MiFID II Rules Draining SMID-cap Stock Liquidity

Most UK fund managers, and those running their underlying companies, believe MiFID II has reduced liquidity and available research relating to small and mid-sized (SMID) firms since taking effect in January 2018.

The YouGov survey of 102 UK fund managers and 105 listed companies, commissioned by Peel Hunt and the Quoted Companies Alliance (QCA), found 62% of respondents believe the quality of research in the SMID space had diminished due to the directive.

'Recessions lie ahead': Global liquidity slowing at fastest rate since 2008

According to the survey, MiFID II: The Search For Research, just under two-thirds felt MiFID II has had a negative impact on the liquidity of UK mid and small-cap stocks, 20 percentage points higher than last year's number.

MiFID II, which came into force on 3 January 2018, requires buy-side firms to pay for research as an 'unbundled' product, separate from other broker services.

The new rules have already seen asset managers reduce the amount of research and number of brokers they are using, leading to widescale exits of analysts from their employers.

Liquidity concerns echoed those from similar research by Hardman & Co in November 2018, which revealed since MiFID II's introduction, liquidity across the market has declined, with average company levels on the main London Stock Exchange falling since July 2018.

In the Peel Hunt/QCA survey, 37% of asset managers said research standards had dropped since January 2018, with 35% expecting even lower standards in future.

As the unintended consequences of this regulation begin to show, 86% of investors expect there to be fewer broking houses in the next 12 months as a direct result of MiFID II.

Just 13% of asset managers polled said they had a positive perception of the directive, while 66% had either a "quite negative" or "very negative" view of the regulation.

Steven Fine, chief executive of Peel Hunt, said of the findings: "The role of sales is changing. Technology is usurping traditional methods, internal procurement teams are ensuring fund managers clearly define where they see value and are ruthlessly enforcing the price they will pay.

"All of this affects the sell-side. We see this as just the beginning. Specialists will become generalists, generalists will cover too many stocks and their product knowledge will dilute, quality will decline, gaps will appear in the market and many smaller companies will de-rate.

"Holding periods will get longer, liquidity will dry up and ‘take-privates' will increase."