As day of the MiFID approaches, specialist brokers advance, not retreat

LONDON (Reuters) - Brokers specializing in researching mid-cap stocks are sharpening their focus and hiring rather than retreating ahead of sweeping regulatory changes that on the face of it could hurt their business.

FILE PHOTO: The trading floor is pictured at the stock exchange in Frankfurt, Germany, December 8, 2016. REUTERS/Ralph Orlowski/File Photo

The idea is that as big sell-side houses cut coverage of niche areas, smaller ones can hone in on them.

The Markets in Financial Instruments Directive, or MiFID-II, comes into force in Europe in less than six months and one of the main impacts will be putting an explicit price on research rather than bundling payments along with trading costs.

As a result, many brokers are jostling for position on buy-side clients’ research lists -- which are likely to shrink as asset managers adapt to paying directly for research.

“The equity research environment is bloated -- we are going to find out who the really good houses are,” said Michael Horan, head of trading services at agency broker Pershing Limited.

Although there is still significant uncertainty over the impact, most market participants believe there will be significant churn in research analyst staffing levels and a reduction in coverage of small and mid-cap companies in particular.

But several houses specializing in mid-caps are responding to this threat by drilling down into their specialty areas in the hope that large brokers retreat from the field, leaving a lucrative gap to fill.

For example, private bank Berenberg has added six new analysts to its UK mid-cap team and plan to increase that further by the end of the year.

Similarly, British mid-cap specialist house Numis has added two analysts to its team, and European peer Kepler Cheuvreux said it would hire more sector specialists in the coming months.

“So far as we are concerned, if small and mid cap coverage thins out a little bit in our core markets, that is just more of an opportunity for us,” said David Mortlock, head of Europe and head of investment banking at Berenberg.


MiFID research “unbundling” regulations aim to shift the model from “push” -- where brokers relentlessly bombard fund managers with research, hoping some of it sticks -- to “pull”. That’s when asset managers pick brokers to receive research from, and risk fines if any other analysis lands in their inbox.

Brokerages, as a result, are under pressure to stand out.

“There’s a tremendous contraction of research provider lists going on already,” said the head of account management at a European broker.

Many have predicted that MiFID will negatively impact coverage of the smaller end of the market, with brokers preferring to concentrate on large stocks which frequently change hands, generating more cash for them.

“In those niche areas, we believe that if you’re not in the top two or three (brokers) then you may no longer get onto broker lists,” said Hester White, MiFID II spokesperson at Peel Hunt, a UK-focused broker.

Brokers’ decisions to increase their focus on small and mid-cap companies could therefore seem counter-intuitive.

But a deeper focus on small- and medium-sized companies is also a response to demand from active asset managers looking to cement their performance so far this year by digging deeper into lesser-known companies and sectors, where bargains are more likely than among extensively covered large cap stocks.

Active asset managers are being squeezed by a rapid surge in the popularity of passive index-tracking funds and ETFs, and many say the mid- and small-cap area offers the greatest opportunities to find value as they seek to justify higher fees.

“I think managers are going to focus their research dollars where they can make more than they have previously,” said Berenberg’s Mortlock.

Furthermore, unbundling will enable investors to reward brokers specifically for high-quality research, for the first time.

Gemma Hurtado de San Leandro, head of Spanish equities at Mirabaud Asset Management, said the regulation would enable her to use large brokers to execute trades fast and efficiently, while rewarding specialized brokers for their research.

“There are brokers that have a lot of volume in the market and help me with the execution of trades, but their research doesn’t add value for me at all,” she said.

Asset managers see research on these areas as crucial to their ability to bounce ideas off analysts in the know, and be introduced to new companies and investment propositions.

Some also set such research apart from global investment bank analyses which they see as too consensual.

For small, regional brokers long battling against larger rivals which have enjoyed economies of scale thanks to “bundled” payments, the new rules are a chance to claw back market share.

“What we really like are local brokers,” said Thomas Brown, head of the European opportunities fund at Miton. “It’s very hard to get a differential view on a stock where there’s already 36 analysts covering it.”

Reporting by Helen Reid Editing by Jeremy Gaunt