You may have heard of Mifid II by now. It’s been covered by the BBC, CNBC, and a slew of other mainstream publications. It’s been an obsession of Bloomberg News for months now, and for good reason; it impacts Bloomberg’s primary audience, that horde of analysts, traders, and portfolio managers whose Bloomberg Terminals cost $24,000 per year to lease.
So what is it?
Before we answer that, let’s talk a bit about how financial research works and how financial decisions are made.
In finance, you have a collection of funds (hedge funds, mutual funds, ETFs, etc.) that pool together cash and trade that cash for securities (bonds, stocks, etc.). The funds choose securities based on the fund’s mandate. However, in the case of active funds (which are still the majority of assets on Wall Street), the managers of those funds must choose which securities to buy based on a variety of quantitative and qualitative metrics. These metrics are designed to distinguish the good from the bad.
Those “metrics” aren’t simple. Most importantly, they require a lot of information to put into them. And that information comes from two sources.
One source is known as the “buy-side analysts”. These are the men and women that these funds hire to work exclusively for the fund to discover securities to buy and sell (and the prices to buy and sell them at). The other source is known as “sell-side analysts”. These are men and women who work for other companies, and the funds will pay for the research those sell-siders provide—in other words, the sell-side analysts sell research. No surprise there.
Most people don’t know how that research is bought. In a few cases, it’s bought in the same way that a retail investor pays for an annual newsletter or magazine—it’s a subscription that’s renewed on a regular basis. But that’s not how most research is bought. In most cases, the firm that sells that research also provides trading services; in other words, they’re brokers as well as research firms. And the funds pay for that research not by giving cash, but by using the firm’s brokerage for a certain amount of trades worth a certain dollar worth of trading commissions.
This is where things get fuzzy and complicated. Without going into the messy details that this monetization model entails, needless to say it looks sketchy from the outside (although most who have direct experience with it would argue that it’s very legitimate and quite efficient).
Here’s where Mifid II comes in. Named after a prior regulation known as the “markets in financial instruments directive” (MiFID), it is an update to existing financial regulation in the European Union. Its biggest change: that weird connection between trading commissions and research is now illegal.
According to Mifid (or MiFID) II, funds will now need to pay an actual dollar amount for research instead of the “in kind” trading agreements of the past.
The broad agreement on Wall Street is that this will be very bad for the sell side. Analysts who were coasting on trading commissions and not providing real value will suddenly lose their income stream—and their jobs. Firms that sell research will get lowball offers from funds who now need to pay commissions AND for research in actual cash.
Others disagree, pointing out that this transition from trading-for-research to cash-for-research has actually been happening for years in the United States before the regulation (which, at least in theory, won’t impact the U.S. financial industry). Nonetheless, it is an important change in the dynamic between analysts on Wall Street, and the people who will be directly affected no matter whether it’s good or bad for researchers is clear: the analysts who rely on research to make investments grow.