Money managers operating in Europe do not expect to see the Markets in Financial Instruments Directive II overhauled in 2020. But they said the outbreak of the COVID-19 pandemic showed that the unbundling of research payments from execution under the rules has had a negative impact on performance and is in serious need of fixing.
Since the pandemic, MiFID II has not shown the resilience to volatile markets that it was designed to help managers face, said Mark Wade, co-director of credit research at Allianz Global Investors in London, in a telephone interview.
"When you look at MiFID II and what it (was) trying to do, it was to help with transparency and costs. It hasn't really played out that way," he said.
Among its key postulates, the rules, effective January 2018, had required money managers operating in Europe to pay for investment research independently rather than to obtain it as part of a fee for execution services.
Separating out research costs from transactions aimed to provide clarity on best execution, sources said. But with less information circulating on trading situations, there has been less liquidity, bid/offer spreads are wider, and the costs of entering and exiting risk positions are less transparent for managers, sources added.
Mr. Wade said that his firm had been waiting for a market shock like the coronavirus pandemic to highlight the problems with MiFID II. "When we look at what research has done since March, it's been very difficult," he said.
Sources said European research budgets of managers have dropped enormously since the implementation of the directive, adding that some European financial services watchdogs such as the French regulator Autorite des Marches Financiers are in favor of reversing some of the rules.
Most managers absorbed new research costs rather than pass them onto investors.
Bond research has already been singled out as a potential area for a reversal of the rules, with Germany's BVI, which represents the country's money management industry and whose members run more than €3 trillion ($3.4 trillion) in assets, calling for an exemption in May.
Still, a formal review could take another year to occur, sources said, warning that the impact of MiFID II is starting to be seen in the performance of managers operating in Europe as compared to their peers in the U.S. MiFID II was scheduled to be reviewed in March 2020 but the review was postponed due to the pandemic.
"By paying for research, you would (expect to) have a smaller bid/offer (spread). But that hasn't happened. We are scratching our heads about what is it that we are getting," Mr. Wade said.
Neil Scarth, principal at Frost Consulting Ltd. in London, an advisory firm specializing in investment research valuation and benchmarking, said managers have already cut overall budgets, which include research budgets, to meet profitability requirements because they are paying for it out of their profit and loss statements. Since the pandemic, it has become clear that due to profitability issues, the lower markets go, the less research managers will have, he said.
Also, "Brexit is a great excuse for Europeans to review (MiFID II)," Mr. Scarth said, adding that it was the U.K. Financial Conduct Authority that proposed most of the research rules that were adopted as part of MiFID II.
There are unofficial proposals for some sort of easing of unbundling of rules for small- and medium-size enterprises with capitalizations of less than €1 billion ($1.1 billion), he said.
