On 2 September 2020, the European Securities Markets Authority (ESMA) published its second Trends, Risks and Vulnerabilities Report (Report) of 2020.
The Report analyses the impact of COVID-19 on financial markets during the first half of 2020 and highlights the risk of a potential decoupling of financial market performance and underlying economic activity, which raises the question of the sustainability of the current market rebound.
The Report also examines the impact on EU sell-side investment research of the rules unbundling research from execution services in the second Markets in Financial Instruments Directive 2014/65/EU (MiFID II).
Background
Introduced in 2018 under MiFID II, the unbundling regime required the separation of payments for research and execution services. Many market participants have criticised the rules and noted that they have a limited impact on transparency, reduced research coverage, quality, the number of analysts and dented liquidity in certain stocks.
In order to provide a detailed, data-based contribution to this discussion, ESMA examined 8,000 EU Listed companies between 2006 and 2019 to review the impact of these unbundling rules on EU sell-side research.
Overview of the findings in the Report
- The Report found that the introduction of MiFID II has not led to a significant change in the number of analysts producing Earnings per Share estimates;
- It noted that recent increases in the number of companies no longer being covered by research analysts appears to be a continuation of a long-term trend and do not coincide with the MiFID II regulation;
- In terms of the quality of the research, it found that this had been steadily improving; and
- Finally, in outlining the results of its study, ESMA made particular reference to small and medium enterprises stating that they did not appear to have been disproportionately affected in terms of research intensity and research coverage.
Commenting on the Report, ESMA stated that “The descriptive findings are consistent with the emerging data-based academic literature on the impact of the MiFID II research unbundling provisions and are complemented by a forthcoming ESMA econometric study.”
Future changes to research unbundling
In July 2020, the European Commission confirmed that it would be removing certain unbundling requirements under MiFID II as part of a package aimed at advancing Europe’s recovery from the COVID-19 pandemic.
The Commission proposed that asset managers be exempt from unbundling when paying for research on small and mid-cap companies and in fixed income, including rates, credit and loan research. The impact of this has yet to be seen.
This suggests that notwithstanding the ESMA findings the EU has recognised that the market criticism is warranted. In DLA Piper’s view there are two countervailing trends over the period that the study covers.
The first trend was that the MiFID II rules accentuated an existing trend on the sell-side to reduce coverage but that this has been partly offset with technological change making it cheaper to set up independent analysts operating under a different business model.
The second trend is that the increase in data about companies and big data analytical tools has meant that all analysts have more information about companies which has improved the quality of analysis over the period.
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