It has been no secret that, since its introduction in 2018, MiFID II has had a detrimental impact on small and mid-sized quoted companies. Amongst many factors, it has heightened the lack of research available on small and mid-caps - not only in terms of reducing quantity but quality too - limited visibility, inhibited price discovery and reduced share trading. Many believe that MiFID II is the reason that fewer brokers participated in the small and mid-cap market segment.
This view is evident in the Peel Hunt/QCA Mid and Small-Cap Survey in which 79% of investors in 2020 believed that MiFID II had a negative impact on liquidity for small and mid-cap stocks - this was up from 54% in 2018 and 63% in 2019. This survey also found that 82% of UK fund managers saw less research being produced on small and mid-caps whilst 99% of companies believed that MiFID II will have contributed towards a fall in the number of brokers.
The impact on research that MiFID II has had on our community has been significant; we therefore welcomed the FCA’s consultation in June 2021 looking at potential changes to UK MiFID’s conduct and organisational requirements.
We welcomed this proposal wholeheartedly. The recognition that there was a need to create an exemption for SME research was vital to ensure that the limitations of MiFID II were addressed and resolved. The ability for SMEs to access capital markets is predicated on investors being able to develop an understanding of the issuer’s business model. Independent research on small and mid-sized quoted companies is essential for increasing visibility and stimulating trading in their shares. Research eases price discovery and enhances liquidity, which in turn reduces the cost of capital for companies and encourages their growth. We therefore believed that there was a strong case for reforming the rules around investment research to lower the compliance burden and facilitate the wider distribution of investment research that smaller companies rely on.
Now that the FCA has released its Policy Statement following the conclusion of the aforementioned consultation, we are optimistic that small and mid-sized quoted companies will have more opportunity within UK public equity markets.
What are the key changes of the Policy Statement ?
· A research exemption for small and mid-caps – research on small and mid-cap listed or unlisted companies (SMEs) who have a market capitalisation below £200 million will be exempt from the inducement rules. This means that research on companies below this threshold can be provided by brokers to asset managers on a bundled basis (where asset managers make a single commission payment to brokers covering execution and research) or for free and will not constitute an inducement under the FCA’s rules. The exemption will come into effect on 1 March 2022.
o The calculation for assessing which companies are under the market capitalisation threshold will change – the calculation will be done once a year, averaging market capitalisation for the preceding 24 months to reduce churn on and off the list.
o The SME exemption will also be extended to cover SME “corporate access” – “corporate access” is the practice whereby a broker brings about contact between an asset manager and a company and the broker charges the asset manager for this introduction.
· An exemption for research providers – research providers will be exempt from the FCA’s inducement rules where they do not provide execution services and are not part of a group that includes a firm offering execution services.
· Clarification on openly available written research – the FCA has clarified that openly available written research will not fall within scope of the inducement rules.
The FCA will also remove certain reporting obligations from 1 December 2021, including:
· The obligation on execution venues to publish a report on a variety of execution quality metrics to enable market participants to compare execution quality at different venues.
· The obligation on investment firms who execute orders to produce an annual report setting out the top 5 venues used for executing client orders and a summary of the execution outcomes achieved.
To view the FCA’s Policy Statement, please click here.
One more step towards improving UK Public Equity Markets
This development is a good step in improving the UK’s public equity markets, allowing small and mid-sized quoted companies more visibility through an increased depth and breadth of research. The small and mid-cap community has vast potential. They represent over 90% of quoted companies. Often acknowledged as the engines of growth, our research has shown that they employ over 3 million people and contribute 5% of total UK tax intake. Whilst we continue to see the developments and impacts of both Brexit and Covid-19, it is important that this community has the opportunity to thrive within the UK, ultimately ensuring a healthy, diverse and prosperous UK economy.