The highly anticipated Markets in Financial Instruments Directive II (MiFID II) regulations officially went into effect today in Europe and has precipitated a collapse in sovereign and corporate bond volumes as traders try to figure out how to comply with new reporting requirements.
As the Wall Street Journal notes, some of the most stringent new rules for traders come from efforts to introduce greater transparency around bond trading, forcing brokers to publish prices for the most actively-traded securities before trades are completed. Not surprisingly, the rules have impaired the speed of trade settlements resulting in trading volumes of euro-denominated government bonds to fall 25% compared with their 30-day average and U.K. government bond volumes to fall around 11%.
Volumes in the corporate bond market—most of which was spared from the MiFID II pre-trade transparency rules—is more mixed with euro-denominated bonds actually slightly above their 30-day average while sterling-denominated bond volumes have crashed nearly 50%.
Neil McLean, head of execution trading for Asia ex-Japan at Nomura, expects the trend to continue in the near term with less business from Europe as clients get used to the rules. That said, McLean admits the true winners and losers from the regulations will only be revealed over the “longer term”…with “more losers than winners”. Per Bloomberg:
“Reality is, it’s going to need a lot of refining as we see the market and clients take on the rules. We have some challenges with categorizing clients and making sure they receive only what the rules allow.”
“Over the longer term, the disruptive nature of this major regulatory change will become more apparent, and the winners and losers will likely emerge more clearly. There will likely be more losers than winners.”
As we’ve pointed out numerous times over the past year, equity research groups are expected to be among the “biggest losers” from the new regulations as investment banks will be forced to charge separately for research and trading activities. Not surprisingly, a study from Frost Consulting recently found that major global investment banks have slashed their equity research budgets by more than half, from a peak of $8.2 billion in 2008 to $3.4 billion in 2017. And, as we noted back in the summer, McKinsey & Co. thinks the pain is just getting started and that banks will have no choice but to fire a ton of equity research analysts who write a bunch of stuff that no one ever reads…which seems like a reasonable guess.
Europe’s impending ban on free research will cost hundreds of analysts their jobs with banks set to cut about $1.2 billion of investment on the area, according to a report by McKinsey & Co.
The consultancy estimates the $4 billion that the top-10 sell-side banks currently spend on research annually is likely to fall by 30 percent as clients become pickier about what they pay for, McKinsey Partner Roger Rudisuli said in an interview. Investment banks’ cash equity research headcount has fallen 12 percent to 3,900 since 2011 compared with as much as 40 percent in sales and trading, leaving the area facing “big cuts” to catch up, he said.
“Two to three global banking players will preserve their status in the new era, winning the execution arms race and dominating trading in equities around the globe,” McKinsey said in a report Wednesday, which Rudisuli helped write. “Over the coming five years, banks will need to make hard choices and play to their strengths. Not only will the top ranks be thinned out, there will be shakeouts in regional markets.”
Meanwhile, many bankers suspect that the declining equity coverage will negatively impact capital access as IPOs and bond deals will be more difficult to market…
“If a corporate broker would only market a firm to investors who pay for research, getting new money in the door will be far more challenging,” said Nick Burchett, U.K. equities manager at Cavendish Asset Management. “Limited access to capital is going to be a huge hurdle for companies coming to market if they now find they have only a very concentrated shareholder base. It may also be tougher to secure those cornerstone investors who are prepared to support a company for the long-term.”
The regulator is unbundling research in an attempt to get a better deal for asset owners. That means asset managers must stop receiving analysis they haven’t purchased. One investment bank, in an attempt to stem the hundreds of research emails that have traditionally been received, is sending automated emails asking not to be sent analysis and seeking written confirmation that the sender will comply.
“There’s going to be a lot of fund managers who have to walk over to the compliance person and say, ‘look I’ve been sent this, or opened this envelope, what do I do?’” said Alistair Haig, who teaches financial markets at the University of Edinburgh Business School.
…which makes perfect sense because it’s nearly impossible to execute a “buy the fucking dip” strategy without an army of 20-something year old equity research analysts telling you to do so.