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MiFID shakeup goes smoothly even as trading volumes dry up

Traders monitor financial data Wednesday at the Frankfurt Stock Exchange in Germany.

The biggest regulatory change in Europe in 10 years got off to a comparatively smooth start as the chairman of the European Securities and Markets Authority said he's seen no teething problems.

"What we can see, for our part, is no glitches so far," Steven Maijoor said in a conference call with reporters. The rules mean that "for the first time we see data of all financial instruments in the EU."

After seven years of preparation, $2 billion in compliance costs and one false start, the finance industry was bracing for one of the most seismic regulatory shifts in history, affecting everything from research to dark pools. Regulators eased the burden on companies ahead of the start period, giving grace periods on some of the biggest issues as banks and asset managers struggled to comply in time.

Investors have been sitting on their hands with trading volumes below average though the first week of the year tends to be quiet anyhow. Client business at one major brokerage in Europe was almost non-existent as the rules were poised to take effect Wednesday, a person with knowledge of the matter said.

TP ICAP, 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 on Wednesday and across most markets this month, according to a representative at the firm. Another brokerage told clients that it wouldn't accept swap trade orders from the last trading week in December through Wednesday, said one of the people, 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, Mr. McLean said, adding that trading in Asia was quiet 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 Tuesday.

"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," Mr. 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, U.K. 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 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," Mr. 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."

The unbundling has sent pricing for analysis plunging. Sydney-based money manager AMP Capital, which oversees about $140 billion in assets, expects its payments for analysis to fall by 30% to 50% from last year for a like-for-like service.

Deutsche Bank said in August it would halve the price of some research packages, citing competition from competitors, according to a memo seen by Bloomberg at the time. Germany's biggest bank offered further discounts to some clients through December, according to two people with knowledge of the matter who asked not be identified because the discussions were private. A Deutsche Bank spokeswoman declined to comment.

Morgan Stanley (MS) also offered discounts to some clients, the people said. It had earlier quoted a small client $25,000 annually for basic equity research and some access to analysts, Bloomberg reported in October. A London-based spokesman for the bank declined to comment on further discounts.

Separately, some providers appear to be willing to take any price to be kept on a money manager's books, according to the chief operating officer of an equity hedge fund that manages more than $1 billion. An executive at another stock-focused hedge fund overseeing about $300 million said it's paying on average $21,000 annually to each of its research providers. Corporate access is included in the price, the person said. They asked not to be identified as the details are private.

Low prices for research could have implications later. Russell Napier, co-founder of research marketplace ERIC, said the U.K. regulator should intervene if a price war for analysis begins.

Despite the long buildup, at least nine of the 28 European Union members have yet to convert the rules into national legislation or regulations. Valdis Dombrovskis, the EU commissioner in charge of financial-services policy, has said markets could face disruption caused by the late transposition.

Others disagree, with Michael McKee, head of financial services regulation at law firm DLA Piper, arguing it will be "more of a whimper than a bang."

"While it is one of the most important pieces of EU legislation for securities markets in years," he said, the fact some countries haven't passed the laws mean "consequently it will still be some time before these major market changes hit home."