The City shake-up leaving analysts shaking as Mifid II looms

22 December 2017, 12:10

The City is just days away from one of the biggest shake-ups it has seen in a decade.

On 3 January, the second version of the Markets in Financial Instruments Directive, or Mifid II, becomes law.

It is one of the most sweeping pieces of legislation ever introduced by the EU and tens of thousands of City folk have spent much of 2017 preparing for it.

The first phase of Mifid was introduced in November 2007 and was aimed at both harmonising the rules governing EU financial markets and also increasing competition.

The second phase, Mifid II, is very much a consequence of the financial crisis and is aimed squarely at protecting investors and increasing transparency in financial markets.

It will cover almost every aspect of securities trading carried out in the EU, covering everything from stocks to bonds, commodities to currencies and derivatives such as futures and options.

And practically, everyone in the financial services sector will be covered, from fund managers to stockbrokers, hedge funds to day traders and banks to small shareholders.

Anyone who has an account with a retail stockbroker and anyone who has a stocks and shares Isa will probably have already received a letter from their broker or fund manager explaining that changes are afoot.

One of the most interesting changes concerns a phenomenon that has taken off during the last decade known as 'dark pools'.

These are facilities set up by investment banks allowing customers to trade large blocks of shares away from a traditional stock exchange, and have become increasingly popular among investors not wanting to give away much about their activities.

Getting on for a third of all shares are now reckoned to be traded this way but, after Mifid II, caps are to be imposed on the amount of trading that can be done in this fashion.

But the biggest shake-up of all is in something known as 'unbundling'. This will oblige stockbrokers to charge their clients separately for research produced by their analysts - the cost of which is currently lumped in with broking commissions.

It is predicted to lead to a lot of job losses among analysts because, at present, fund managers do not really think that hard about whether a piece of broker's research adds value to their business.

Moreover, the cost of this research is largely passed on to the clients of the fund manager. The problem is that a lot of research does not really add much value.

Huge companies such as BP, Shell and HSBC are followed by literally dozens of analysts. That makes it hard for an analyst covering one of these stocks to come up with an original investment thesis that will change the way their fund manager client looks at that stock.

So, in the absence of proof that the research is adding value, a lot of analysts are expected to be laid off.

The big fund managers, the likes of Blackrock, Schroders and Newton, will easily be able to pay for research that they want. But retail investors, some of whom only get to see or hear about broker's research via the media, may lose out because there will be less research around.

There also has to be a danger that the broking arms of the big investment banks will continue to produce research but sell it very cheaply - forcing smaller and niche operators out of the market. This again could prove bad for a wider dissemination of investment ideas.

The other main impact of Mifid is the amount of information about each individual trade.

Banks and brokers will have to be able to prove that they carried out each trade at the best possible price for their customers as well as providing much more detail about each trade.

It promises to generate an awful lot more data and an awful lot more paperwork. This is likely to be painful. One stockbroker, WH Ireland, issued a warning last week which said a higher than expected cost of preparing for Mifid II had hit its profitability.

And that may not be the only headache.

For reasons best known to themselves, the European Commission has decided that Mifid II will not kick in at the start of the new tax year, the start of a working week, or even a working month, but in the middle of a working week.

It promises to be a headache for compliance departments right across Europe.