies excluding the UK, only 39 per cent identified a pullback in analyst coverage, while a fifth noted poorer quality research.

Contradicting the watchdog, Sandra Novakov, head of investor relations at Citigate Dewe Rogerson, contends the issue is particularly acute for UK SMEs (defined in this study as companies with a market cap of $1bn and under). Analyst scrutiny raises the profile of smaller companies, so Ms Novakov believes lower coverage poses a “very real risk that they drop off the radar of institutional investors. This can lead to a reduction in liquidity that is hard to recover from”. Such illiquidity could undermine the reason for remaining listed.