New research from the University of Bath has revealed that the European Union’s MiFID II financial market reforms have reduced research activity and adversely affected liquidity in London’s main stock market, although the impact on London’s Alternative Investment Market (AIM) was mitigated by its special adviser rules.
The EU’s Markets in Financial Instruments Directive II (MiFID II) was introduced in 2018 with the aim of improving transparency around research costs, which had previously been bundled into brokers’ overall fees to clients.
The legislation demanded that these fees be ‘unbundled’ to make hidden costs more explicit to investors and also to reduce the overproduction of seemingly ‘free’ research.
However, according to the findings from the University of Bath’s ‘Research unbundling and market liquidity: Evidence from MiFID II’ study, this has led to a significant reduction in the amount of market research provided to clients, with the UK’s Financial Conduct Authority (FCA) estimating that research budgets were cut by 20-30% since the introduction of MiFID II.
This reduction in research has had a tangible impact on market liquidity, with an estimated 12% drop in analyst coverage leading to a significant deterioration in the highly regulated London Stock Exchange’s ‘Main Market’.
The average number of analysts providing research coverage fell from 9.1 to 8.0 during the research period, which covered three years before and after the introduction of MiFID II.
In contrast, AIM saw an increase in research coverage of 6.3% over the same period, with liquidity also improving. This was partly due to the demand for research for large companies falling, resulting in a flow of analysts to the less-populated market.
The more significant factor was likely to be AIM’s requirement for companies to retain a ‘nominated adviser’ (NOMAD), found the study, who often produced research on their associated AIM company. The quality of research benefited from the close relationship between the NOMAD and the firm, ultimately improving the company’s market liquidity.
Dr Ru Xie from the University of Bath’s School of Management and co-author of the study said, “MiFID II was a laudable attempt at improving transparency for clients, who could now see what research they were paying for and its cost alongside the regular bills for trading stocks and shares.
“But many brokers, under fierce competition with each other to attract clients, were forced to absorb those costs, meaning that they reduced the amount of market research they provided to clients.”
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