How MiFID II could affect boutique asset managers 08 September 2015

How MiFID II could affect boutique asset managers

In May 2015 an upgrade to the Markets in Financial Instrument Directive (MiFID) was adopted by the EU. It will be implemented in July 2016 and is due to come into effect in January 2017. Whilst some of the laws bring plenty of advantages to a majority of international businesses, boutique asset managers may have a different view.

Boutique asset management firms currently have many perks that give them their allure. By specialising on a certain segment, smaller firms can easily snap up the niche investments that the bigger companies completely miss. While boutiques are showing us that bigger isn’t always better, some think tanks believe that the updated MiFID could soon push them out of the market altogether.

What’s the problem?

The New City Initiative (NCI) and Open Europe believe that there is a case for reform in European asset management and their report details the dangers that the industry could face. The report also outlines the importance of the asset management industry to the European economy:

“At a time when Europe is struggling to find its way back to economic growth, it becomes all the more important to safeguard a sound and vibrant asset management industry.”

Their first worry is that the introduction of MiFID II will lead to EU regulations that introduce significant costs for UK asset managers. Whilst bigger businesses would see the benefits outweighing the cost, boutique firms would be paying despite not seeing enough of a benefit to justify it.

One of the main arguments against MiFID II is that the regulations that will be imposed on UK firms may not allow the UK’s business sector to prosper. In the report’s foreword, Dominic Johnson, Chairman of New City Initiative suggests:

“The investment management community and especially the ‘boutique’ (i.e. smaller firms) community find that the regulatory burden imposed upon them by the EU (AIFMD, MiFID II, etc.) is so expensive and onerous, that in themselves these regulations are an issue in terms of our business sector prospering.”

While it is widely agreed upon that businesses need to operate in a regulated market, it is also important to ensure that the benefits of the regulation outweigh the costs, but in many cases this could be disputed.

Sacrificing data for transparency

Another cause for concern identified by the think tanks regards external research. One of MiFID II’s proposals has been to ban companies paying for external research. The report outlines the potential outcomes and issues that the proposal could have on the industry:

“Smaller firms tend to be heavily reliant on external research, and would find it a lot more difficult to face this extra cost. A number of smaller managers may even be forced out of the market.”

A decision like this would massively favour larger companies who can easily afford to pay the costs for broker data, or may even have an internal research team, while smaller companies would suffer as they would be unable to afford the extra costs. NCI and Open Europe’s research has concluded that:

“An outright ban on the cost of research being passed on to investors would clearly favour larger asset management companies – especially those that can afford their own in-house research services.”

The think tanks recommend that an alternative should be sought, one that offers further transparency to investors while allowing companies to purchase broker research using dealing commission, dropping the MiFID II recommendation.

Whilst MiFID II is aiming to introduce more transparency into the industry, this report identifies that the consequences of the proposed method could have a negative consequence across the EU:

“Forcing asset managers to pay for broker research from their own resources rather than using dealing commissions would be disproportionate and could have serious unintended consequences. Nonetheless, further transparency on this issue can be beneficial to the reputation of the industry.”

What can be done to preserve boutique asset managers?

NCI and Open Europe have worked to try to detail how the changes to legislation could make it a more effective tool for regulation. They report that UK fund managers wanting to distribute and market across the EU and Switzerland could face an estimated initial cost of €1.5 million with an ongoing annual cost of around €1.4 million.

However, smaller ‘boutique’ asset managers who don’t market their funds in other EU countries take no advantage from the ‘passport’ system that would allow them to do business across Europe. Therefore, it has been suggested that these asset managers should be granted an exception from the EU’s regulations, allowing them to be regulated by their home country.

The suggestion outlined in the report does not say asset managers working exclusively in their home country should be unregulated, instead it proposes:

“Fund managers and asset management companies covered by this new exemption would still have to register with the national regulator of their home member state, but would be subject to a lighter supervisory regime.”

This will ensure that smaller businesses are able to continue to work as their regulatory compliance costs would be reduced, leading to less of an incentive to merge with bigger companies.

The report from the think tanks also argued that implementing an exemption throughout Europe would be fairly straightforward:

“Such an exemption should be fairly straightforward to apply in practice. Compared to other economic sectors, the existence of an EU passport makes it easy to identify fund managers who wish to operate in other EU member states and those who do not.”

Whilst the implementation of MiFID II may make business across Europe easier via a system described as a ‘business passport’, there are still hurdles to be tackled in each EU member state that contradict the idea of a single market throughout Europe.

MiFID II could have unintended consequences on the asset management industry if not amended. Ultimately, those who do not work outside of their country will be paying unnecessary regulatory fees and this could lead to the loss of boutique asset managers who provide an alternative to using big businesses.

With regards to the recommendations, the report concludes:

“If the recommendations set out in this paper are implemented, EU rules are made more proportionate and hurdles at the national level are removed, then the benefits to asset managers and their investors, and to the European economy as a whole, could be significant.”