EU rules damaged liquidity in London’s main market
EU financial market reforms inadvertently affected liquidity and reduced research activity in London’s main stock market, according to new research from the University of Bath on Wednesday.
The EU’s markets in financial instruments directive II, known as Mifid II, aimed to improve transparency around research costs. The costs were previously parcelled into brokers’ overall fees to clients but the 2018 legislation unbundled them to make the costs more explicit to investors.
They also aimed at cutting down on the overproduction of the seemingly free research but many brokers, under fierce competition to attract clients, were forced to absorb these costs instead. This meant they reduced the amount of market research they provided to clients.
The UK Financial Conduct Authority estimated that research budgets were cut by 20 to 30 per cent since the introduction of Mifid II.
The University of Bath found the average number of analysts providing research coverage fell to 8.0 from 9.1 from 2015 to 2020, three years before and after Mifid II was introduced.
Dr Ru Xie at the University of Bath’s School of Management said this drop in analyst coverage led to a deterioration in market liquidity in the London Stock Exchange’s main market. In contrast, London’s alternative investment market (AIM) saw liquidity improve.
It also saw research coverage increase over the same five-year period, though naturally from a smaller base level.
“The reasons for this are twofold: as the demand for research for large companies fell, there was a flow of analysts to the less-populated market. However, the more significant factor may be a special feature of AIM, which requires companies to retain a ‘nominated adviser’,” Dr Xie said.
She explained that nominated advisers often had teams which produced research on their associated AIM company and that the quality of this research benefited from a close relationship with the firm.
“When this research is issued it improves the AIM company’s market liquidity. We therefore suggest that [nominated adviser] requirement may have mitigated the adverse effect of Mifid II that we identify in London’s main market, particularly for SMEs who are not required to have a nominated adviser if they are listed there,” Dr Xie said.
She added that the findings supported the ongoing debate about the merits of unbundling rules, as well as plans in the UK to ditch the rules.
UK Chancellor Jeremy Hunt outlined his commitment to remove the Mifid II requirements back in July in tandem with his ‘Mansion House reforms’ intended to advance the UK’s finance sector.
City PM contacted the Treasury for comment.