Rachel Kent’s Investment Research Review highlights crucial reforms to bolster UK investment research, revitalising London’s status as a prime listing destination, writes Neil Shah, director of content & strategy, Edison Group.
The UK government’s recent Investment Research Review, carried out by top city-lawyer Rachel Kent, has been well-received for shining a spotlight on the pivotal role of investment research in revitalising London as a leading listing destination. Following the recognition that the current model for accessing investment research is flawed, the recommendations laid out in Rachel Kent’s review show a comprehensive commitment to remodelling the system.
Chancellor Jeremy Hunt accepted the review’s findings and has signalled that Kent’s recommendations will be implemented in due course. It is positive to hear that government understands the importance of research in driving market competitiveness and supporting UK businesses, especially SMEs. Indeed, by unlocking the potential of investment research, London can regain some of the lost ground against other financial centres.
Why is this needed?
The confidence crisis in the UK’s equity market continues to spook both investors and potential listings away from the once fertile ground of the London Stock Exchange. Of course, this is a multi-faceted problem compounded by the current economic situation and a post-Brexit fallout which has seen some companies choose to list elsewhere.
Yet the most recent high-profile cases of Arm and We Soda retracting their London listing intention are symptomatic of a greater malaise – the mixed outlook for small and mid-cap stocks which underpin the UK market’s attractiveness as a whole. Of course, a cost of living crisis usually means decreased appetite for growth stocks, yet the problem goes back much further in time.
The chancellor’s intention to direct pension fund investments into UK equities can resolve some of the current liquidity issues, yet companies outside the FTSE100 first need the necessary exposure to land on institutional investors’ radar. This is where investment research is vital. The issue is that, post-MIFID, the volume of research for small and mid-caps has greatly declined. Since the MIFID unbundling rules came into effect in 2018, regulations regarding payment for third-party research have had the unintended consequence of squeezing fund managers’ budgets, funnelling most of their budgets into research on well-known stocks with larger market caps.
Unbundling the Unbundling Rules
Viewed by many in the EU and the UK as a failed experiment built on good intentions, MIFID is now being rolled back in both jurisdictions. Ironically, the UK has the post-Brexit advantage of being able to slash regulations more swiftly than the European trading bloc, despite having pushed for unbundling implementation across the EU ahead of 2018.
Rachel Kent’s recommendation to move away from the unbundling rules of MiFID II also offers much-needed flexibility that enables UK managers to access non-UK research more easily. This allows the UK to align with US rules, an opportunity not afforded by the current model. Bundling research with other third-party services once more will allow fund managers to allocate resources more flexibly, charge investors for research costs and bring back demand for research coverage across the board, and not just high-profile names.
However, it is important to note that moving away from unbundling rules alone will not be a panacea. Asset managers, having already evaluated research inputs and established pricing structures, may be cautious about an influx of unwanted emails. Adapting to the new regulations, including fund-level transparency on research budgets, will take time and patience and we may likely not see a huge impact on the distribution of research until later down the line. Designed to provide a more immediate impact, the Research Review includes the introduction of a research platform.
The Research Platform: A “Netflix” for investment research?
One of the significant proposals from the Investment Research Review is the establishment of an on-demand research platform, acknowledging the market’s struggle to effectively match supply and demand. This is likely to be a temporary measure designed to establish a marketplace connecting issuers and research providers and galvanising free access to research for smaller companies.
Similar initiatives have been tried in other jurisdictions, with good success. The Deutsche Börse Scale exchange provides a promising precedent, with its research scheme serving as a catalyst to help SMEs connect with fund managers and investors. In its current form, the Scale research scheme provides a base level of freely available company coverage on a regular and consistent basis, spanning macroeconomic trends, market sensitivities and competitive environment. The provision of research is complemented by regular investor talks in various European cities to connect Scale companies with relevant investors.
The specific funding model for the platform remains unclear, and it will be crucial to see sufficient funding put in place in order to effectively connect issuers and providers without putting undue pressure on budgets. In any case, the measure is a positive step towards fixing the supply-demand imbalance and reinvigorating the important role investment research can play in raising the profile of UK equities for investors, both institutional and private.
While the transition away from unbundling rules poses challenges, the changes recommended by Rachel Kent in the Investment Research Review present significant opportunities. Widening access to investment research will contribute to the valuation of UK equities and increase liquidity in the capital markets. The establishment of a research platform, combined with enhanced transparency, quality standards, and a focus on small-cap companies, will rejuvenate the UK’s investment landscape and reinforce London’s position as a premier listing destination. Through these reforms, the UK can propel itself closer to other flourishing financial centres worldwide.
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